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Exchange Rates. Chapter 8. Figure 8.1 Exchange rates, trade and multinational activity. Firm in Home serve foreign markets / source from abroad?. no. yes, source from abroad. yes, serve foreign market. Stay domestic. Export or local production?. Import or local production?.

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slide2

Figure 8.1 Exchange rates, trade and multinational activity

Firm in Home

serve foreign markets / source from abroad?

no

yes, source from abroad

yes, serve foreign market

Stay

domestic

Export or

local production?

Import or

local production?

export

import

local production

local production

Export

Multinational activity:

horizontal

Multinational activity:

vertical

Import

nature of exchange rate risk

nature of exchange rate risk

Selling in foreign currency

Producing and selling in foreign currency

Producing in foreign currency

Buying in foreign currency

exposure to exchange rate risks
Economic exposure

Transaction risk

Translation risk

Spot versus forward exchange rates

Exposure to exchange rate risks
slide7

Figure 8.3 Australia – USA; spot and forward exchange rates of US dollar, 1976-2011

Data source: IFS.

slide8
Arbitrage (Table 8.3)

Players and markets

Forward exchange rates and hedging

Trading volume (Fig. 8.4)

slide10

Figure 8.4 Global foreign exchange market turnover, 1998 – 2010

Data source: BIS (2010), triennial central bank survey

slide11

Figure 8.5 Most used currencies on the foreign exchange market, 1998 – 2010

Data source: BIS (2010); * Because two currencies are involved in each transaction, the sum of the percentage shares of individual currencies totals 200 percent instead of 100 percent.

slide12
Exchange rates and prices

Effective exchange rates

slide13

Figure 8.6 Exchange rates and prices, 1960-2009

Calculations based on World Development Indicators online; 64 observations; the line has a 45 slope.

slide15

Figure 8.8 De facto exchange rate arrangements, April 30, 2010

Data source: IMF (2010, Appendix II); selected countries listed for each regime, see also Table 23.1

slide18

Figure 8.10 Out-of-sample exchange rate forecasting

Data source: Meese and Rogoff (1983)

slide19

Figure 8.11 Canada; interest rates and inflation rate (CPI), 1970 – 2011

Data source: IFS; bank rate (end of period) and cpi (% change), monthly data

slide20

Figure 8.12 UK; interest rates and term structure, 1980-2011

Data source: IFS; 3 and 6 month Paris Interbank Offer rate

arbitrage and interest parity
Fisher equation:

r = i - π

Covered interest parity (Fig. 8.13)

Equilibrium condition:

[F(1+iUS)/E]L = [(1+iEU)]L

 F/E = (1+iEU)/(1+iUS)

Arbitrage and interest parity
slide23

(BOX 8.4) Figure 8.14 Australia – USA: 12-month covered interest parity

Data source: IFS; shown interest rates are interbank offered rates, 1986-2005

interest parity transaction costs exchange rates and capital mobility
rhome = rforeign + risk + TC

A simple version of uncovered interest parity (UIP) condition:

rhome = rforeign + dE ; TC = 0, risk = dE

Given rforeign ,UIP indicates that in a world of

high degree of capital mobility, the domestic

interest rate can differ from the foreign interest

rate only if the exchange rate is not fixed.

Interest parity, transaction costs, exchange rates, and capital mobility