ExchangeRates

ExchangeRates - Open Economy Macroeconomics Exchange rates...

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1 Open Economy Macroeconomics Exchange rates “Democrats flex their muscles over yen” Claims by powerful US Democrats that Tokyo is deliberately keeping its currency weak to encourage exports shows that the new leaders in the House of Representatives are ready to expand their range of economic targets beyond Beijing. Financial Times, February 9, 2007. “S Korean exporters express their concern” The weakness of the yen has drawn concern from South Korean exporters, especially carmakers such as Hyundai Motor, as they struggle to compete against Japanese rivals in overseas markets. Financial Times, February 9, 2007. The weakness of the Yen a year ago’
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2 On the other hand: “Mazda earnings soar on yen” Mazda Motor Corp. posted a 7.5 percent rise in quarterly profit Thursday, powered by the yen's slide and increased exports to North America and Europe . CNNMoney.com, February 8, 2007 The Foreign Exchange Market z Exchange rate: Price of one nation’s money in terms of another nation’s money. Spot exchange rate : price for immediate exchange. Forward exchange rate : price for an exchange that will take place sometime in the future. Other currency prices : futures, swaps, options.
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3 Exchange rate determination The market for British Pounds against US Dollars 1.95 S £ D £ 300 2.05 320 Billions of £ The demand comes from anyone who wants to buy Pounds. For example, US importers of goods from England; US investors who want to buy British Bonds or stocks of British companies. The supply comes from anyone who wants to sell Pounds. For example, US exporters who invoiced their deliveries to England in Pounds; British investors who wants to buy US treasury Bills or stocks of US companies. $ per £ What makes prices of currencies consistent in different markets or traders? z Arbitrage Purchase Pounds with Dollars in London; Sell Pounds for Dollars in New York. z Triangular arbitrage Purchase Euro with Dollars in Frankfurt; Sell Euro for Pounds in London; Sell Pounds for Dollars in New York.
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4 For Nom P P e RER = RER = Real exchange rate e Nom = Nominal exchange rate (Foreign currency needed to buy one unit of domestic currency) P = Domestic price P For = Foreign price Real Exchange Rate: The price of domestic goods relative to foreign goods The Purchasing Power Parity Theory (PPP) posits that foreign and domestic (basket of) goods should have the same price. That is, the real exchange rate should be 1 (RER=1) and the nominal exchange rate is only determined by the relative price Purchasing Power Parity (PPP) This is also called Law of One Price . P P e For Nom =
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5 z Goods are tradable. Households’ services like house cleaning are not tradable. Transatlantic transportation is tradable because it can be
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ExchangeRates - Open Economy Macroeconomics Exchange rates...

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