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Exchange Rate Determination

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Exchange Rate Determination ... Relative Interest Rates High interest rates in home country relative to a foreign country may cause domestic currency to appreciate ... – PowerPoint PPT presentation

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Title: Exchange Rate Determination


1
Exchange Rate Determination
  • International Business (MB 40)

2
Outline
  • Defining Exchange Rate
  • Measuring Exchange Rate Movements
  • Appreciation/Depreciation of a currency
  • Exchange Rate Equilibrium
  • Factors that influence Exchange Rate Movements

3
Meaning of Exchange Rate and Measuring Changes in
Exchange Rates
  • Value of one currency in units of another
    currency
  • A decline in a currencys value is referred to as
    depreciation and an increase in currencys value
    is called appreciation.
  • If currency A can buy you more units of foreign
    currency, currency A has appreciated and foreign
    currency depreciated
  • If currency A can buy you less units of foreign
    currency, currency A has depreciated and foreign
    currency appreciated

4
Exchange Rate Equilibrium
  • Forces of Demand 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

5
Factors that influence the Exchange Rate
  • Political Events
  • Expectations of the Market
  • Relative Inflation Rates
  • Relative Interest Rates
  • Relative Income Levels
  • Exchange rate is the results of an interaction of
    these factors

6
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

7
Market Expectations
  • Expectations about future exchange rate changes
    on the basis of current and future political and
    economic conditions
  • 1960s Strong
  • Between 1960s and 1970s weak
  • Strong now
  • 1995 European Exchange Rate Mechanism
  • Devaluation of Asian Currencies

8
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?

9
Relative Interest Rates
  • High interest rates in home country relative to a
    foreign country may cause domestic currency to
    appreciateWhy?

10
Relative Income Levels
  • Increase in domestic income relative to foreign
    income may lead to a decline in the value of
    domestic currency Why?

11
Exchange Rate Determination
  • An interaction of factors
  • Is it possible for a country with high real
    returns to have a low currency value?
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