2. Foreign Exchange Rates and
Markets
Foreign
Exchange
• Is foreign money needed to
carry out international
transactions.
Exchange
Rate
• Is the price measured in one
country’s currency of buying one
unit of another country’s currency.
4. • Any change in consumer tastes or
preferences for the products of foreign
country may alter the demand for that
nation’s currency and change its exchange
rate.
Determinants of Foreign Exchange
5. • A nation’s currency is likely to depreciate if
its growth of national income is more rapid
than that of other countries.
Determinants of Foreign Exchange
6. • Changes in relative price levels of two
nations may change the demand and
supply of currencies and alter the
exchange rate between the two nation’s
currencies.
Determinants of Foreign Exchange
7. • Changes in relative interest rates between
two countries may alter their exchange
rate.
Determinants of Foreign Exchange
8. • It can cause changes in exchange rates.
Determinants of Foreign Exchange
9.
10. 10
The Foreign Exchange Market
Foreign exchange (dollars)
Exchange rate
Peso/$
SD
Supply of Dollars by
people who want pesos
Demand for Dollars by
people who have pesos
11. Currency Appreciation and
Depreciation
Currency
Depreciation
• It is an increase in the number of
units of a particular currency needed
to purchase one unit of foreign
exchange.
Currency
Appreciation
• It is an decrease in the number of
units of a particular currency
needed to purchase one unit of
foreign exchange.
12. 12
Changes in the Equilibrium
Exchange Rate
Foreign exchange (dollars)
Exchange rate
Peso/$ SD Supply of Dollars
by people who
want pesos
Demand for Dollars by
people who have pesos
S’
$ -depreciation
Peso- appreciation
13. Arbitrageurs and Speculators
Arbitrageur
• Someone who takes advantage of
temporary geographic differences in the
exchange rate by simultaneously
purchasing a currency in one market and
selling it in another market.
Speculator
• Someone who buys or sells foreign
exchange in hopes of profiting from
fluctuations in the exchange rate
over time.
15. Exchange Rates Regimes
1)Flexible Exchange Rate
• Rate determined in foreign
exchange markets by the
markets by the forces of
demand and supply without the
government intervention.
16. Exchange Rates Regimes
2)Fixed Exchange Rate
• Rate of exchange between
currencies pegged within a narrow
range and maintained by the
central banks’ ongoing purchases
and sales of currencies .
17. Exchange Rates Regimes
• Is an increase in the official pegged price
of foreign exchange in terms of domestic
currency.
a) Currency Devaluation
• Is a reduction in the official pegged price of
foreign exchange in terms of domestic
currency.
b) Currency Revaluation
18. Exchange Rates Regimes
3) Manage Float
Exchange Rate
•Attempt to influence
exchange rates by buying
and selling currencies.
19. is a theory, which establishes the
fact that the exchange rates between
currencies are in equilibrium in the
event of equality in the purchasing
power of each of the countries.
Purchasing Power Parity Theory(PPP)
It is more of a long run predictor
than a day to day indicator of the
relationship between changes in the
price level and the exchange rate.
20. the “law of one price”
applies to individual
commodities whereas
PPP applies to the
general price level
“Law of one price”
• price of similar
products to two
countries should be
equal when
measured in a
common currency.
Purchasing Power Parity Theory(PPP)
21. Example: American steel $100 per ton, Japanese steel 10,000 yen per ton
If E = 50 yen/$ then prices are:
American Steel Japanese Steel
In U.S. $100 $200
In Japan 5000 yen 10,000 yen
If E = 100 yen/$ then prices are:
American Steel Japanese Steel
In U.S. $100 $100
In Japan 10,000 yen 10,000 yen
Law of one price E = 100 yen/$
22. An example of one measure of the law of
one price, which underlies purchase power
parity, is the Big Mac Index
23. Range and quality of goods
Trade barriers and nontradables
Differences in price level measurement
24. Interest Rate Parity
It assumes that a country's currency
exchange rate and risk-free interest rate
are correlated, and that an arbitrage
investor cannot profit through the
relationship.
• Interest rate parity is a financial theory
that connects forward exchange rates,
spot exchange rates, and nations'
individual interest .
25. Difference between Forward Exchange Rate and Spot
Exchange Rate = Difference between the interest
rates of two countries
The Forward exchange rates are when an investor
agrees to exchange a currency at a specified rate at a
specified future date.
A spot exchange rate is what the trader can get for his
currency right now.
Interest Rate Parity
26. 26
The Dollar and Interest Rates
While there is a strong
correspondence between
real interest rates and the
exchange rate, the
relationship between
nominal interest rates and
exchange rate movements
is not nearly as pronounced
27. Past Exchange Rate Regimes
1. 2.
•Fixed exchange rates
•No control over
monetary policy
•Influenced heavily by
production of gold and
gold discoveries
Gold standard Bretton Woods
System
Fixed exchange rates
using U.S. dollar as
reserve currency
International Monetary
Fund (IMF)
28. 3. 4.
•World Bank
•General Agreement on
Tariffs and Trade (GATT)
•World Trade
Organization
Bretton Woods
System (cont’d)
European Monetary
System
•Exchange rate
mechanism
Past Exchange Rate Regimes
(cont’d)
29. Managed float regime is the current international
financial environment in which exchange rates fluctuate from
day to day, but central banks attempt to influence
their countries' exchange rates
by buying and selling currencies. It is also known as a dirty
float.
In an increasingly integrated world economy, the currency
rates impact any given country's economy through the trade
balance. In this aspect, almost all currencies
are managed since central banks or governments intervene
to influence the value of their currencies.
The Current System : Managed
Float
30. The International Monetary Fund
The IMF's stated
goal was to stabilize
exchange rates and
assist the
reconstruction of the
world’s international
payment
system post-World
War II.
Countries contribute
money to a pool
through a quota
system from which
countries with payment
imbalances can
borrow funds
temporarily.
The organization's
stated objectives are to
promote international
economic cooperation,
international trade,
employment, and
exchange rate stability,
including by making
financial resources
available to member
countries to
meet balance of
payments needs
