foreign exchange rates domestic currency units direct rate = foreign currency unit for example, usd...

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FOREIGN EXCHANGE RATES Domestic Currency Units Direct Rate = Foreign Currency Unit for example, USD 0.7948/C$

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FOREIGN EXCHANGE RATES

Domestic Currency UnitsDirect Rate =

Foreign Currency Unit

for example, USD 0.7948/C$

FOREIGN EXCHANGE RATES

Foreign Currency UnitsIndirect Rate =

Domestic Currency Unit

for example, Mex$ 10.966/USD

FOREIGN EXCHANGE RATESCross (Inferred) Rate

If we know the rate of exchange between U.S. dollars and Canadian dollars, as well as the exchange rate between US dollars and Mexican pesos, we can infer the exchange rate between Canadian dollars and Mexican pesos:

USD 0.7948/C$ * Mex$10.966/USD

= Mex$8.7158/C$

LATERAL ARBITRAGE

Canada

Mexico

United StatesMex$8.869/C$

Mex$10.966/USD

USD 0.7948/C$

LATERAL ARBITRAGE

Since the quoted rate between the Mexican peso and the Canadian dollar is higher than it should be, we want to sell at that quoted rate.

USD 0.7948/C$*Mex$10.966/USD<Mex$8.869/C$

LATERAL ARBITRAGE

USD 1,000,000

divided by USD 0.7948/C$

C$ 1,258,178

times Mex$ 8.869/C$

Mex$11,158,782

divided by Mex$10.966/USD

USD 1,017,580

LATERAL ARBITRAGE

The market forces created by arbitrage activities exert pressures on the exchange rates that drive them to equilibrium (within transactions costs):

USD 0.7948/C$ * Mex$10.966 < Mex$8.869/C$

LAW OF ONE PRICE

With free trade, identical goods will tend toward a single, worldwide price (adjusted for transportation costs, duties, etc.)

t t tP = P * X d f

PURCHASING POWER PARITY

If the Law of One Price Holds in all periods

t+1 t+1 t+1P = P * X d f

t t tP = P * X d f

PURCHASING POWER PARITY

t+1 X

1+infl = (1+infl ) d f t X

or

t+1 t (1+infl ) X = X * d (1+infl ) f

CANADIAN/US DOLLAR EXCHANGE RATE (C$/USD)

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

Jan-

76Ja

n-77

Jan-

78Ja

n-79

Jan-

80Ja

n-81

Jan-

82Ja

n-83

Jan-

84Ja

n-85

Jan-

86Ja

n-87

Jan-

88Ja

n-89

Jan-

90Ja

n-91

Jan-

92Ja

n-93

Jan-

94Ja

n-95

Jan-

96Ja

n-97

Jan-

98Ja

n-99

Jan-

00Ja

n-01

Jan-

02Ja

n-03

Jan-

04Ja

n-05

Nominal Exchange Rate Real Exchange Rate

PERCENTAGE DEVIATION FROM PURCHASING POWER PARITY OF CANADIAN

DOLLAR

-40%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

Jan-

76Ja

n-77

Jan-

78Ja

n-79

Jan-

80Ja

n-81

Jan-

82Ja

n-83

Jan-

84Ja

n-85

Jan-

86Ja

n-87

Jan-

88Ja

n-89

Jan-

90Ja

n-91

Jan-

92Ja

n-93

Jan-

94Ja

n-95

Jan-

96Ja

n-97

Jan-

98Ja

n-99

Jan-

00Ja

n-01

Jan-

02Ja

n-03

Jan-

04Ja

n-05

Deviation from PPP

CANADIAN NET TRADE BALANCE WITH THE UNITED STATES

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

Jan-

76Ja

n-77

Jan-

78Ja

n-79

Jan-

80Ja

n-81

Jan-

82Ja

n-83

Jan-

84Ja

n-85

Jan-

86Ja

n-87

Jan-

88Ja

n-89

Jan-

90Ja

n-91

Jan-

92Ja

n-93

Jan-

94Ja

n-95

Jan-

96Ja

n-97

Jan-

98Ja

n-99

Jan-

00Ja

n-01

Jan-

02Ja

n-03

Jan-

04Ja

n-05

Net Trade Balance

MEXICAN PESO/US DOLLAR EXCHANGE RATE (Mex$/USD)

0

2

4

6

8

10

12

14

Jan-

76Ja

n-77

Jan-

78Ja

n-79

Jan-

80Ja

n-81

Jan-

82Ja

n-83

Jan-

84Ja

n-85

Jan-

86Ja

n-87

Jan-

88Ja

n-89

Jan-

90Ja

n-91

Jan-

92Ja

n-93

Jan-

94Ja

n-95

Jan-

96Ja

n-97

Jan-

98Ja

n-99

Jan-

00Ja

n-01

Jan-

02Ja

n-03

Jan-

04Ja

n-05

Nominal Exchange Rate Real Exchange Rate

PERCENTAGE DEVIATION FROM PURCHASING POWER PARITY OF MEXICAN

PESO

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

Jan-

76Ja

n-77

Jan-

78Ja

n-79

Jan-

80Ja

n-81

Jan-

82Ja

n-83

Jan-

84Ja

n-85

Jan-

86Ja

n-87

Jan-

88Ja

n-89

Jan-

90Ja

n-91

Jan-

92Ja

n-93

Jan-

94Ja

n-95

Jan-

96Ja

n-97

Jan-

98Ja

n-99

Jan-

00Ja

n-01

Jan-

02Ja

n-03

Jan-

04Ja

n-05

Deviation from PPP

MEXICAN NET TRADE BALANCE WITH THE UNITED STATES

-1,000

0

1,000

2,000

3,000

4,000

5,000

6,000

Jan-

76Ja

n-77

Jan-

78Ja

n-79

Jan-

80Ja

n-81

Jan-

82Ja

n-83

Jan-

84Ja

n-85

Jan-

86Ja

n-87

Jan-

88Ja

n-89

Jan-

90Ja

n-91

Jan-

92Ja

n-93

Jan-

94Ja

n-95

Jan-

96Ja

n-97

Jan-

98Ja

n-99

Jan-

00Ja

n-01

Jan-

02Ja

n-03

Jan-

04Ja

n-05

Net Trade Balance

MEXICAN PESO/CANADIAN DOLLAR EXCHANGE RATE (Mex$/C$)

0

1

2

3

4

5

6

7

8

9

10

Jan-

76Ja

n-77

Jan-

78Ja

n-79

Jan-

80Ja

n-81

Jan-

82Ja

n-83

Jan-

84Ja

n-85

Jan-

86Ja

n-87

Jan-

88Ja

n-89

Jan-

90Ja

n-91

Jan-

92Ja

n-93

Jan-

94Ja

n-95

Jan-

96Ja

n-97

Jan-

98Ja

n-99

Jan-

00Ja

n-01

Jan-

02Ja

n-03

Jan-

04Ja

n-05

Nominal Exchange Rate Real Exchange Rate

PERCENTAGE DEVIATION FROM PURCHASING POWER PARITY OF MEXICAN

PESO vs. CANADIAN DOLLAR

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

Jan-

76Ja

n-77

Jan-

78Ja

n-79

Jan-

80Ja

n-81

Jan-

82Ja

n-83

Jan-

84Ja

n-85

Jan-

86Ja

n-87

Jan-

88Ja

n-89

Jan-

90Ja

n-91

Jan-

92Ja

n-93

Jan-

94Ja

n-95

Jan-

96Ja

n-97

Jan-

98Ja

n-99

Jan-

00Ja

n-01

Jan-

02Ja

n-03

Jan-

04Ja

n-05

Deviation from PPP

MEXICAN NET TRADE BALANCE WITH CANADA

-

200,000

400,000

600,000

800,000

1,000,000

1,200,000

Jan-

00A

pr-0

0Ju

l-00

Oct

-00

Jan-

01A

pr-0

1Ju

l-01

Oct

-01

Jan-

02A

pr-0

2Ju

l-02

Oct

-02

Jan-

03A

pr-0

3Ju

l-03

Oct

-03

Jan-

04A

pr-0

4Ju

l-04

Oct

-04

Jan-

05

Ca

na

dia

n D

olla

rs

Net Trade Balance

Questions?