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Session 19. What Determines Exchange Rate ?. Movements of Exchange Rate. 1. Long-term Trends. The movement of exchange rate over the entire period. 2. Medium-term Trends. The movement of exchange rate over periods of several years. These are sometimes counter to the longer trends.

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Session 19

Session 19

What Determines Exchange Rate ?


Movements of exchange rate
Movements of Exchange Rate

1. Long-term Trends

The movement of exchange rate over the entire period.

2. Medium-term Trends

The movement of exchange rate over periods of severalyears. These are sometimes counter to the longer trends.

3. Short-term Variability

The movement of exchange rate over short periods. These are the exchange rates from month to month (and indeed, from day to day , hour to hour, and evenminute to minute.)


Exchange rates in the short run
Exchange Rates in the Short-run

This depends on the demands and supplies of assets denominated in different currencies.

1. The basic return on the bond itself (the interest rate)

2. The expected gain and loss on the currency exchanges


The role of interest rates
The Role of Interest Rates

Malaysia

What happen to Malaysia currency ?

Bond

Interest = 5%

Thai

Exchange Money

Bond

Interest = 10 %

High Demand for the “Thai” currency will occur.

The amount of “Thai” currency will be reduced from the system.

The value of “Thai” currency will appreciate. ( i.e. from 1 dollar/25 baht to 1 dollar/24)

The value of “Malaysia” currency will depreciate.


The role of the expected future spot exchange rate
The Role of the Expected Future Spot Exchange Rate

Expected FutureSpot Rate

Current Spot Rate

Singapore

Singapore

Hong Kong

Hong Kong

1 USD / 25 SGD

$ 1 USD / 20 SGD

1 USD / 25 HKD

1 USD/ 30 HKD

High Demand for the “Singapore” currency will occur.

The amount of “Singapore” currency will be reduced from the system.

The value of “Singapore” currency will appreciate. ( i.e. from “1 USD /25 SGD” to “1 USD/24 SGD”)


Exchange rates in the long run
Exchange Rates in the Long-run

Price Level

(i.e., + transport cost, tariff, bribe, and etc)

Suppose : $1 = £1 (at the outset)

U.S.

U.K.

Export

= $1

> $1

Export

> £1

= £1

Continue on the next slide


U.S.

Afterward

Importing Price > £1

(Let’s say “£1 + XXX”)

$1 + XXX

U.K.

£1 + XXX

£1

Bank

£1 + XXX


Suppose : 25 Bath = Australia $1 = U.S. $1 (at the outset)

75 baht/ $1AUS

= Australia $1

75 Baht

Australia

U.S.

Thailand

50 Baht

= U.S. $1

50 baht/ $1US


Inflation Rate

U.S.

Thai

= 25 Baht

Export

= $1

= $2

Inflation

= 50 Baht

Thai people buy less

The market system will impact on the exchange rate.

Countries with relatively high inflation rates have currencies whose valuestend to depreciate in the foreign exchange market.(i.e., from “1 dollar/25 baht” to “1 dollar/15 bath”)


U.S.

Thai

= 25 Baht

Deflation

Export

= $1

= $ 0.5

= 12.5 Baht

Thai people buy more

The market system will impact on the exchange rate.

Countries with relatively low inflation rates have currencies whose valuestend to appreciate in the foreign exchange market.(i.e., from “1 dollar/25 baht” to “1 dollar/30 bath”)


15 baht /1 dollars

11 baht/1 dollars

10 baht/1 dollars

The values of baht tend to depreciate.


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