Day 3 - Exchange Rates (Class Copy)
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Transcript of Day 3 - Exchange Rates (Class Copy)
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Determination of Exchange Rates, Exchange Rate Dynamics and
Intervention
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Exchange Rate Terminologies Exchange Rate – the price of one nation’s currency in terms of another currency, the numerator being the reference currency.
a. Spot Rate – the price at which currencies are traded for immediate delivery, or in two days in the
interbank market.
b. Forward Rate – the price at which foreign exchange is quoted for delivery at a specified future date.
Currency Devaluation/Depreciation – the decrease in the stated value of a pegged currency, one whose value is set by the government.
Currency Revaluation/Appreciation – the increase in the par value of a pegged currency.
Floating Currency – one whose value is set by the market forces.
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Determination of Exchange Rates
The Foreign Exchange (Forex) Market
Forex Market – network of markets and institutions that handle foreign currency. The commodity being bought and sold is the foreign currency.
a. Spot Market – deals with currency transactions for immediate delivery, or in two days. (over the counter)
b. Forward Market – deals with currency transactions for delivery at a specified future date.
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Determination of Exchange Rates
The Foreign Exchange (Forex) Market
What would the possible reasons why people would want to buy foreign currency? (Demand for foreign currency)
a. Travel/Tourism (domestic residents who want to travel
abroad)
b. Trade (purchase of goods and services by domestic residents from another country)
c. Investment (financial and/or real investments by domestic residents in another country)
d. Speculation and hedging (expectations by domestic residents on the foreign currency.
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Determination of Exchange Rates
The Foreign Exchange (Forex) Market
What would the possible reasons why foreigners would want to buy our domestic currency? (Supply for local currency)
a. Travel/Tourism (foreign residents who want to
travel the domestic country)
b. Trade (purchase of domestic goods and services by foreign residents)
c. Investment (financial and/or real domestic
investments by foreign residents)
d. Speculation and hedging (expectations by foreign residents on the domestic currency)
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Determination of Exchange Rates
The Foreign Exchange (Forex) Market
In summary, the following are factors that affect the DEMAND and SUPPY in the forex:
a. Exchange rate
b. Real Rate (domestic)
c. Real Rate (foreign)
d. Inflation Rate (domestic)
e. Inflation Rate (foreign)
f. Expectations (speculations)
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• Factors Affecting Supply and Demand
– Relative Inflation Rates (domestic)• Growth in the money supply would cause the price of
domestic goods and services to rise relative to those in other countries
• Domestic residents may get to find foreign goods and services cheaper and may switch consumption from domestic to foreign goods
• Higher domestic inflation should lead to a depreciation of the local currency
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Determination of Exchange Rates
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• Factors Affecting Supply and Demand (Shapiro and Sarin, 2009)
– Relative Interest Rates• Higher interest rates may attract foreign capital inflow
(provided a rise in real interest rates)• Higher real interest rates will cause the domestic currency to
appreciate
– Relative Economic Growth• Strong economic growth attracts foreign capital• The production of high quality products lead to higher
demand by both domestic and foreign consumers
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Determination of Exchange Rates
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• Factors Affecting Supply and Demand
– Political and Economic Risks
• Politically stable nations generate less risky assets
• Capital seeks safe havens for investments and the currency of such havens would appreciate
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Determination of Exchange Rates
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• Participants in the Forex Market– Bank and Non-Bank Forex Dealers– Individuals and Firms conducting International
Commercial and Investment Transactions– Speculators and Arbitrageurs– Central Banks and Treasuries– Forex Brokers
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Determination of Exchange Rates
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• The amount of currency appreciation or depreciation is computed as the percentage increase or decrease in value of the domestic currency in terms of another currency
KenYu: If less of a foreign currency is required to buy a domestic currency, that means that the domestic currency has depreciated. If there a + sign, appreciation; - sign, depreciation.Tip: In computing for the appreciation/depreciation, the DC is the base currency!
• Sample Problem 1:– In 2002, the yen went from $0.0074074 to $0.0084746.
By how much did the yen appreciate against the dollar?– By how much has the dollar depreciated against the yen?11
Calculating Exchange Rate Changes
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• 2nd Sample Problem:– On April 1, 1998, the government of
Yugoslavia devalued the Yugoslav dinar, setting its new rate at 10.92 dinar to the dollar, from 6 dinar previously.• By how much has the dinar devalued against
the dollar?• By how much has the dollar appreciated
against the dinar?
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Calculating Exchange Rate Changes
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• 3rd Sample Problem:– On July 2, 1997, the Thai baht fell 17%
against the US$. By how much has the dollar appreciated against the baht?
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Calculating Exchange Rate Changes