Introduction to Finance

currency exchange rate
refl ects the value 
of one currency relative to another. The relationship between currencies depends on both the 
supply and demand for each currency relative to the other. The supply of a currency in interna-
tional markets depends largely on the imports of the issuing country; that is, how much of its 
currency the country spends in world markets. Demand for a currency depends on the amount 
of exports that currency will buy from the issuing country. Demand also depends on the confi -
dence of market participants in the restraint and stability of the monetary authority issuing the 
currency. If demand for a particular currency falls relative to its supply, then the exchange rate 
falls and the international purchasing power of that nation’s money supply drops. Domestic 
infl ation, political instability, or an excess of imports over exports can cause one currency to 
decline relative to another currency. If a currency is widely accepted, the demand for it may be 
increased by the desire of people worldwide to hold it as an international medium of exchange. 
Such is the case of the U.S. dollar, which is widely held internationally because of its general 
acceptance and ability to hold its value. International fi nance is discussed in detail in Chapter 6.
A major international development occurred when 11 countries of the 15-member 
European Union, which met necessary economic and fi nancial qualifi cations, agreed to give 
up their individual currencies and adopt a unifi ed currency called the 
euro
beginning on 
January 1, 1999. For example, the French gave up the franc, the Germans the mark, and the 
Italians the lira. Greece qualifi ed in 2000 and was admitted as the twelfth euro-member coun-
try in 2001. Offi
cial implementation of the euro began on January 1, 2002. It is interesting 
to note that all members of the European Union do not currently use the euro, either because 
they have chosen to keep their own national currencies or because they do not qualify for 
adoption due to fi scal defi cit and other constraints. The creation of the euro was accompanied 
by the formation of the European Central Bank, which replaces the central banks of each of 
the participating countries.
Although our focus is on the U.S. monetary system, we operate in a global economy. Thus, 
we must interact with other monetary systems, and a change in either the European Union or 
Japanese monetary systems will directly aff ect the U.S. monetary system. For example, when 
the European Central Bank increases interest rates in the European Union, the value of the 
U.S. dollar weakens relative to the euro. This increases the cost of products imported into the 
United States unless the Federal Reserve takes countering actions.
A growing interest in the use of digital currencies is worth watching.