CHAPTER 2 THE DETERMINATION OF EXCHANGE RATES - PowerPoint PPT Presentation

Loading...

PPT – CHAPTER 2 THE DETERMINATION OF EXCHANGE RATES PowerPoint presentation | free to view - id: 1d27e1-ZDc1Z



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

CHAPTER 2 THE DETERMINATION OF EXCHANGE RATES

Description:

Equilibrium Exchange Rates. Consider a world with two currencies, i.e. the dollar and the euro. ... Equilibrium Exchange Rates. EXAMPLE: Euro Appreciation ... – PowerPoint PPT presentation

Number of Views:22
Avg rating:3.0/5.0
Slides: 31
Provided by: asl5
Category:

less

Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: CHAPTER 2 THE DETERMINATION OF EXCHANGE RATES


1
CHAPTER 2 THE DETERMINATION OF EXCHANGE RATES
  • CHAPTER 2 THE DETERMINATION OF EXCHANGE RATES

2
Part I. What is an Exchange Rate?
  • … price at which suppliers/demanders of one
    currency are willing to exchange the currency for
    another from demanders/suppliers.
  • …the price of a unit of a currency in terms of
    another currency

3
Part I. Equilibrium Exchange Rates
  • Consider a world with two currencies, i.e. the
    dollar and the euro.
  • If e0 is the /euro exchange rate, that means
    that demanders of the euro will pay e0 for each
    unit of the euro.

4
Goals
  • Dd. And Ss. Of foreign exchange
  • Equilibrium Exchange rates
  • Concepts Spot and forward rates
  • - appreciation depreciation
  • Expectations and currency values
  • The role of central banks

5
Part I. Equilibrium Exchange Rates
  • I. SETTING THE EQUILIBRIUM
  • A. Exchange Rates
  • e0 is the market-clearing prices that
    equilibrates the quantities supplied and
    demanded of foreign currency.

6
Equilibrium Exchange Rates
  • B. How Americans Purchase German Goods
  • 1. Foreign Currency Demand
  • -derived from the demand for foreign
    countrys goods, services, and financial
    assets.
  • e.g. The demand for German goods by
    Americans

7
Equilibrium Exchange Rates
  • 2. Foreign Currency Supply
  • a. derived from the foreign countrys
    demand for local goods.
  • b. They must convert their currency
    to purchase.
  • e.g. German demand for US goods means
    Germans convert Euros to US in order to buy.

8
Equilibrium Exchange Rates
  • 3. Equilibrium Exchange Rate
  • occurs where the quantity supplied
  • equals the quantity demanded of a
  • foreign currency at a specific local
  • price.

9
Equilibrium Exchange Rates
  • C. How Exchange Rates Change
  • 1. Increased demand
  • as more foreign goods are demanded, the
    price of the foreign currency in local currency
    increases and vice versa.

10
Equilibrium Exchange Rates
  • 2. Home Currency depreciation a. Foreign
    currency more valuable than the home
    currency.
  • b. Conversely, then the foreign
  • currencys value has appreciated
  • against the home currency.

11
Appreciation/Depreciation?
  • Define currency appreciation?
  • Define currency depreciation?

12
Equilibrium Exchange Rates
  • Calculating a Depreciation/Appreciation
  • (e1 - e0)/ e0
  • where e0 old currency value
  • e1 new currency value
  • suppose the Euro depreciates/ appreciates agains
    the dollar, given direct quotes you would use the
    above formula to find the amount of
    depreciation/appreciation in the Euro.

13
Equilibrium Exchange Rates
  • To find the currency appreciation /depreciation
    of the USD however we would use
  • (e0 - e1)/ e1
  • where e0 old currency value
  • e1 new currency value

14
Equilibrium Exchange Rates
  • EXAMPLE Euro Appreciation
  • If the dollar value of the Euro goes from
    0.64 (e0) to 0.68 (e1), then the Euro has
    appreciated by
  • (.68 - .64)/ .64 6.25

15
Equilibrium Exchange Rates
  • US Depreciation would be
  • We use the formula,
  • (e0 - e1)/ e1
  • substituting
  • (.64 - .68)/ .68 - 5.88
  • the US depreciation.

16
Currency Quotes
  • Direct Quote
  • Amount of home currency per unit of foreign
    currency
  • Indirect Quote
  • Amount of foreign currency per unit of home
    currency
  • Reciprocals Illustrate!

17
Part II. Expectations and The Asset Market Model
of Exchange Rates
  • I. WHAT AFFECTS A CURRENCYS VALUE?
  • A. Current events
  • B. Current supply
  • C. Demand flows
  • D. Expectation of future exchange rate

18
EXPECTATIONS
  • II. Role of Expectations
  • A. Currency financial asset
  • B. Exchange rate simple relation of two
    financial assets
  • It reflects the supply of and demand for foreign
    currency denominated assets.
  • III. Asset Market Model The demand for money
    today depends on expectations of factors that can
    effect its future value. Currency values are
    forward looking!

19
EXPECTATIONS
  • B. Soundness of a Nations Economic
  • Policies
  • - a nations currency tends to strengthen
    with sound economic policies.

20
Other factors affecting equilibrium exchange
rates
  • Differences in interest rates between nations
    Higher interest rates in one country attract
    foreign investments and hence cause domestic
    currencies to appreciate
  • Positive Economic (GNP) growth also attracts
    financial capital and lead to similar effects
  • Levels of political and economic risks

21
EXPECTATIONS
  • IV. EXPECTATIONS AND CENTRAL BANK BEHAVIOR
  • - exchange rates also influenced
  • by expectations of central bank
    behavior.

22
EXPECTATIONS
  • A. Central Bank Reputations
  • B. Central Bank Independence
  • C. Currency Boards

23
What is the role of a central bank?
  • Monetary Policy
  • Used to stabilize prices (inflation and
    deflation)
  • Interest rates
  • Currency value interest rate parity

24
Some monetary policies…
  • Change of the reserve requirement
  • Trading in the foreign exchange market I.e.
    buying and selling foreign currencies
  • Buying and selling treasury bonds
  • Printing money

25
THE ROLE OF CENTRAL BANKS
  • I. FUNDAMENTALS OF CENTRAL BANK INTERVENTION
  • A. Role of Exchange Rates
  • LINKS BETWEEN
  • THE DOMESTIC AND THE
  • WORLD ECONOMY

26
THE ROLE OF CENTRAL BANKS
  • B. IMPACT OF EXCHANGE RATE CHANGES
  • 1. Appreciation
  • -domestic prices increase
  • relative to foreign prices.
  • -Exports less competitive
  • Imports more attractive

27
THE ROLE OF CENTRAL BANKS
  • 2. Currency Depreciation
  • - domestic prices fall relative
    to foreign prices.
  • - Exports more price competitive.
  • Imports less attractive

28
THE ROLE OF CENTRAL BANKS
  • C. Foreign Exchange Market Intervention
  • 1. Definition the official purchases and
    sales of currencies through the central
    bank to influence the home exchange rate.

29
THE ROLE OF CENTRAL BANKS
  • 2. Goal of Intervention
  • - alter the demand for one
  • currency by changing the supply of another.

30
THE ROLE OF CENTRAL BANKS
  • D. The Effects of Foreign Exchange
  • Intervention
  • 1. Effects of Intervention
  • - either ineffective or
    irresponsible
  • 2. Lasting Effect
  • - If permanent change results
About PowerShow.com