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Exchange Rates

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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Exchange Rates

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  1. Exchange Rates Chapter 8

  2. 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

  3. Economic exposure Transaction risk Translation risk Spot versus forward exchange rates Exposure to exchange rate risks

  4. Figure 8.2 Some exchange rates; daily data, 2000 – 2011 Data source: www.federalreserve.gov

  5. Figure 8.3 Australia – USA; spot and forward exchange rates of US dollar, 1976-2011 Data source: IFS.

  6. Arbitrage (Table 8.3) Players and markets Forward exchange rates and hedging Trading volume (Fig. 8.4)

  7. Figure 8.4 Global foreign exchange market turnover, 1998 – 2010 Data source: BIS (2010), triennial central bank survey

  8. 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.

  9. Exchange rates and prices Effective exchange rates

  10. Figure 8.6 Exchange rates and prices, 1960-2009 Calculations based on World Development Indicators online; 64 observations; the line has a 45 slope.

  11. Figure 8.7 Exchange rates and intervention

  12. 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

  13. Figure 8.9 US dollar: effective exchange rates, 1973-2011 Data source: www.federalreserve.gov

  14. Figure 8.9 US dollar: effective exchange rates, 1973-2011 Data source: www.federalreserve.gov

  15. Figure 8.10 Out-of-sample exchange rate forecasting Data source: Meese and Rogoff (1983)

  16. 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

  17. Figure 8.12 UK; interest rates and term structure, 1980-2011 Data source: IFS; 3 and 6 month Paris Interbank Offer rate

  18. 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

  19. Figure 8.13 Two investment options

  20. (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

  21. 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

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