Foreign Exchange
MACROECONOMICS
GROUP 4
Foreign Exchange Rates and
Markets
Foreign
Exchange
• Is foreign money needed to
carry out international
transactions.
Exc...
Changes in Tastes
Relative Income Changes
Relative Price-Level
Relative Interest Rate
Speculation
• Any change in consumer tastes or
preferences for the products of foreign
country may alter the demand for that
nation’s ...
• A nation’s currency is likely to depreciate if
its growth of national income is more rapid
than that of other countries....
• Changes in relative price levels of two
nations may change the demand and
supply of currencies and alter the
exchange ra...
• Changes in relative interest rates between
two countries may alter their exchange
rate.
Determinants of Foreign Exchange
• It can cause changes in exchange rates.
Determinants of Foreign Exchange
10
The Foreign Exchange Market
Foreign exchange (dollars)
Exchange rate
Peso/$
SD
Supply of Dollars by
people who want pes...
Currency Appreciation and
Depreciation
Currency
Depreciation
• It is an increase in the number of
units of a particular cu...
12
Changes in the Equilibrium
Exchange Rate
Foreign exchange (dollars)
Exchange rate
Peso/$ SD Supply of Dollars
by people...
Arbitrageurs and Speculators
Arbitrageur
• Someone who takes advantage of
temporary geographic differences in the
exchange...
Exchange Rate
Regimes
Flexible (Floating) exchange rates.
Fixed exchange rates.
Managed Float (Dirty Float) exchange rates...
Exchange Rates Regimes
1)Flexible Exchange Rate
• Rate determined in foreign
exchange markets by the
markets by the forces...
Exchange Rates Regimes
2)Fixed Exchange Rate
• Rate of exchange between
currencies pegged within a narrow
range and mainta...
Exchange Rates Regimes
• Is an increase in the official pegged price
of foreign exchange in terms of domestic
currency.
a)...
Exchange Rates Regimes
3) Manage Float
Exchange Rate
•Attempt to influence
exchange rates by buying
and selling currencies.
is a theory, which establishes the
fact that the exchange rates between
currencies are in equilibrium in the
event of equa...
the “law of one price”
applies to individual
commodities whereas
PPP applies to the
general price level
“Law of one price”...
Example: American steel $100 per ton, Japanese steel 10,000 yen per ton
If E = 50 yen/$ then prices are:
American Steel Ja...
An example of one measure of the law of
one price, which underlies purchase power
parity, is the Big Mac Index
Range and quality of goods
Trade barriers and nontradables
Differences in price level measurement
Interest Rate Parity
It assumes that a country's currency
exchange rate and risk-free interest rate
are correlated, and th...
 Difference between Forward Exchange Rate and Spot
Exchange Rate = Difference between the interest
rates of two countries...
26
The Dollar and Interest Rates
While there is a strong
correspondence between
real interest rates and the
exchange rate,...
Past Exchange Rate Regimes
1. 2.
•Fixed exchange rates
•No control over
monetary policy
•Influenced heavily by
production ...
3. 4.
•World Bank
•General Agreement on
Tariffs and Trade (GATT)
•World Trade
Organization
Bretton Woods
System (cont’d)
E...
Managed float regime is the current international
financial environment in which exchange rates fluctuate from
day to day,...
The International Monetary Fund
The IMF's stated
goal was to stabilize
exchange rates and
assist the
reconstruction of the...
Foreign Exchange
Foreign Exchange
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Foreign Exchange

  1. 1. Foreign Exchange MACROECONOMICS GROUP 4
  2. 2. Foreign Exchange Rates and Markets Foreign Exchange • Is foreign money needed to carry out international transactions. Exchange Rate • Is the price measured in one country’s currency of buying one unit of another country’s currency.
  3. 3. Changes in Tastes Relative Income Changes Relative Price-Level Relative Interest Rate Speculation
  4. 4. • Any change in consumer tastes or preferences for the products of foreign country may alter the demand for that nation’s currency and change its exchange rate. Determinants of Foreign Exchange
  5. 5. • A nation’s currency is likely to depreciate if its growth of national income is more rapid than that of other countries. Determinants of Foreign Exchange
  6. 6. • Changes in relative price levels of two nations may change the demand and supply of currencies and alter the exchange rate between the two nation’s currencies. Determinants of Foreign Exchange
  7. 7. • Changes in relative interest rates between two countries may alter their exchange rate. Determinants of Foreign Exchange
  8. 8. • It can cause changes in exchange rates. Determinants of Foreign Exchange
  9. 9. 10 The Foreign Exchange Market Foreign exchange (dollars) Exchange rate Peso/$ SD Supply of Dollars by people who want pesos Demand for Dollars by people who have pesos
  10. 10. Currency Appreciation and Depreciation Currency Depreciation • It is an increase in the number of units of a particular currency needed to purchase one unit of foreign exchange. Currency Appreciation • It is an decrease in the number of units of a particular currency needed to purchase one unit of foreign exchange.
  11. 11. 12 Changes in the Equilibrium Exchange Rate Foreign exchange (dollars) Exchange rate Peso/$ SD Supply of Dollars by people who want pesos Demand for Dollars by people who have pesos S’ $ -depreciation Peso- appreciation
  12. 12. Arbitrageurs and Speculators Arbitrageur • Someone who takes advantage of temporary geographic differences in the exchange rate by simultaneously purchasing a currency in one market and selling it in another market. Speculator • Someone who buys or sells foreign exchange in hopes of profiting from fluctuations in the exchange rate over time.
  13. 13. Exchange Rate Regimes Flexible (Floating) exchange rates. Fixed exchange rates. Managed Float (Dirty Float) exchange rates. 1 2 3 Exchange Rate Regimes
  14. 14. Exchange Rates Regimes 1)Flexible Exchange Rate • Rate determined in foreign exchange markets by the markets by the forces of demand and supply without the government intervention.
  15. 15. Exchange Rates Regimes 2)Fixed Exchange Rate • Rate of exchange between currencies pegged within a narrow range and maintained by the central banks’ ongoing purchases and sales of currencies .
  16. 16. Exchange Rates Regimes • Is an increase in the official pegged price of foreign exchange in terms of domestic currency. a) Currency Devaluation • Is a reduction in the official pegged price of foreign exchange in terms of domestic currency. b) Currency Revaluation
  17. 17. Exchange Rates Regimes 3) Manage Float Exchange Rate •Attempt to influence exchange rates by buying and selling currencies.
  18. 18. is a theory, which establishes the fact that the exchange rates between currencies are in equilibrium in the event of equality in the purchasing power of each of the countries. Purchasing Power Parity Theory(PPP) It is more of a long run predictor than a day to day indicator of the relationship between changes in the price level and the exchange rate.
  19. 19. the “law of one price” applies to individual commodities whereas PPP applies to the general price level “Law of one price” • price of similar products to two countries should be equal when measured in a common currency. Purchasing Power Parity Theory(PPP)
  20. 20. Example: American steel $100 per ton, Japanese steel 10,000 yen per ton If E = 50 yen/$ then prices are: American Steel Japanese Steel In U.S. $100 $200 In Japan 5000 yen 10,000 yen If E = 100 yen/$ then prices are: American Steel Japanese Steel In U.S. $100 $100 In Japan 10,000 yen 10,000 yen Law of one price  E = 100 yen/$
  21. 21. An example of one measure of the law of one price, which underlies purchase power parity, is the Big Mac Index
  22. 22. Range and quality of goods Trade barriers and nontradables Differences in price level measurement
  23. 23. Interest Rate Parity It assumes that a country's currency exchange rate and risk-free interest rate are correlated, and that an arbitrage investor cannot profit through the relationship. • Interest rate parity is a financial theory that connects forward exchange rates, spot exchange rates, and nations' individual interest .
  24. 24.  Difference between Forward Exchange Rate and Spot Exchange Rate = Difference between the interest rates of two countries The Forward exchange rates are when an investor agrees to exchange a currency at a specified rate at a specified future date. A spot exchange rate is what the trader can get for his currency right now. Interest Rate Parity
  25. 25. 26 The Dollar and Interest Rates While there is a strong correspondence between real interest rates and the exchange rate, the relationship between nominal interest rates and exchange rate movements is not nearly as pronounced
  26. 26. Past Exchange Rate Regimes 1. 2. •Fixed exchange rates •No control over monetary policy •Influenced heavily by production of gold and gold discoveries Gold standard Bretton Woods System Fixed exchange rates using U.S. dollar as reserve currency International Monetary Fund (IMF)
  27. 27. 3. 4. •World Bank •General Agreement on Tariffs and Trade (GATT) •World Trade Organization Bretton Woods System (cont’d) European Monetary System •Exchange rate mechanism Past Exchange Rate Regimes (cont’d)
  28. 28. Managed float regime is the current international financial environment in which exchange rates fluctuate from day to day, but central banks attempt to influence their countries' exchange rates by buying and selling currencies. It is also known as a dirty float. In an increasingly integrated world economy, the currency rates impact any given country's economy through the trade balance. In this aspect, almost all currencies are managed since central banks or governments intervene to influence the value of their currencies. The Current System : Managed Float
  29. 29. The International Monetary Fund The IMF's stated goal was to stabilize exchange rates and assist the reconstruction of the world’s international payment system post-World War II. Countries contribute money to a pool through a quota system from which countries with payment imbalances can borrow funds temporarily. The organization's stated objectives are to promote international economic cooperation, international trade, employment, and exchange rate stability, including by making financial resources available to member countries to meet balance of payments needs

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