chap. 13 - Note: These notes should at best be considered...

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Note: These notes should at best be considered the outline or summary of lectures delivered in class. Class lectures contain much more material than these notes indicate . Foreign Exchange Foreign exchange: the price of one currency in terms of another country’s currency – e.g., how many Mexican pesos (MP) once can obtain in exchange for $1? In turns out that $1 buys about 13.33 MPs. Or: 1 MP costs $.075. Spot price (rate): the exchange rate when payment and delivery of the foreign exchange (forex) are made now. Forward price: the rate on forex when delivery and payment are made in the future. It would be coincidental if the spot and forward (futures) prices are the same; at the same time, the difference tends to be rather small. Forex should be viewed as a commodity or, better, as an asset. Recall: currency is a medium of exchange – thus forex is a means of trade as well. When the dollar appreciates relative to other currencies, it means the more of the forex can be obtained per dollar – or that each unit of a foreign currency can buy fewer dollars. What about when the dollar depreciates? When the $ appreciates, foreign-made goods cost less in the US – and to an American traveler visiting abroad costs less (meals and hotels cost less, as do merchandise one buys abroad). This makes foreign exporters to the US better off – when they convert their dollars into their local currency, they end up with more of their local currency. By the same token, American exporters find it less profitable. Also: US sellers into the US markets now face more price competition. Of course, things are reversed if the US$ depreciates. Determination of Forex rates: Means of trade: In the long-run (LR) the difference in export and imports help determine exchange rates – e.g., if the US imports more than it exports for years, and the payment is made in US$ (as it is), then the supply of dollars would rise relative to the demand for $, putting downward pressure on the $. But this takes a very long time for larger economies to develop. Part of the reason is that exports and imports amount to a small fraction of the total value of forex market. The US imports around $1.9-bill per
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chap. 13 - Note: These notes should at best be considered...

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