ch04 exchange rate determination

Download Ch04 Exchange rate determination

Post on 29-Nov-2014

864 views

Category:

Business

3 download

Embed Size (px)

DESCRIPTION

International financial management

TRANSCRIPT

  • 1. Chapter 4 Exchange Rate Determination Cost and Management Accounting: An Introduction,nd edition International Financial Management, 2 7th edition Jeff Madura and Roland Fox Colin Drury ISBN 978-1-40803-213-9 2011 Cengage Learning EMEAEMEA ISBN 978-1-4080-3229-9 2011 Cengage Learning
  • 2. Chapter Objectives To explain how exchange rate movements are measured. To explain how the equilibrium exchange rate is determined. To examine the factors that affect the equilibrium exchange rate. Cost and Management Accounting: An Introduction,nd edition International Financial Management, 2 7th edition Jeff Madura and Roland Fox Colin Drury ISBN 978-1-40803-213-9 2011 Cengage Learning EMEAEMEA ISBN 978-1-4080-3229-9 2011 Cengage Learning
  • 3. Measuring Exchange Rate Movements (1) An exchange rate measures the value of one currency in units of another currency. When a currency declines in value, it is said to depreciate. When it increases in value, it is said to appreciate. On the days when some currencies appreciate while others depreciate against a particular currency, that currency is said to be mixed in trading. Cost and Management Accounting: An Introduction,nd edition International Financial Management, 2 7th edition Jeff Madura and Roland Fox Colin Drury ISBN 978-1-40803-213-9 2011 Cengage Learning EMEAEMEA ISBN 978-1-4080-3229-9 2011 Cengage Learning
  • 4. Measuring Exchange Rate Movements (2) The percentage change (% ) in the value of a foreign currency is computed as St St 1 St 1 where St denotes the spot rate at time t. A positive % represents appreciation of the foreign currency, while a negative % represents depreciation. Cost and Management Accounting: An Introduction,nd edition International Financial Management, 2 7th edition Jeff Madura and Roland Fox Colin Drury ISBN 978-1-40803-213-9 2011 Cengage Learning EMEAEMEA ISBN 978-1-4080-3229-9 2011 Cengage Learning
  • 5. Annual Changes in the Value of the Euro Date Exchange Rate 1/1/2000 1/1/2001 1/1/2002 1/1/2003 1/1/2004 $1.001/ $.94/ $.89/ $1.05/ $1.26/ Annual % 6.1% 5.3% +18.0% +20.0% Cost and Management Accounting: An Introduction,nd edition International Financial Management, 2 7th edition Jeff Madura and Roland Fox Colin Drury ISBN 978-1-40803-213-9 2011 Cengage Learning EMEAEMEA ISBN 978-1-4080-3229-9 2011 Cengage Learning
  • 6. Exchange Rate Equilibrium (1) An exchange rate represents the price of a currency, which is determined by the demand for that currency relative to the supply for that currency. Cost and Management Accounting: An Introduction,nd edition International Financial Management, 2 7th edition Jeff Madura and Roland Fox Colin Drury ISBN 978-1-40803-213-9 2011 Cengage Learning EMEAEMEA ISBN 978-1-4080-3229-9 2011 Cengage Learning
  • 7. Exchange Rate Equilibrium (2) Value of $1.60 $1.55 $1.50 S: Supply of Equilibrium exchange rate D: Demand for Quantity of Cost and Management Accounting: An Introduction,nd edition International Financial Management, 2 7th edition Jeff Madura and Roland Fox Colin Drury ISBN 978-1-40803-213-9 2011 Cengage Learning EMEAEMEA ISBN 978-1-4080-3229-9 2011 Cengage Learning
  • 8. Exchange Rate Equilibrium (3) The liquidity of a currency affects the sensitivity of the exchange rate to specific transactions. With many willing buyers and sellers, even large transactions can be easily accommodated. Conversely, illiquid currencies tend to exhibit more volatile exchange rate movements. Cost and Management Accounting: An Introduction,nd edition International Financial Management, 2 7th edition Jeff Madura and Roland Fox Colin Drury ISBN 978-1-40803-213-9 2011 Cengage Learning EMEAEMEA ISBN 978-1-4080-3229-9 2011 Cengage Learning
  • 9. Factors that Influence Exchange Rates (1) e = f ( INF , INT , INC , GC , EXP ) e INF INT INC GC EXP = percentage change in the spot rate = change in the relative inflation rate = change in the relative interest rate = change in the relative income level = change in government controls = change in expectations of future exchange rates Cost and Management Accounting: An Introduction,nd edition International Financial Management, 2 7th edition Jeff Madura and Roland Fox Colin Drury ISBN 978-1-40803-213-9 2011 Cengage Learning EMEAEMEA ISBN 978-1-4080-3229-9 2011 Cengage Learning
  • 10. Factors that Influence Exchange Rates (2) Relative Inflation Rates $/ r1 r0 S1 S0 D1 D0 Quantity of U.S. inflation U.S. demand for British goods, and hence . British desire for U.S. goods, and hence the supply of . Cost and Management Accounting: An Introduction,nd edition International Financial Management, 2 7th edition Jeff Madura and Roland Fox Colin Drury ISBN 978-1-40803-213-9 2011 Cengage Learning EMEAEMEA ISBN 978-1-4080-3229-9 2011 Cengage Learning
  • 11. Factors that Influence Exchange Rates (3) Relative Interest Rates $/ r0 r1 S0 S1 D0 D1 Quantity of U.S. interest rates U.S. demand for British bank deposits, and hence . British desire for U.S. bank deposits, and hence the supply of . Cost and Management Accounting: An Introduction,nd edition International Financial Management, 2 7th edition Jeff Madura and Roland Fox Colin Drury ISBN 978-1-40803-213-9 2011 Cengage Learning EMEAEMEA ISBN 978-1-4080-3229-9 2011 Cengage Learning
  • 12. Factors that Influence Exchange Rates (4) Relative Interest Rates A relatively high interest rate may actually reflect expectations of relatively high inflation, which may discourage foreign investment. It is thus useful to consider the real interest rate, which adjusts the nominal interest rate for inflation. Cost and Management Accounting: An Introduction,nd edition International Financial Management, 2 7th edition Jeff Madura and Roland Fox Colin Drury ISBN 978-1-40803-213-9 2011 Cengage Learning EMEAEMEA ISBN 978-1-4080-3229-9 2011 Cengage Learning
  • 13. Factors that Influence Exchange Rates (5) Relative Interest Rates real nominal interest rate interest inflation rate rate This relationship is sometimes called the Fisher effect. Cost and Management Accounting: An Introduction,nd edition International Financial Management, 2 7th edition Jeff Madura and Roland Fox Colin Drury ISBN 978-1-40803-213-9 2011 Cengage Learning EMEAEMEA ISBN 978-1-4080-3229-9 2011 Cengage Learning
  • 14. Factors that Influence Exchange Rates (6) Relative Income Levels $/ r1 r0 S0 ,S1 D1 D0 U.S. income level U.S. demand for British goods, and hence . No expected change for the supply of . Quantity of Cost and Management Accounting: An Introduction,nd edition International Financial Management, 2 7th edition Jeff Madura and Roland Fox Colin Drury ISBN 978-1-40803-213-9 2011 Cengage Learning EMEAEMEA ISBN 978-1-4080-3229-9 2011 Cengage Learning
  • 15. Factors that Influence Exchange Rates (7) Government Controls Governments may influence the equilibrium exchange rate by: imposing foreign exchange barriers, imposing foreign trade barriers, intervening in the foreign exchange market, and affecting macro variables such as inflation, interest rates, and income levels. Cost and Management Accounting: An Introduction,nd edition International Financial Management, 2 7th edition Jeff Madura and Roland Fox Colin Drury ISBN 978-1-40803-213-9 2011 Cengage Learning EMEAEMEA ISBN 978-1-4080-3229-9 2011 Cengage Learning
  • 16. Factors that Influence Exchange Rates (8) Expectations Foreign exchange markets react to any news that may have a future effect. News of a potential surge in U.S. inflation may cause currency traders to sell dollars. Many institutional investors take currency positions based on anticipated interest rate movements in various coun