1 US dollar= 0.750 euros 1 Euro= 1.3 US dollars
Three reasons for foreign exchange• Tourism• International Trade• International Investing
What really is traded?• Bank deposits or bank transfers of deposits denominated in foreign currency.• The foreign exchange market exists as a network of large commercial banks trading foreign-currency-denominated deposits.• Legally speaking, physical exchange of money takes place only in the case of tourism.
Demand and Supply TheoryDetermined by free market.Role of domestic monetary authorities.Factors determining demand are- economic growth, relative pricestability, and variety of competitive goods and services available forexport.
Factors affecting Foreign Exchange Rates• Differentials in inflation and interest rate.• Current account deficits.• Public debt.• Terms of trade.• Political stability and economic performance.
Criticisms of Purchasing Power Parity Theory• Limitations of the Price Index• Neglect of the demand / supply approach• Unrealistic Approach• Unrealistic Assumptions• Neglects Impact of International Capital Flow.• Rare Occurrence