Financial Management · The economic environment for business

Exchange Rates and International Trade for ACCA FM

Updated 11 October 2026 · Fact-checked

An exchange rate is the price of one currency in terms of another. Under floating systems, supply and demand set it, driven by inflation, interest rates, trade balances and expectations. To answer FM questions, identify which currency strengthens or weakens, then trace the effect on exports, imports, costs and profit.

Understand Exchange Rates and International Trade

An exchange rate is the price of one currency in terms of another. If $1 = €0.90, one dollar buys 90 euro cents. A currency appreciates when it buys more foreign currency. It depreciates when it buys less.

In a floating system, the market sets the rate through supply and demand for currencies. In a fixed system, the government or central bank pegs the rate and must buy or sell currency, or change interest rates, to defend it. Between these sit managed floats, where the central bank intervenes only to smooth sharp moves. A devaluation is a deliberate cut in a fixed rate. A revaluation is a deliberate rise.

Main factors that move a floating rate:

Inflation: higher inflation than trading partners makes exports dearer, cuts demand for the currency and weakens it over time.
Interest rates: higher rates attract foreign capital and tend to strengthen the currency.
Balance of payments: a current account deficit means more currency is sold to pay for imports, which tends to weaken it.
Expectations and speculation: if traders expect a currency to fall, they sell it now, which can cause the fall.
Government policy and intervention: central bank buying or selling, and confidence in the economy.

For businesses, currency movements matter in three ways. Transaction effects hit receipts and payments in foreign currency. Translation effects change the home-currency value of foreign assets and profits when consolidated. Economic effects change long-run competitiveness. A stronger home currency makes exports dearer abroad and imports cheaper. A weaker home currency does the opposite.

Trade is also shaped by tariffs, quotas and trading blocs. These change prices and market access, so they affect where firms sell, source and invest.

Key rules to remember

Direct quote meaning: Home currency per 1 unit of foreign currency; If a rate rises, the foreign currency has strengthened and the home currency has weakened. Always check which currency is the base.
Converting currency: Foreign amount × rate = home amount (when rate is home per foreign); divide when the quote is foreign per home; Multiply or divide depends on the quote. Check that the answer is sensible.
Percentage change in a currency: (New rate − Old rate) ÷ Old rate × 100; Apply it to the currency that is the base of the quote, otherwise the sign and size will be wrong.
Effect of home currency strength: Home currency stronger → exports dearer abroad, imports cheaper; weaker → the reverse; This is the rule most OT questions test.

How to solve Exchange Rates and International Trade questions

Use this method for scenario questions on exchange rates, trade and business impact.

1Write down the quote and identify the base currency, for example '1 £ = $1.25' means £ is the base.
2Decide whether the base currency has strengthened or weakened by comparing old and new rates.
3Identify the business position: is it an exporter, importer, or does it hold foreign assets or debt?
4Work out the direction of the effect: more or fewer home currency units received or paid.
5Calculate the amount if numbers are given, converting carefully (multiply or divide as the quote requires).
6Classify the risk as transaction, translation or economic, and name the cause if asked (inflation, interest rates, deficit, expectations).
7State the conclusion in one clear sentence and, for written parts, add one sensible response such as hedging or pricing in the home currency.

Quickest way: Strong/weak check for objective questions

When to use it: Section A and OT case questions asking who gains or loses from a currency move.

Mark the home currency as strong or weak after the move.
Strong home currency: exporters lose, importers gain. Weak: exporters gain, importers lose.
For cause questions, match the keyword: high inflation → weaker; higher interest rates → stronger; deficit → weaker.
Eliminate options that contradict the direction, then check any numbers by sense: foreign receipts convert to fewer home units if home is stronger.

Common mistakes in Exchange Rates and International Trade

Multiplying when you should divide in a conversion.
Students ignore which currency is the base of the quote.
Fix: Write the quote as '1 base = X other'. To get the other currency, multiply by X. To get the base, divide by X.
Saying a higher exchange rate always means the home currency has strengthened.
A bigger number feels like 'stronger'.
Fix: Check the base. If the quote is home per foreign, a higher number means the home currency has weakened.
Claiming a weaker currency is always good for a country's businesses.
Students focus only on exports.
Fix: Also consider imported inputs and foreign-currency debt, which cost more. The net effect depends on the business.
Confusing fixed and floating systems.
Both involve central banks, so the roles blur.
Fix: Floating: market sets the rate, intervention is occasional. Fixed: authorities commit to a rate and must defend it using reserves or interest rates.
Mixing up transaction, translation and economic risk.
All three arise from the same rate changes.
Fix: Transaction: specific future foreign payments or receipts. Translation: consolidation of foreign accounts. Economic: long-term loss of competitiveness.

Worked examples

Example 1

A UK company exports goods and will receive $500,000 in three months. The current rate is £1 = $1.25. At the time of payment the rate is £1 = $1.40. Calculate the sterling received at each rate and state the effect.

Show the solution

Quote: £1 = $X, so £ is the base. Convert dollars to pounds by dividing by the rate.
At $1.25: 500,000 ÷ 1.25 = £400,000.
At $1.40: 500,000 ÷ 1.40 = £357,143 (rounded).
Difference: 400,000 − 357,143 = £42,857 less.
The pound has strengthened (it buys more dollars), so the dollar receipt is worth fewer pounds.

Answer: The company receives about £357,143 instead of £400,000, a loss of about £42,857. A stronger home currency hurts the exporter.

Example 2

Country A has a persistent current account deficit and inflation well above its trading partners. Its currency floats. State the likely direction of its exchange rate and the effect on an importer in Country A.

Show the solution

Higher inflation makes Country A's goods less competitive, reducing export demand and so demand for its currency.
A deficit means more of its currency is sold to buy foreign currency for imports.
Both factors point to depreciation of Country A's currency.
With a weaker currency, each unit of foreign currency costs more in home currency.
An importer therefore pays more in home currency for the same foreign-priced goods, so costs rise.

Answer: Country A's currency is likely to depreciate, making imports dearer and squeezing importers' margins unless they can raise prices or hedge.

Exam tips

Always write the quote and the base currency before calculating. Most lost marks come from converting the wrong way.
In OT questions, decide strong or weak first, then pick the answer. It avoids being tricked by wording.
In Section C, name the type of risk (transaction, translation or economic) and tie your point to the scenario, not generic theory.
Give both sides in policy questions: fixed rates give certainty but need reserves, floating rates adjust automatically but are volatile.
Sense-check results: if a stronger home currency gives you more home currency from an export, you probably used the wrong operation.

Practice questions from The economic environment for business

Exchange Rates and International Trade in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Exchange Rates and International Trade: frequently asked questions

What is the difference between fixed and floating exchange rates?

In a floating system, supply and demand in the market set the rate and it changes continuously. In a fixed system, the authorities set a rate and defend it by buying or selling currency or changing interest rates. Fixed rates give certainty but need reserves; floating rates adjust automatically but can be volatile.

What factors affect exchange rates in ACCA FM?

The main ones are relative inflation, interest rate differences, the balance of payments, market expectations and speculation, and government or central bank intervention. Higher inflation tends to weaken a currency, and higher interest rates tend to strengthen it.

How do exchange rate changes affect a business?

They change the home-currency value of foreign receipts and payments (transaction risk), of foreign assets and profits in consolidation (translation risk), and long-run competitiveness (economic risk). The effect depends on whether the business exports, imports or holds foreign assets or debt.

Is a weaker currency good for exporters?

Usually yes, because their goods become cheaper abroad or earn more in home currency. But if they rely on imported materials or have foreign-currency debt, their costs rise, so the net effect can be mixed.