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THE FOREIGN EXCHANGE MARKET Objectives of the Chapter This chapter deals with the nature and organization of the foreign exchange market. At its most basic, the equilibrium exchange rate can be thought of as the price that equates the international supply of and demand for a country’s money. For example, the exchange rate on the British pound (expressed as American dollars per British pound) would be determined by the supply of pounds arising from British purchases of American goods, services, and assets, and by the demand for British pounds arising from American purchases of British goods, services, and assets. You might want to track a few of the major currencies and related commentaries in the daily listings in the financial press. After studying Chapter 17 you should be able to identify 1. what an exchange rate is. 2. what the reciprocal of the exchange rate means. 3. the organization of the modern foreign exchange market. 4. the distinction between spot and forward exchange rates. 5. determinants of demand and supply for foreign exchange. 6. how a system of flexible foreign exchange rates works. 7. how a system of fixed foreign exchange rates works. Important Concepts Appreciation (depreciation): An increase (decrease) in the market price of a currency under a floating exchange rate system. Fixed exchange rate: A rate whose officially declared value is maintained by central bank intervention. (Also referred to as a pegged exchange rate.) Floating exchange rate: A rate whose value is determined purely by the market forces of supply and demand, with no direct intervention by central banks. (Also referred to as a flexible exchange rate.) Foreign exchange market: A computerized communications network embracing all the major financial centers in the globe, where sellers and buyers of any national money can quickly and efficiently carry out any desired currency exchange. Foreign exchange market When a central bank buys or sells foreign exchange in order to intervention: manipulate or peg the exchange rate. 89
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This note was uploaded on 02/18/2010 for the course ECON 343 taught by Professor Dblack during the Fall '09 term at University of Delaware.

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