Economics Investment Chapter 9

8/17/2019 Economics Investment Chapter 9

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CHAPTER 9

CURRENCY EXCHANGE RATESPresenter’s name

Presenter’s title

dd Month yyyy


2/25

1 !NTR"#UCT!"N

The foreign exchange (FX) market is the mar$et %or tradin& '(rren'ies a&ainstea'h other

) The *X mar$et is the +orld’s lar&est mar$et

) The *X mar$et %a'ilitates +orld trade

) The *X ,arti'i,ants -(y and sell '(rren'ies needed %or trade. -(t also

transa't to hed&e and s,e'(late on '(rren'y e/'han&e rates

0 An exchange rate is the ,ri'e o% a 'o(ntry’s '(rren'y in terms o% another

'o(ntry’s '(rren'y

Co,yri&ht 2314 C*A !nstit(te 2


3/25

2 THE *"RE!GN EXCHANGE MAR5ET

0 C(rren'ies are re%erred to -y theirISO code 6e&. US#. CH*. EUR7

0 Exchange rate: The n(m-er o%

(nits o% one '(rren'y 6the ,ri'e

'(rren'y7 that one (nit o% another

6the -ase '(rren'y7 +ill -(y0 Con8ention %or e/'han&e rate

A:B ; N(m-er o% (nits o% A that one

(nit o% B +ill -(y

A ; Pri'e '(rren'y

< ;

0 This means that one !ndian r(,ee

+ill -(y =19=> US dollars

0 !% this e/'han&e rate %alls to =3>. ther(,ee +ill -(y %e+er US dollars That

means that it +ill ta$e %e+er US

dollars to -(y a r(,ee !n other

+ords.

) The r(,ee is de,re'iatin& relati8e

to the US dollar or

) The US dollar is a,,re'iatin&

relati8e to the r(,ee

Co,yri&ht 2314 C*A !nstit(te ?


4/25

REA@ EXCHANGE RATES

0 A real e/'han&e rate is an e/'han&e rate that has -een ad(sted %or therelati8e ,(r'hasin& ,o+er o% the t+o '(rren'ies’ home 'o(ntries

) B(oted e/'han&e rates are nominal exchange rates

) e 'al'(late a real e/'han&e rate -y ad(stin& the e/'han&e rates %or the

relati8e ,ri'e le8els o% the 'o(ntries in the ,air

0 The real e/'han&e rate. (sin& AU# and US#. is the s,ot rate ad(sted %or the

relati8e ,ri'e le8els

+here

is the nominal or s,ot e/'han&e rate and is the relati8e ,ri'e le8el

0



5/25

SP"T AN# *"RAR# RATES

0 A spot exchange rate is an e/'han&e rate %or an immediate deli8ery 6that is.e/'han&e7 o% '(rren'ies

0 A forward exchange rate is an e/'han&e rate %or the e/'han&e o% '(rren'ies

at some s,e'i%ied. %(t(re ,oint in time

Co,yri&ht 2314 C*A !nstit(te >


6/25

THE *X MAR5ET

PA!I"IPA#!S A#$ P%POSES

0 "ompanies and indi&id'als

transa't %or the ,(r,ose o% the

international trade o% &oods and

ser8i'es

0 "apital market ,arti'i,ants transa't%or the ,(r,ose o% mo8in& %(nds into

or o(t o% %orei&n assets

0 edgers. +ho ha8e an e/,os(re to

e/'han&e rate ris$. enter into

,ositions to red('e this ris$0 Spec'lators ,arti'i,ate to ,ro%it

%rom %(t(re mo8ements in %orei&n

e/'han&e

!PES OF FX PO$%"!S0 C(rren'ies %or immediate deli8ery

6spot market7

0 Forward contracts. +hi'h are

a&reements %or a %(t(re e/'han&e

at a s,e'i%ied e/'han&e rate

0 FX swaps. +hi'h are a

'om-ination o% a s,ot 'ontra't and

a %or+ard 'ontra't. (sed to roll

%or+ard a ,osition in a %or+ard

'ontra't

0 FX options. +hi'h are o,tions to

enter into an *X 'ontra't some

time in the %(t(re at a s,e'i%ied

e/'han&e rate

Co,yri&ht 2314 C*A !nstit(te =


7/25

*X PART!C!PANTS

*% SI$E

0 Cor,orations

0 Real money a''o(nts

0 @e8era&e a''o(nts

0 Retail a''o(nts0 Go8ernments

0 Central -an$s

0 So8erei&n +ealth %(nds

SE++ SI$E

0 @ar&e dealin& -an$s

0 "ther %inan'ial instit(tions

Co,yri&ht 2314 C*A !nstit(te D

S,ot ?=F

"TC %or+ards 12F

E/'han&e)traded deri8ati8es 4F

*X and '(rren'y s+a,s 44F

*X o,tions and other 4F

Exhi,it -./FX !'rno&er ,0 Instr'ment


8/25

? CURRENCY EXCHANGE

RATE CA@CU@AT!"NS

0 A direct c'rrenc0 1'ote (sesthe domesti' '(rren'y as the

,ri'e '(rren'y and the %orei&n

'(rren'y as the -ase '(rren'y

0 An indirect c'rrenc0 1'ote

(ses the domesti' '(rren'y asthe -ase '(rren'y and the

%orei&n '(rren'y as the ,ri'e

'(rren'y

Example

Consider the (ote US#:


9/25

!N PRACT!CE

0 There are a n(m-er o% 'on8entions. +hi'h sim,ly re%er to a ,arti'(lar e/'han&erate Jsee E/hi-it 9)= %or a more 'om,rehensi8e listK

0 #ealers +ill (ote a -id 6at +hi'h the dealer +ill -(y7 and an o%%er ,ri'e 6at

+hi'h the dealer +ill sell7 JNote -id L o%%erK


FX ate 2'ote"on&ention

#ame"on&ention

Act'al atio(Price c'rrenc03*ase

c'rrenc0)

EUR e(ro US#:EURPY dollaryen PY:US#

G


10/25

APPREC!AT!NG "R #EPREC!AT!NG

A,,re'iation or de,re'iation is+ith res,e't to the -ase

'(rren'y relati8e to the ,ri'e

'(rren'y

0 Appreciation is a &ain in

8al(e o% one '(rren'y relati8eto another '(rren'y

0 $epreciation is the loss in

8al(e o% one '(rren'y relati8e

to another '(rren'y

The ,er'enta&e 'han&e is theratio o% the e/'han&e rates

min(s one

F 'han&e ;

0 Example

S(,,ose US#:CO5 is 232333 and in'reases

to 23?2>

0 The ,er'enta&e 'han&e is

0 This means that the CIe'h $or(na 6CO57

a,,re'iated 3=22F a&ainst the US dollar

) !t ta$es more US dollars to -(y ea'h

$or(na

0 This also means that the US dollar

de,re'iated -y

relati8e to the CIe'h $or(na

0



11/25

CURRENCY CR"SS)RATES


Gi8en three '(rren'ies. a c'rrenc0 cross.rate is the im,lied e/'han&e rateo% a third 'o(ntry ,air &i8en the e/'han&e rates o% t+o ,airs o% three'(rren'ies that ha8e a 'ommon '(rren'y

0 !% ar-itra&e is ,ossi-le. 'ross)rates +ill -e 'onsistent

Example 4 S(,,ose yo( ha8e the %ollo+in& (otes

AU#:US# ; 312 US#:#55 ; >>32Dhat is the AU#:#55 e/'han&e rate

Example 5 S(,,ose yo( ha8e the %ollo+in& (otes

!@S:US# ; ?4> N"5:US# ; =1D3=hat is the !@S:N"5 e/'han&e rate

67889-

Gi8en three '(rren'ies. a c'rrenc0 cross.rate is the im,lied e/'han&e rateo% a third 'o(ntry ,air &i8en the e/'han&e rates o% t+o ,airs o% three'(rren'ies that ha8e a 'ommon '(rren'y

0 !% ar-itra&e is ,ossi-le. 'ross)rates +ill -e 'onsistent


12/25

*"RAR# RATE BU"TAT!"NS

0 *or+ard e/'han&e rates are(oted in terms o% ,oints 6pips

,oints in ,er'enta&e7

!% %or+ard rate Q s,ot rate.

the -ase '(rren'y is tradin& at a

forward premi'm!% %or+ard rate L s,ot rate.

the -ase '(rren'y is tradin& at a

forward disco'nt

0 Points are 113.333 6mo8e the

de'imal ,la'e %o(r ,la'es7

0 *or+ard (otes 'an -e s,e'i%ied

as the n(m-er o% ,i,s %rom the

s,ot rate or as a ,er'enta&e o%

the s,ot rate

Example Usin& ,i,s

S(,,ose that the US#:EUR s,ot rate is

1?>>9 and that the one)month %or+ard is

14D ,i,s There%ore. the %or+ard rate is

*or+ard rate ;

Example Usin& a ,er'enta&e

S(,,ose that the s,ot rate o% US#:CH* is

3913> and that the one)month %or+ard

,oints as a ,er'enta&e o% the s,ot rate is

332F The one)month %or+ard rate is

*or+ard rate ; 3913> / 13332

; 67-46954

0



13/25

*"RAR# #!SC"UNTS AN# PREM!UMS

Consider the relationshi, -et+een%or+ard and s,ot rates

+here

; *or+ard rate

; S,ot rate

; #omesti' interest rate

; *orei&n interest rate

; Time 6in years7

This means that any ,remi(m or

dis'o(nt is a %(n'tion o% the interest

rates 6domesti'. . and %orei&n. 7 and

time.

0

Example

S(,,ose that the AU#:US# s,ot rate

is 33 and that the one)month

%or+ard rate is 3D9

There%ore.

0 ; 3D9.

0 ; 33. and

0 ; ?3:?=3

There is a %or+ard dis'o(nt o%

33 3D9 ; 33319

or 19 ,i,s. so L

0

Co,yri&ht 2314 C*A !nstit(te 1?


14/25

CA@CU@AT!NG *"RAR# RATES

Usin& .

+e 'an 'al'(late a %or+ard rate -ased on . . .and

0

Example

S(,,ose +e ha8e the s,ot e/'han&e rate o% the CA#:US# o% 139=9 !% the

one)year T)-ill interest rate in the United States is 3139F and the Canadian

one)year Treas(ry rate is 39>F. +hat is the one)year %or+ard rate

The estimated %or+ard rate is 113=1. +hi'h means that the %or+ard rate

sho(ld -e tradin& at a ,remi(m o% 113=1 139=9 ; 92 ,i,s

0



15/25

4 EXCHANGE RATE REG!MES

0 An exchange rate regime is the ,oli'y %rame+or$ %or %orei&n e/'han&e

0 The ideal '(rren'y re&ime 6+hi'h does not e/ist7 +o(ld 'onsist o% the %ollo+in&

'ir'(mstan'es

1 E/'han&e rate is 'redi-le and %i/ed

2 All '(rren'ies are %(lly 'on8erti-le

? All 'o(ntries (nderta$e inde,endent monetary ,oli'y %or domesti'

o-e'ti8es

Co,yri&ht 2314 C*A !nstit(te 1>

!nde,endently*loatin& Rate

Re&ime

Pe&&edSystem

*i/edE/'han&e

Rate Re&ime


16/25

EXCHANGE RATE REG!MES

egime !0pe $escriptionNo se,arate le&altender

*i/ed #ollariIation Use another nation’s '(rren'y as themedi(m o% e/'han&e 6US#7

Shared '(rren'y *i/ed Monetary (nion Use a '(rren'y o% a &ro(, o%'o(ntries as the medi(m o% e/'han&e

C(rren'y -oardsystem

*i/ed Use another '(rren'y in reser8e as the monetary-ase. maintainin& a %i/ed ,arity

*i/ed ,arity or %i/edrate system

*i/ed Use another '(rren'y or -as$et o% '(rren'ies inreser8e. -(t +ith some dis'retion 6,arity -ands7

Tar&et Ione *i/ed *i/ed ,arity 6,e&7 +ith %i/ed horiIontal inter8ention

-ands

Co,yri&ht 2314 C*A !nstit(te 1=


17/25

EXCHANGE RATE REG!MES

Co,yri&ht 2314 C*A !nstit(te 1D

egime !0pe $escription

A'ti8e and ,assi8e'ra+lin& ,e&s

Pe& Ad(st the e/'han&e rate a&ainst a sin&le'(rren'y. +ith ad(stments %or in%lation 6,assi8e7or anno(n'ed in ad8an'e 6a'ti8e7

*i/ed ,arity +ith

'ra+lin& -ands

Pe& Similar to tar&et Ione. -(t -ands 'an -e +idened

Mana&ed %loat *loat Allo+ e/'han&e rate to %loat. -(t inter8ene tomana&e it to+ard tar&ets

!nde,endently%loatin& rates

*loat E/'han&e rate is mar$et determined 6s(,,ly anddemand7


18/25

> EXCHANGE RATES. !NTERNAT!"NA@ TRA#E.

AN# CAP!TA@ *@"S

0 The net e%%e't o% im,orts and e/,orts a%%e'ts a 'o(ntry’s 'a,ital %lo+s

Trade de%i'it Ca,ital a''o(nt s(r,l(s

Trade s(r,l(s Ca,ital a''o(nt de%i'it

0 Usin& the national a''o(nts relationshi,. +e see the relationshi, -et+een trade and

e/,endit(res:sa8in&s and ta/es:&o8ernment s,endin&

0 The ,otential %lo+ o% %inan'ial 'a,ital in or o(t o% a 'o(ntry is miti&ated -y 'han&es in

asset ,ri'es and e/'han&e rates


X M ; 6S I 7 6T G7

E/,orts less im,orts

Sa8in&s lessin8estment

Ta/es less &o8ernment

s,endin&

Trade s(r,l(s or de%i'it

*is'al s(r,l(s or de%i'it


19/25

EXCHANGE RATES AN# TRA#E

There are t+o theories on the e/'han&e rate:trade relationshi,

1 Marshall@erner theory

) The e%%e'ti8eness o% '(rren'y de8al(ations or de,re'iation on trade de,ends

on the ,ri'e sensiti8ities 6that is. ,ri'e elasti'ities7 o% the &oods and ser8i'es

) !% the &oods and ser8i'es are hi&hly elasti'. trade res,onds to de8al(ation or

de,re'iation. im,ro8in& the domesti' e'onomy

) !% the &oods and ser8i'es are inelasti'. trade is less res,onsi8e to

de8al(ation or de,re'iation

2 The A-sor,tion A,,roa'h

) !% there is de8al(ation or de,re'iation. this 'han&e in the e/'han&e rate m(st

in'rease in'ome relati8e to e/,endit(res to im,ro8e the e'onomy

) This a%%e'ts national in'ome thro(&h the +ealth e%%e't more sa8in&s and

-(yin& %inan'ial assets %rom %orei&ners



20/25

C"NC@US!"NS AN# SUMMARY

0 The %orei&n e/'han&e mar$et is -y %ar the lar&est %inan'ial mar$et in the +orld !thas im,ortant e%%e'ts. either dire'tly or indire'tly. on the ,ri'in& and %lo+s in all

other %inan'ial mar$ets

) There is a +ide di8ersity o% &lo-al *X mar$et ,arti'i,ants that ha8e a +ide

8ariety o% moti8es %or enterin& into %orei&n e/'han&e transa'tions

0 !ndi8id(al '(rren'ies are (s(ally re%erred to -y standardiIed three)'hara'ter'odes These '(rren'y 'odes 'an also -e (sed to de%ine e/'han&e rates 6the

,ri'e o% one '(rren'y in terms o% another7 There are a 8ariety o% e/'han&e rate

(otin& 'on8entions

) A dire't '(rren'y (ote ta$es the domesti' '(rren'y as the ,ri'e '(rren'y and

the %orei&n '(rren'y as the -ase '(rren'y

) An indire't (ote (ses the domesti' '(rren'y as the -ase '(rren'y

) To 'on8ert -et+een dire't and indire't (otes. in8ert the (ote

) *X mar$ets (se standardiIed 'on8entions %or (otin& e/'han&e rate %or

s,e'i%i' '(rren'y ,airs



21/25


0 C(rren'ies trade in %orei&n e/'han&e mar$ets -ased on nominal e/'han&erates An in'rease in the e/'han&e rate. (oted in indire't terms. means that

the domesti' '(rren'y is a,,re'iatin& 8ers(s the %orei&n '(rren'y

0 The real e/'han&e rate meas(res the relati8e ,(r'hasin& ,o+er o% the

'(rren'ies An in'rease in the real e/'han&e rate im,lies a red('tion in the

relati8e ,(r'hasin& ,o+er o% the domesti' '(rren'y

0 Gi8en e/'han&e rates %or t+o '(rren'y ,airs A:B and A:C +e 'an 'om,(te

the 'ross)rate 6B:C 7 -et+een '(rren'ies B and C

0 S,ot e/'han&e rates are %or immediate settlement 6ty,i'ally. T 27. +hereas

%or+ard e/'han&e rates are %or settlement at a&reed)on %(t(re dates

0 *or+ard rates 'an -e (sed to mana&e %orei&n e/'han&e ris$ e/,os(res or 'an-e 'om-ined +ith s,ot transa'tions to 'reate *X s+a,s



22/25


0 The s,ot e/'han&e rate. the %or+ard e/'han&e rate. and the domesti' and%orei&n interest rates m(st ointly satis%y an ar-itra&e relationshi, that e(ates

the in8estment ret(rn on t+o alternati8e -(t e(i8alent in8estments

0 *or+ard rates are ty,i'ally (oted in terms o% %or+ard ,oints The ,oints are

added to the s,ot e/'han&e rate to 'al'(late the %or+ard rate

0 The -ase '(rren'y is said to -e tradin& at a %or+ard ,remi(m i% the %or+ard rateis hi&her than the s,ot rate 6that is. %or+ard ,oints are ,ositi8e7 Con8ersely. the

-ase '(rren'y is said to -e tradin& at a %or+ard dis'o(nt i% the %or+ard rate is

less than the s,ot rate 6that is. %or+ard ,oints are ne&ati8e7

0 The '(rren'y +ith the hi&her interest rate +ill trade at a %or+ard dis'o(nt

0 Points are ,ro,ortional to the s,ot e/'han&e rate and to the interest ratedi%%erential and a,,ro/imately ,ro,ortional to the term o% the %or+ard 'ontra't

0 Em,iri'al st(dies s(&&est that %or+ard e/'han&e rates may -e (n-iased

,redi'tors o% %(t(re s,ot rates. -(t the mar&in o% error on s('h %ore'asts is too

lar&e %or them to -e (sed in ,ra'ti'e



23/25


0 Virt(ally e8ery e/'han&e rate is mana&ed to some de&ree -y 'entral -an$sThe ,oli'y %rame+or$ that ea'h 'entral -an$ ado,ts is 'alled an We/'han&e

rate re&ime

0 An ideal '(rren'y re&ime +o(ld ha8e three ,ro,erties

1 The e/'han&e rate -et+een any t+o '(rren'ies +o(ld -e 'redi-ly %i/ed

2 All '(rren'ies +o(ld -e %(lly 'on8erti-le and

? Ea'h 'o(ntry +o(ld -e a-le to (nderta$e %(lly inde,endent monetary ,oli'y

in ,(rs(it o% domesti' o-e'ti8es. s('h as &ro+th and in%lation tar&ets

0 The !M* identi%ies the %ollo+in& ty,es o% re&imes dollariIation. monetary (nion.

'(rren'y -oard. %i/ed ,arity. tar&et Ione. 'ra+lin& ,e&. 'ra+lin& -and.

mana&ed %loat. and inde,endent %loat

) Most maor '(rren'ies traded in *X mar$ets are %reely %loatin&. al-eit s(-e't

to o''asional 'entral -an$ inter8ention

Co,yri&ht 2314 C*A !nstit(te 2?


24/25


0 Any %a'tor that a%%e'ts the trade -alan'e m(st ha8e an e(al and o,,ositeim,a't on the 'a,ital a''o(nt. and 8i'e 8ersa

0 The im,a't o% the e/'han&e rate on trade and 'a,ital %lo+s 'an -e analyIed

%rom t+o ,ers,e'ti8es

1 The elasti'ities a,,roa'h %o'(ses on the e%%e't o% 'han&in& the relati8e

,ri'e o% domesti' and %orei&n &oods This a,,roa'h hi&hli&hts 'han&es inthe 'om,osition o% s,endin&

2 The a-sor,tion a,,roa'h %o'(ses on the im,a't o% e/'han&e rates on

a&&re&ate e/,endit(re:sa8in& de'isions



25/25


0 The elasti'ities a,,roa'h leads to the Marshall@erner 'ondition. +hi'hdes'ri-es 'om-inations o% e/,ort and im,ort demand elasti'ities s('h that

de,re'iation o% the domesti' '(rren'y +ill mo8e the trade -alan'e to+ard

s(r,l(s and a,,re'iation +ill lead to+ard a trade de%i'it

0 The idea (nderlyin& the Marshall@erner 'ondition is that demand %or im,orts

and e/,orts m(st -e s(%%i'iently ,ri'e sensiti8e so that an in'rease in the

relati8e ,ri'e o% im,orts in'reases the di%%eren'e -et+een e/,ort re'ei,ts and

im,ort e/,endit(res

) !% there is e/'ess 'a,a'ity in the e'onomy. then '(rren'y de,re'iation 'an

in'rease o(t,(t:in'ome -y s+it'hin& demand to+ard domesti'ally ,rod('ed

&oods and ser8i'es

) !% the e'onomy is at %(ll em,loyment. then '(rren'y de,re'iation m(st red('e

domesti' e/,endit(re to im,ro8e the trade -alan'e

Co,yri&ht 2314 C*A !nstit(te 2>

Economics Investment Chapter 9

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