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Exchange Rate Determination. International Business (MB 40). Outline. Defining Exchange Rate Measuring Exchange Rate Movements Appreciation/Depreciation of a currency Exchange Rate Equilibrium Factors that influence Exchange Rate Movements.

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Exchange rate determination

Exchange Rate Determination

International Business (MB 40)


Outline
Outline

  • Defining Exchange Rate

  • Measuring Exchange Rate Movements

    • Appreciation/Depreciation of a currency

  • Exchange Rate Equilibrium

  • Factors that influence Exchange Rate Movements


Meaning of exchange rate and measuring changes in exchange rates
Meaning of Exchange Rate and Measuring Changes in Exchange Rates

  • Value of one currency in units of another currency

  • A decline in a currency’s value is referred to as depreciation and an increase in currency’s value is called appreciation.

  • If currency A can buy you more units of foreign currency, currency A has appreciated and foreign currency depreciated

  • If currency A can buy you less units of foreign currency, currency A has depreciated and foreign currency appreciated


Exchange rate equilibrium
Exchange Rate Equilibrium Rates

  • Forces of Demand and Supply

  • Demand for foreign currency negatively related to the price of foreign currency

  • Supply of foreign currency positively related to the price of foreign currency

  • Forces of demand and supply together determine the exchange rate


Factors that influence the exchange rate
Factors that influence the Exchange Rate Rates

  • Political Events

  • Expectations of the Market

  • Relative Inflation Rates

  • Relative Interest Rates

  • Relative Income Levels

    Exchange rate is the results of an interaction of these factors


Political events
Political Events Rates

  • Fall of Berlin Wall and unification of East and West Germany

  • Rumors about resignation of Mikhail Gorbachov

  • Tiannanmon Square

  • Persian Gulf War

  • September 11, 2001


Market expectations
Market Expectations Rates

  • Expectations about future exchange rate changes on the basis of current and future political and economic conditions

  • 1960s Strong $

  • Between 1960s and 1970s: weak $

  • Strong $ now

  • 1995 European Exchange Rate Mechanism

  • Devaluation of Asian Currencies


Relative inflation
Relative Inflation Rates

  • High inflation relative to a foreign country, decline in value of currency—Why?

  • Low inflation relative to a foreign country, increase in value of currency—Why?


Relative interest rates
Relative Interest Rates Rates

  • High interest rates in home country relative to a foreign country may cause domestic currency to appreciate—Why?


Relative income levels
Relative Income Levels Rates

  • Increase in domestic income relative to foreign income may lead to a decline in the value of domestic currency– Why?


Exchange rate determination1
Exchange Rate Determination Rates

  • An interaction of factors

  • Is it possible for a country with high real returns to have a low currency value?


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