foreign exchange rate (2).pptx

8/14/2019 foreign exchange rate (2).pptx

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Foreign exchange market

International trade

Chapter -7

Lecture- 6


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Determination of exchange rates

Meaning of foreign exchange rate

It is the price of one currency in terms of others. It

is the rate at which exports and imports of a nation

are valued at a given point in time.


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It is the market where the national currencies are

traded for one another. It performs mainly three

functions:1. To transfer the purchasing power between

countries.

2. To provide credit channels for foreign trade.3. To protect against foreign exchange rate.


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Who needs foreign exchange market?

When people wish to operate in the foreign

exchange market they intend to buy or sell foreign

exchange depending on their demand for and

supply of foreign exchange.


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Demand side

People desire to have or acquire foreign exchange

for the following reasons:1. To purchase goods and services from other

countries.

2. To send a gift aboard or make a visit aboard.3. To purchase financial assets in a particular

country

4. To speculate on the value of foreign currencies.


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Supply side

Foreign currencies flow into the domestic

economy due to the following:1. Foreigners purchasing home ,countries goods

and services through export.

2. Joint venture or through financial marketoperations.

3. Currency dealers and speculators.

4. Visiting domestic territory and sending gift.


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Determination theory

exchange rate movements affect a nation's trading

relationships with other nations.

A higher currency makes a country's exports more

expensive and imports cheaper in foreign markets;

a lower currency makes a country's exports cheaper

and its imports more expensive in foreign markets.


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Purchasing power parity (PPP)

1.Purchasing power parity(PPP) is an economic theory

and a technique used to determine the relative value of

currencies estimating the amount of adjustment needed on

the exchange rate between countries in order for theexchange to be equivalent to (or on par with) each

currency's purchasing power.

It asks how much money would be needed to purchase the

same goods and services in two countries, and uses that to

calculate an implicit foreign exchange rate. Using that PPP

rate, an amount of money thus has the same purchasing

power in different countries.


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Purchasing power parity (PPP)

The relative version of PPP is calculated as:

S= P1/P2

Where:"S" represents exchange rate of currency 1 to

currency 2

"P1" represents the cost of good "x" incurrency 1

"P2" represents the cost of good "x" in

currency 2


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Interest rates

2. The international Fisher effect is a hypothesisin international finance that suggests differences in nominal

interest rates reflect expected changes in the spot exchange

rate between countries.

The hypothesis specifically states that a spot exchange rate

is expected to change equally in the opposite direction of

the interest rate differential; thus, the currency of the

country with the higher nominal interest rate is expected todepreciate against the currency of the country with the

lower nominal interest rate, as higher nominal interest rates

reflect an expectation of inflation


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Interest rates

The Fisher equation is

r= R-I

This means, the real interest rate (r) equalsthe nominal interest rate (R) minusexpected inflation rate(I)


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Interest rates

The nominal interest rate is the interest rate you hearabout at your bank. If you have a savings account for

instance, the nominal interest rate tells you how fast the

number of dollars in your account will rise over time. The

real interest rate corrects the nominal interest rate for the

effect of inflation in order to tell you how fast

the purchasing power of your savings account will rise

over time.

Real interest rate = Nominal Interest Rate - Expected

Inflation Rate Nominal Interest Rate = Real interest Rate

+ Expected Inflation Rate


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Other considerations

3. Confidence in the currency-saving tendency by

customer.

4. Technical factors- seasonal demand for currency, the

slight strengthening of a currency followed by a

prolonged weakness etc.


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Exchange control methods

Meaning of exchange control methods: exchange control

refers to a governments inter in the foreign exchange

market. In other words, it means legal restrictions on the

business involving foreign exchange and its sale and

purchase in the national market. It is government

domination in the foreign exchange market.

In the words of Haberler, Exchange control is the state

regulation excluding the free play of economic forces

from the free play of foreign exchange marketSumming

up, exchange control is a, method of influencing

international trade, investment and the payments

mechanism.


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Unilateral Methods

(A)Unilateral methods are those methods of exchange

control which are adopted by the government of a

country without any consultation or understanding

with any other country. The main methods under thishead are as follows:

1. Exchange pegging.

2. Exchange Equalization Account.

3. Clearing Agreement

4. Stand still Agreement.

5. Compensation Agreement.


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Unilateral Methods

6. Blocked Accounts.

7. Payment Agreements.

8. Rationing of Foreign exchange

9. Multiple Exchange Rates


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Bilateral or Multilateral Methods

(B) Bilateral or Multilateral Methods.

When two or more than two countries decide to adopt

certain measures for stabilizing the rates of exchange

between them, these are called bilateral or

multilateral methods. The main methods are:-

1. Clearing Agreements.2. Transfer Moratoria

3. International Liquidity.

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