Post on 22-Dec-2015
• The Prices for International Transactions: Real and Nominal Exchange Rates
• Nominal Exchange Rates: • Rate you can trade one currency for
another • 80 yen per dollar or 1/80 = .0125 dollar
per yen
• “appreciation” or stronger: dollar buys……more foreign currency• “depreciation” or weaker: dollar buys…..less foreign currency
• When exchange rate changes from 80 yen per dollar to 90 yen per dollar: the dollar has……
appreciated because …..the dollar can now buy more yen • When exchange rate changes from 90 yen per
dollar to 80 yen per dollar: the dollar has…..depreciated because ……the dollar can now buy less yen
FOREX: Who, What, Where, When, Why
• Exchange rates are determined in the foreign exchange market
• open to a wide range of different types of buyers and sellers
• currency trading is continuous: 24 hours a day except weekends.
• The spot exchange rate refers to the current exchange rate.
• The forward exchange rate refers to an exchange rate that is quoted and traded today but for delivery and payment on a specific future date.
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• People may need to exchange currencies in a number of situations.
• Example: travel to another country may buy foreign currency in a bank in their home country, where they may buy foreign currency cash, traveller's cheques or a travel-card.
• From a local money changer they can only buy foreign cash
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• At the destination, the traveler can buy local currency at the airport, either from a dealer or through an ATM.
• They can also buy local currency at their hotel, a local money changer, through an ATM, or at a bank branch.
• When they purchase goods in a store and they do not have local currency, they can use a credit card, which will convert to the purchaser's home currency at its prevailing exchange rate.
• If they have traveler's cheques or a travel card in the local currency, no currency exchange is necessary.
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• If a traveler has any foreign currency left over on their return home, may want to sell it, which they may do at their local bank or money changer.
• The exchange rate as well as fees and charges can vary significantly on each of these transactions, and the exchange rate can vary from one day to the next.
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• A currency pair is the …..• quotation of the relative value of a currency
unit against the unit of another currency in the foreign exchange market. (= e = nominal exchange rate)
• The quotation EUR/USD 1.2500 means that 1 Euro is exchanged for 1.2500 US dollars.
USD GBP CAD EUR AUD
$1 US will buy: 0.64478 1.01455 0.76359 0.96702
• An exchange rate index - • way of measuring the performance of a
currency against a basket of other currencies.• US Dollar Index• For example, the US dollar index measures the
US dollar against 6 main currencies.
Real Exchange Rate
• Rate you can trade goods/services of one country for that of another
• Ex: for every case of American beer you can buy, you would get 2/3 case of German beer
Real and Nominal Exchange Rates working together Ex: American rice = $100/bushel Japanese rice = 16,000 yen/bushel• What is the real exchange rate? = nominal x domestic P / foreign P• e x P / P*• use to convert prices into a common currency
• e x P / P* (80 yen/$) x ($100/bushel US rice) (16,000yen/bushel Japanese rice) =
8,000 yen / per bushel US rice 16,000 yen/per bushel Japanese rice = ½ bushel Japanese rice per bushel of American rice
• Real Exchange Rate = key determinant of how much a country imports or exports
• Use the Price of basket of goods for both US price (P) and foreign price (P*) and the nominal exchange rates (e)
• Measures the price of a basket of goods domestically relative to the price of foreign goods
• Finding the nominal exchange rate:e = P* / P (-assuming there is purchasing power parity)
• Convert foreign price of good to US $: P*/ e
Purchasing Power Parity
• Purchasing power of the dollar is = to that of other currencies
• According to the theory: The ( e ) between two countries must reflect the different price levels in those countries
• ( e ) change when PL changes **When increase MS, PL increases = value
decreases = depreciate vs. other currencies
If Britain pursues tighter MS and less inflation than the US, then the value of the Pound will appreciate vs. the US $
If the US pursues easy MS and allows more inflation than Britain, then the value of the US$ will depreciate vs. the Pound
• Purchasing Power Parity does not always hold true
• Many goods are not easily traded • Not always perfect substitutes
Case Study: Increasing Openness of the US Economy
• Transportation (ships/jets) • Telecommunications • Technology – change in kinds of goods (easily
transported) • Govt. policies – more free trade : NAFTA,
GATT
Case Study: Are US Trade Deficits a National Problem?
Trade deficit a problem? Maybe a symptom of the problem …= reduce
national savings …. = not providing for future
FOREX Market • Demand curve = Demand for US $ …comes from • Foreign Demand for : • US exports • US financial investments (savings) • Speculation • Ex : if D for US goods increases, shift D for US $ to
right = appreciate• Ex: if Int. Rates in US increase, shift D for US $ to
right = appreciate …..why? ..• Higher int rates = incentive for foreigners to buy US
$ to save (bonds) ….= higher return on their financial investments
• Supply curve = Supply of US $...comes from: • Americans buy imports• US buy foreign financial investments (savings) • Speculation
• If US imports (M) increase = increase Supply of US $ = Supply shifts right = depreciate
• If Foreign int. rates increase = increase Supply of US $ = Supply shifts right = depreciate..why…
• If foreign int rates increase = incentive for Americans to supply $ to buy foreign bonds (savings