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Chapter 18

Chapter 18. International Finance and Exchange Rates. Chapter Outline. International Financial Transactions Foreign Exchange Markets Alternative Foreign Exchange Systems Determinants of Exchange Rates. Balance of Payments.

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Chapter 18

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  1. Chapter 18 International Finance and Exchange Rates

  2. Chapter Outline • International Financial Transactions • Foreign Exchange Markets • Alternative Foreign Exchange Systems • Determinants of Exchange Rates

  3. Balance of Payments • Balance of Payments: the accounting system for how money moves between countries to facilitate the purchase of goods, services, financial instruments, and physical investments. • Current Account:The portion of the Balance of Payments accounting that represents that impacts of trade, short-term investment payments, and American payments of foreign taxes, foreign payments of American taxes, and the net transfer of private money. • The Capital Accountrepresents the changes in holding of longer term financial and physical assets by citizens of one country in another country.

  4. Balance of Payments United States, 2009($ millions)

  5. Current Account Mirrors the Balance of Trade

  6. Foreign Purchases of US Assets & US Purchases of Foreign Assets

  7. Trade Requires Currency • Trade between countries is beneficial. • International trade requires that the currency of the trading partners be exchanged. • The market where people come to trade currencies is called the foreign exchangemarket. • E.g. the production and export of a radio can require several currency transactions.

  8. Foreign Exchange Markets • The demand for a currency (say the dollar) is also the supply of the other currency (say the yen). • The supply for a currency (say the dollar) is also the demand of the other currency (say the yen).

  9. Modeling Foreign Exchange Price of Yuan in U.S. dollars A curve which represents the willingness of those who have Yuan to trade them for U.S. dollars equilibrium exchange rate A curve which represents the willingness of those who have Yuan to trade them for U.S. dollars Quantity of Yuan

  10. Various Exchange Rates

  11. Various Exchange Rates

  12. Alternative Foreign Exchange Systems • Floating exchange rate system: a system whereby markets determine the value of a currency relative to all other currencies. • Fixed exchange rate system : a system whereby a government sets the value of a currency relative to all other currencies and uses its reserve of foreign currencies or gold to maintain the exchange rate. • Gold standard:one means by which a country can execute a fixed exchange rate. • Managed Float exchange rate system: a system wherebygovernments decide the range of exchange rates they will allow the market to create, and act only when either the top end or the bottom end of that range is breached.

  13. Price of Yuan in Dollars S1 S2 ERfixed D2 D1 Yuan* Yuan Fixed Exchange Rates

  14. Price of Yuan in Dollars S1 S2 ERceiling ERtarget ERfloor D2 D1 Yuan* Yuan Managed Float

  15. Determinants of Exchange Rates • Desire to hold one currency or another to • Facilitate trade • Facilitate the purchase of financial assets • Interest Rates • Projected Inflation Rates • Relative safety of the currency

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