exchange rate determination (1)
TRANSCRIPT
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Exchange Rate Determination
International Finance (MB 74)
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Outline
Defining Exchange Rate
Measuring Exchange Rate Movements Appreciation/Depreciation of a currency
Exchange Rate Equilibrium
Factors that influence Exchange Rate
Movements
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Meaning of Exchange Rate and
Measu
ring Changes in Exchange Rates
Value of one currency in units of anothercurrency
A decline in a currencys value is referred to asdepreciation and an increase in currencys valueis called appreciation.
If currency A can buy you more units of foreign
currency, currency A has appreciated and foreigncurrency depreciated
If currency A can buy you less units of foreigncurrency, currency A has depreciated and foreign
currency appreciated
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Appreciation/Depreciation
Percentage change in value US $NewValue of Foreign Currency
per unit of $ - Old value of foreign currency per $
-------------------------------------------------- X 100Old value of Foreign Currency per $
Percentage change in value of Foreign
CurrencyNewValue of $ per units ofForeign Currency - Old value of $ per unit of foreign currency
-------------------------------------------------- X 100Old value of $ per unit of Foreign Currency
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Exchange Rate Equilibrium
Forces ofDemand and Supply
Demand for foreign currency negatively
related to the price of foreign currency
Supply of foreign currency positively
related to the price of foreign currency
Forces of demand and supply together
determine the exchange rate
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Demand for Foreign Currency
Price for Foreign Currency
Units of Foreign Currency ()
$1.50
$2.00
D
D
50m 75 m
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Supply of Foreign Currency
Supply for Foreign Currency
Units of Foreign Currency ()
$1.50
$2.00
50 m 75 m
S
S
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Equilibrium Exchange Rate
Exchange Rate
Units of Foreign
Currency()
S
SD
D
$1.6775
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Factors that influence the
Exchange Rate Expectations of the Market
Political Events
Relative Inflation Rates
Relative Interest Rates
Relative Income Levels
Exchange rate is the results of an interaction
of these factors
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Market Expectations
Expectations about future exchange rate changeson the basis of current and future political and
economic conditions 1960s Strong $
Between 1960s and 1970s: weak $
Strong $ in 1999 2001
WeakDollar today 2005 1995 European Exchange Rate Mechanism
Devaluation of Asian Currencies
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Political Events
Fall of Berlin Wall and unification of East
and West Germany
Rumors about resignation of Mikhail
Gorbachov
Tiannanmon Square
Persian Gulf War
September 11, 2001
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Relative Inflation
High inflation relative to a foreign country,
decline in value of currencyWhy?
Low inflation relative to a foreign country,
increase in value of currencyWhy?
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Relative Interest Rates
High interest rates in home country relative
to a foreign country may cause domestic
currency to appreciateWhy?
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Relative Income Levels
Increase in domestic income relative to
foreign income may lead to a decline in the
value of domestic currency Why?
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Exchange Rate Determination
An interaction of factors
Is it possible for a country with high real
returns to have a low currency value?
Is it possible for a country with low real
returns to have a high currency value?