IIF-Seminar on Forex

IIF-Seminar on Forex - Lecture 4 The foreign exchange...

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1 Lecture 4: The foreign exchange market and Exchange Rate Policy See Connolly (2007), International Business Finance, Chapter 3   Sushanta Mallick Queen Mary, University of London [email protected]
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2 Outline FX Market: Determinants and Functions Exchange rate definitions: Spot and forward rates Measuring Exchange Rate Movements Equilibrium Exchange Rates Factors that influence Exchange Rates Government Controls Speculating on Anticipated Exchange Rates Models of Exchange Rate Determination Financial Crises in emerging markets
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3 Key issues Explain how exchange rate movements are measured Examine how the supply and demand for any  currency can be viewed as an asset choice issue  within the portfolio of investors Explain how the equilibrium exchange rate is determined Examine factors that determine the equilibrium exchange  rate Explore how the three major approaches to  exchange rate determination – parity conditions, the  balance of payments, and the asset approach –  combine to explain in part the currency crises  experienced in Asia and Latin America
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4 Definitions The exchange rate is the price of one currency in terms of another It can be expressed as the foreign currency price of the domestic currency one pound costs €1.4925 – typically used in UK Or the domestic currency price of foreign currency one euro costs £0.67 Basic Movements in Rates - when one currency  depreciates against another, the other must  appreciate.
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5 Spot & Forward Rates and Cross- Rates The spot rate is the quote for immediate delivery of foreign exchange although there is usually a one or two-day settlement lag The forward exchange rate is for delivery at any later date forward quotes are available easily at 30 day, 90 day, 180 day and 360 day horizons and at any other date by bilateral negotiation Exchange rates are usually quoted and traded against a reference currency (aka vehicle currency) the US dollar is most widely used reference currency now it used to be the pound and may become the euro A cross rate is an exchange rate not involving the usual reference currency e.g. yen per pound Cross rates are typically determined via the reference currency yen per pound = yen per dollar times dollars per pound But may be an independently traded rate (e.g. pounds per euro)
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6 Exchange rate Nominal exchange rate – the rate at which we can trade the currency of one country for the currency of another Nominal rates are those quoted in newspapers and on  trading screens, often with a bid-ask spread e.g.  1.4924 - 1.4926 Real exchange rate – the rate at which we can trade the goods and services of one country with the goods and services of another Measures the price of a basket of goods and services available
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