give the meaning of foreign exchange and foreign exchange rate
giving reasons, explain the relation between foreign exchange rate and demand for foreign exchange.
Foreign exchange refers to the stock of foreign currency held by a country at a particular point of time.
Foreign exchange rate is the rate at which the currency of one country is traded for currency of another country. In other words, it refers to the cost of one currency in terms of another currency.
Demand for foreign currencies is inversely related with the exchange rate. In other words, higher the exchange rate, lower will be the demand for foreign currencies and vice-versa. A rise in the exchange rate (from say, $1= Rs 40 to $1= Rs 50) implies that the goods from abroad become more expensive (that is, it now cost Rs 50 to purchase a commodity worth $1 instead of Rs 40 earlier). This would result in a reduction in the demand for the foreign commodities. This fall in the demand for foreign goods reduces the demand for dollars and vice-versa.
Graphically, the demand curve for foreign currency is represented as follows.
The demand curve for exchange rate is the negatively sloped DD curve.