Lecture 6 Exchange rate

Different currency systems
180 Different
currencies in the World
Afghanistan Afghani
Albanian Lek
Macedonian Denar
US Dollar
British Pound
EU area Euro
Swiss Franc
Turkish Lira
Zambian kwacha

Countries want the payments to be realized in the home currency!
Germany Russia
German firm exports goods/services to
German firm will get Russian rubles
needsEuro to pay workers, supplies
NEEDFOR CURRENCY
EXCHANGE

USA Turkey
USA firm wants to purchase mining
operations in: (needs to pay in Lira!)
Profit will need to be repatriated in $
NEEDFOR CURRENCY
EXCHANGE

Macedonia France
Macedonian tourist need to pay in €
for hotel, meals, sightseeing, museums
When back home he will needDenars
NEEDFOR CURRENCY
EXCHANGE

Types of interactions
Countries interact with each other in two ways:
TRADE & INVESTMENT
TRADE – import and export of goods and services
INVESTMENT – borrowing and lending of money
- foreign ownership of property
Macroeconomic variable – TRADE BALANCEthat measures the difference
betweenthe total valueof exportsand total valueof imports
Macroeconomic variable – EXCHANGE RATE that measures the number of
units of one currency that exchangesfor one unit for anothercurrency

Foreign Exchange & Exchange Rate
Foreign exchange is the process of converting the currency of one
country into the currency of another country.
The exchange rate is the
amount of currency of
one country that can be
traded for one unit of the
currency of another
country.

Exchange Rate
Exchange Rate is a price of one currency in terms of another currency!
Most countries – have their own currency
Small countries – use the currency of an economically larger neighbor
Ecuador, El Salvador, Panama decide to DOLLARISE and use US $
Some countries – use a common currency- Euro!
DOLLARIZATION
a country that is not the
United States uses the U.S.
dollar as its currency

Foreign Exchange Market - Forex
The market in which people or firms use one currency to purchase another
currency is called the Foreignexchange market.
Demand Supply
USA
* US domestic firms that export g/s
(earning need to be converted in US$)
* Foreigntourists that come to the USA
(buying hotel, meals, museums in US$)
* Foreigninvestors
(for buying property, bonds in US$)
* Foreignfirms that sell g/s to the USA
(earnings in US$ need to be converted!)
* US tourist visiting other countries
(hotel, meals, --- in home currency)
* US investors abroad
(they need foreign currency more!)

Exercise:
Which of the following would be participating in the foreign exchange
market?
A Bill has lost trust in the currency of his country and purchases gold
B An American manufacturer buys Euros to purchase parts from a German supplier
C Ana from Skopje goes to a shop that sells Chinese products and buy with Denars
D Honda, a Japanese car manufacturer decides to open a new plant in the U.S

Exercise:
Which of the following would be participating in the foreign exchange
market?
A Bill has lost trust in the currency of his country and purchases gold
B An American manufacturer buys Euros to purchase parts from a German supplier
C Ana from Skopje goes to a shop that sells Chinese products and buy with Denars
D Honda, a Japanese car manufacturer decides to open a new plant in the U.S
The purchase or sale of foreign currencies is done through the Forex!

Strong vs. Weak currencies
US tourists want to spend
300 US$ in London
BANK - FEM
US 1 = 2£
They will get
600£
US 1 = 1,5£
They will get
450£
US 1 = 0,5£
Theywill get
150£
Depended on political situation,
GDP, inflation, interest rates--

Most traded currencies (hard ones)
Most traded currencies in the world (hard vs. soft currencies)
Currenciesmost traded on Foreign Exchange Market, 2016
Currency % DailyShare
US Dollar 87.6%
Euro 31.3 %
Japanese Yen 21.6 %
British Pound 12.8 %
Australian Dollar 6.9%
Canadian Dollar 5.1 %
Swiss Franc 4.8%
Chinese Yuan 2.6 %
The foreign exchange
market is dominated by the
U.S. Dollar, the Euro, the
Japanese Yen, and the
British Pound.

Demanders and Suppliers of Currencies in Forex
In foreign exchange markets, demand and supply become closely interrelated,
because a personor firmwho demands one currency must at the same time supply
another currency—and vice versa.
A
B
C
D
Firms that import or export goods and services
Tourists visiting other countries
FDI - International investors buying ownership (or part-ownership) in a foreign firm
PortfolioInvestment-International investors making financial investments that do
not involve ownership

A Firms that import or export goods and services
Chinese
firm
Exports goods/servicesto the U.S.A
USA
Needs Chinese Yuan to pay its:
- workers
- suppliers
- investors
Will pay in US Dollars
Forex
Supplier of US Dollars
Demander of Chinese Yuan

B Tourists visiting other countries
Chinese
tourists
That take trip to the….need US$
USA
Need US Dollars for:
- Hotel’s room
- Meals
- Sightseeing
- Museums…
Back at home need Chinese Yuan
Forex
Supplier of Chinese Yuan
Demander of US Dollars

C FDI - International investors buying ownership (or part-ownership) in a foreign firm
Chinese
firm
Purchases a whole beer USA firm USA
firm
- Purchasing a firm
- FDI = at least 10% ownership
or start-upa new company
abroad
Back US $ profit in Chinese Yuan
Forex

D PortfolioInvestment-International investors making financial investments that do not
involve ownership
Chinese
firm
Purchases bonds from US
government od deposit money USA
firm
- Purchasing bonds
- PI = purely financial investment
without management responsibility
Back US $ profit in Chinese Yuan
Forex

Portfolio investments and Hedging
D Portfolio investment is often linked to expectations about how exchange rates will shift
USA
financial
investor
Purchases bonds from UK
government UK
Government
24,000 $ = 1£ = 1,50 $ = 16,000 £
Expect in a month pound to rise:
16,000 £ = 1£ = 1,60 $ = 25,600 $
PROFIT = 1,600 $
20,000 £ = 1£ = 1,50 $ = 30,000 $
Expect in a month pound to fall:
30,000 $ = 1£ = 1,40 $ = 21,429 £
PROFIT = 1,429 £
NO GUARANTEES & investor can suffer losses if the exchange rates don’t move as predicted

Portfolio investments and Hedging
D Hedge = Financial transaction that protect companies against currency risk!
USA firm
Exports goods to France and expect to
get 1 million Euros in 1 year! France
USA firm doesn’t know what will happen in a year!
Signs a Financial agreement and pays a fee to provide a hedge!
If Euro grows, fee is paid for nothing, if it falls the USA firm is protected!

Demanders and Suppliers in Forex (home!)
The Demand and Supply Line-ups in Foreign Exchange Markets
Demand for the U.S. Dollar Comes from… Supply of the U.S. Dollar Comes from…
A U.S. exporting firm that earned foreign
currency and is trying to pay U.S.-based
expenses
A foreign firm that has sold imported goods
in the United States, earned U.S. dollars,
and is trying to pay expenses incurred in its
home country
Foreign tourists visiting the United States U.S. tourists leaving to visit other countries
Foreign investors who wish to make direct
investments in the U.S. economy
U.S. investors who want to make foreign
direct investments in other countries
Foreign investors who wish to make
portfolio investments in the U.S. economy
U.S. investors who want to make portfolio
investments in other countries

Exercise
US Giant Manufacturing company sold $1 million dollars worth of goods to a
company in Mexico to be paid in 6 months in Mexican pesos. Currently the
exchange rate is $1 = 20 Pesos and US Giant will receive $20 million pesos. US
Giant is afraid that the value of the pesos will fall during the 6 month period
and that a dollar may buy 25 pesos instead of 20 pesos and that the payment of
20 million pesos will only be worth $800,000 in 6 months. US Giant decides to
pay a financial firm $10,000, in exchange they would pay the difference (if there
is) between the $1 million value of the goods and the value of the payment in
pesos in 6 months. US Giant is:
A
B
C
Doing direct investment
Doing a portfolio investment
Hedging

The size of Foreign Exchange Market
A
B
C
D
International Tourism (large industry) = 1 trillion US $ / year
Global exports of goods and services = 18 trillion US $ / year
FDI (Foreign Direct Investment) = 1,4 trillion US $ / year
Foreign Exchange Market transactions = 5,3 trillionUS $ / DAY

Appreciation and Depreciation of Currencies
If you are an American visiting Mexico for Summer, and want to buy a cream:
Exchange rate 1 USA$ = 15 MXN
60
MNX
60 MNX= 4 USA$
60 MNX= 3 USA$
US $ is APPRECIATED

APPRECIATION: when a currency is worth more in terms of other currencies;
also called “strengthening”
Exchange rate 1 USA$ = 15 MXN Exchange rate 1 USA$ = 20 MXN
Export fallsImport risesUS $ is APPRECIATED
Mexico
USA
It’s cheaper domestic consumers
to import foreign goods
Export from the USA gets
more expensive!

If you are an American visiting Mexico for Summer, and want to buy a cream:
60
MNX
60 MNX= 4 USA$
60 MNX= 6 USA$
US $ is DEPRECIATED

DEPRECIATION: when a currency is worth less in terms of other currencies;
also called “weakening”
Exchange rate 1 USA$ = 15 MXN Exchange rate 1 USA$ = 10 MXN
Export risesImport fallsUS $ is DEPRECIATED
Mexico
USA
It’s expensive domestic consumers
to import foreign goods
Export from the USA gets
cheaper!

The impact of the changed exchange rate
Exchange rate movements affect
exporters, tourists, and international investors in different ways.

Case 1:
A U.S exporting firm
A Stronger US $ A Weaker US $
WHY?
Because strong $ US = will buy weak foreign currency!
A U.S exporting firm Mexican company
goods
weak peso
Forex
Foreign weak currencies will buy less US
dollars! Profit will fall!

Case 2:
A foreign firm exporting to
the USA
WHY?
Because strong $ US will buy more weak foreign currency!
A U.S exporting firm Mexican company
goods
Strong $
Forex
Earned strong US$ can buy more local currency!
Higher profit for the firm!

Case 3:
A US tourist abroad
WHY?
Because strong $ US will buy more weak foreign currency!
A U.S tourist Mexican hotel
Trip to Mexico
pesos
Forex
Will receive more Mexican pesos for the strong US$
and the trip will be cheaper!

Exercise:
Which of the following year is the best for an American tourist to travel to
South Africa? Theamount of money he likesto spend is $5000!
A January 2008, when 1$ = 7 SAR
B January 2009, when 1$ = 10 SAR
C January 2010, when 1 $ = 7,5 SAR

Exercise:
Which of the following year is the best for an American tourist to travel to
South Africa? The amount of money he likes to spend is $5000!
A January 2008, when 1$ = 7 SAR (35,000 SAR to spend)
B January 2009, when 1$ = 10 SAR (50,000 SAR to spend)
C January 2010, when 1 $ = 7,5 SAR (35,500 SAR to spend)
2009 is the best year to travel to South Africa!
When currency is strong (US$)it’s not a good time for foreign tourists to visit
the USA

Case 4:
A US investor abroad
WHY?
Because earned weak currency can buy fewer US dollars!
A U.S investor abroad Mexican bank
Invest money
pesos
Forex
Will receive weak Mexican pesos that will buy less US
dollars! Demotivated to invest when US$ is strong!

Case 5:
A foreign investor in the
USA
WHY?
Because will earn strong US$ that can change with more pesos!
A U.S bank Mexican investor
Invest money
US dollars
Forex
Will receive more Mexican pesos for the earned strong
US dollars!

Homework
1) What term describes when a business start-up a new enterprise in a different country?
a) foreign development
b) foreign direct investment
c) portfolio investment
d) foreign financial investment
Exercises: Guess the right choice and explain it!
2) If currency A appreciates relative to currency B, then currency B:
a) will match currency A
b) will not be affected
c) appreciates against currency A
d) depreciates against currency A

3) If the Euro becomes stronger, which of these examples would that stronger Euro benefit?
a) American students studying in France
b) Italian students studying in Germany
c) Dutch firms purchasing parts in the USA
d) American businesses purchasing cheese from Italy
4) If tourists can purchase more Japanese Yen than before for each US$ they exchange, then:
a) The US$ has lost strength against the Japanese Yen
b) The Japanese Yen has lost strength against the US dollar
c) The Japanese Yen has gained strength against the US dollar
d) The Japanese Yen and the US dollar have both appreciated
5) The exchange rate between the US dollar and the Euro is 1Euro = $1.25. Which of the
following exchange rates shows a depreciation of the Euro?
a) 1 Euro = $ 1,15
b) 1 Euro = $ 1,49
c) 1 Euro = $ 1,35
d) 1 Euro = $ 0,70

6) Which currency on the foreign exchange market is the most frequently traded?
a) US Dollar
b) Swiss Franc
c) Japanese Yen
d) Australian Dollar
7) The foreign exchange market is where the purchase and sale:
a) of foreign goods takes place
b) of foreign land assets takes place
c) of foreign currencies takes place
d) of foreign stocks and bonds takes place
8) If a currency over time buys fewer units of another currency, then:
a) that currency has appreciated
b) that currency is stronger
c) that currency has depreciated
d) that currency has achieved purchasing power parity

Lecture 6 Exchange rate

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