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International Economics

International Economics. Chapter 10 Exchange Rates and The Foreign Exchange Market. Main Contents Exchange rates and international transition The foreign exchange market The demand for foreign currency assets Equilibrium in the foreign exchange market.

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International Economics

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  1. International Economics

  2. Chapter 10 Exchange Rates and The Foreign Exchange Market Main Contents Exchange rates and international transition The foreign exchange market The demand for foreign currency assets Equilibrium in the foreign exchange market

  3. Key terms appreciation depreciation exchange rate rate of appreciation forward exchange rate spot exchange rate interbank trading interest parity condition liquidity risk rate of return vehicle currency real rate of return interest rate arbitrage

  4. Dynamic definition Ⅰ. Exchange rates and international transition ⅰ. Foreign Exchange Static definition • ⅱ.Exchange rate • Conception: P329 • Two kinds quotations Direct quotation ＄ 0.009198 per yen Indirect quotation ￥ 108.72 per dollars

  5. 台幣汇率 2004/12/114:33

  6. How to calculate cross rate? Suppose 3 currencies: A, B and C. (Ａ/Ｃ)/(Ｂ/Ｃ)＝Ａ/Ｂ For example, someday on New York foreign exchange market, 1French Franc=0.25 dollar， 1French Franc=0.57DMThen, 1dollar＝0.57DM／0.25dollar＝2.28DM or    1DM＝0.25dollar／0.57DM＝0.44dollar

  7. Appreciation:A rise in the pounds in terms of dollars is an appreciation of the pound against the dollar. Depreciation:A fall in the dollar price of pounds is a depreciation of the pound against the dollar. c.Two changes in exchange rate ＄ 1.50 per pound ＄ 1.25 per pound pound: depreciation dollar:appreciation ＄ 1.50 per pound ＄ 1.75 per pound pound: depreciation dollar:appreciation

  8. Basic rate(key currency, pegged currency Cross rate d.Classification of exchange rate Buying rate Selling rate Middle rate=(buying rate+selling rate) ÷ 2 Spot rate Forward rate

  9. 交叉匯率表 美元 英鎊 加幣 日圓 法郎 瑞郎 馬克 歐元 澳幣 台幣 人民幣 美元 - 0.522 1.187 102.750 4.923 1.137 1.468 0.751 1.286 32.186 8.276 英鎊 1.913 - 2.271 196.570 9.421 1.913 2.809 1.436 2.464 61.659 15.854 加幣 0.842 0.440 - 86.540 4.147 0.957 1.236 0.633 1.083 27.115 6.972 日圓 0.010 0.005 0.012 - 0.056 0.011 0.014 0.007 0.013 0.313 0.081 法郎 0.142 0.095 0.217 16.221 - 0.232 0.000 0.153 0.261 6.538 1.681 瑞郎 0.879 0.460 1.044 90.400 4.330 - 1.291 0.661 1.131 28.308 7.279 馬克 0.496 0.331 0.808 69.970 0.000 0.774 - 0.512 0.876 21.925 5.638 歐元 1.331 0.696 1.581 136.850 6.553 1.514 1.954 - 1.712 42.840 11.020 澳幣 0.777 0.406 0.923 79.899 3.828 0.884 1.142 0.584 - 25.028 6.435 台幣 0.031 0.016 0.037 3.192 0.153 0.035 0.046 0.023 0.040 - 0.257 人民幣 0.121 0.063 0.143 12.415 0.595 0.137 0.177 0.091 0.155 3.889 -

  10. ⅲ.Exchange rate and international transition a. Domestic and foreign prices (＄ 1.50 /￡)× (￡50)= ＄75 (＄ 1.25 /￡)× (￡50)= ＄62.50 (＄ 1.75 /￡)× (￡50)= ＄87.50 Conclusion:P331-332 b.Exchange rates and relative prices Table13-2 Conclusion

  11. Ⅱ. The foreign exchange market ⅰ. Conception P333 ⅱ. The actors a. commercial banks b.corporations c.non-bank financial institutions d.central banks ⅲ. Characteristics of the market a.two conceptions: arbitrage; vehicle currency b.characteristics

  12. Apple computer ⅳ.Deals on the foreign exchange marketa. Spot rates and forward rates pound account dollar account Wells Fargo National Westminister Banks dollars pounds Spot Rates Bank of America

  13. ￥9000 ＄100 30 days later ＄0.0105/yen 9000× 0.0105=94.50 +$5.50 ＄0.0115/yen 9000× 0.0115=103.50 －$3.50 ＄0.0107/yen 9000× 0.0107=96.30 +$3.70 Forward Rates

  14. ＄1 million b. Foreign exchange swaps multinational company Swiss Francs suppliers ＄1 million in three months

  15. put option call option Long Hedge / Buying Hedge c.Futures and options Hedging Short Hedge / Selling Hedge Speculation

  16. Ⅲ. The demand for foreign currency assets ⅰ. Assets and asset returns a. defining asset returns dollar rate of return (nominal rate of return) real rate of return

  17. b.three factors influencing asset returns Dollar rate of return inflation Real rate of return Risk Liquidity asset returns

  18. ⅱ.Interest rate, exchange rate and asset returns 5 steps Example: $1.1/€ $1.165/ € €: 5% $: 10% step 1: $1.1/€ €1=$1.1 step 2: €1 5% €1.05 step3: €1.05× $1.165/ €=$1.223 step4: (1.223—1.10)/1.10=11% step5: 11%>10% Conclusion: euro deposit offers the higher return.

  19. Question: $0.7/DM $0.76/ DM RDM: 5% R$: 10% Which offers the higher rate of returns?

  20. A simple rule R€ :today’s interest rate on one-year euro deposits R$ : today’s interest rate on one-year dollar deposits E$/€ : today’s dollar/euro exchange rate Ee$/€ : dollar/euro exchange rate expected to prevail a year from today The expected rate of return on a euro deposit in terms of dollar=R€ +(Ee$/€ -- E$/€ )/ E$/€

  21. R$ -- [ R€ +(Ee$/€ -- E$/€ )/ E$/€ ] Positive : dollar Negative: euro Zero: same Same Question: E$/DM =$0.7/DM Ee$/DM=$0.76/ DM RDM: 5% R$: 10%

  22. Ⅳ. Equilibrium in the foreign exchange market ⅰ.The basic equilibrium condition -----------Interest Parity Conception Formula R$ = [ R€ +(Ee$/€ -- E$/€ )/ E$/€ ]

  23. ⅱ.Determination of the equilibrium dollar/euro exchange rate R$ = [ R€ +(Ee$/€ -- E$/€ )/ E$/€ ] E$/€ = Ee$/€/ (R$ -- R€ +1) R$ E$/€ Ee$/€ R€

  24. E$/€ R$ E$/€ R*€ R*€ R$ E$/€ E*$/€ R*€

  25. the return on dollar deposits is higher that on euro deposits. No one would demand for euro deposits Excess demand for dollar Excess supply of euro The dollar/euro exchange rate falls towards E1$/€ a. At point 2 R$ E$/€ 2 E2$/€ 1 E1$/€ R*€

  26. b. At point 3 Return on dollar deposits the return on dollar deposits is lower that on euro deposits. E$/€ No one would demand for dollar deposits 2 E2$/€ 1 E1$/€ Excess demand for euro Excess supply of dollar E3$/€ 3 The dollar/euro exchange rate falls towards E1$/€ Rate of return (in dollar terms)

  27. c. At point 1: equilibrium the return on dollar deposits is as same as that on euro deposits. No excess demand for euro and dollar No excess supply Excess of dollar The dollar/euro exchange rate falls towards E1$/€

  28. ⅳ.Interest rates and equilibrium A rise in the interest rate on dollars A rise in the interest rate on euro conclusion

  29. At point 1, Dollar appreciation R$ >R* € E1 $/€E2 $/€ New equilibrium point 2 R`$ R$ E$/€ 1` 1 E1$/€ 2 E2$/€ R* €

  30. R€ ⅠⅡ At point 1, Dollar depreciation R$ <R*€ E1$/€E2$/€ New equilibrium point 2 R$ E$/€ 2 E2$/€ Ⅱ 1 E1$/€ Ⅰ R*€ Conclusion : P347

  31. ⅴ. The expected exchange rate and equilibrium Current exchange rate: $1.00/€ Future exchange rate: $1.05/€ The expected rate of dollar depreciation =(1.05—1.00)/1.00=5% Future exchange rate: $1.06/€The expected rate of dollar depreciation =(1.05—1.00)/1.00=5% Conclusion : P350

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