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IFM_IM_ch04 - Chapter 4 Exchange Rate Determination Lecture...

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Chapter 4 Exchange Rate Determination Lecture Outline Measuring Exchange Rate Movements Exchange Rate Equilibrium Demand for a Currency Supply of a Currency for Sale Equilibrium Factors That Influence Exchange Rates Relative Inflation Rates Relative Interest Rates Relative Income Levels Government Controls Expectations Interaction of Factors Speculating on Anticipated Exchange Rates 35
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36 International Financial Management Chapter Theme This chapter provides an overview of the foreign exchange market. It is designed to illustrate (1) why a market exists, and (2) why exchange rates change over time. Topics to Stimulate Class Discussion 1. Why are MNCs affected by exchange rate movements? 2. Why did exchange rates change recently? 3. Show the class a current exchange rate table from a periodical—identify spot and forward quotations. Then show the class an exchange rate table from a date a month ago, or three months ago. The comparison of tables will illustrate how exchange rates change, and how forward rates of the earlier date will differ from the spot rate of the future date for a given currency. 4. Make up several scenarios and ask the class how each scenario would, other things equal, affect the demand for a currency, the supply of a currency for sale, and the equilibrium exchange rate. Then integrate several scenarios together to illustrate that in reality other things are not held constant, which makes the assessment of exchange rate movements more difficult. POINT/COUNTER-POINT: How Can Persistently Weak Currencies Be Stabilized? POINT: The currencies of some Latin American countries depreciate against the U.S. dollar on a consistent basis. The governments of these countries need to attract more capital flows by raising interest rates and making their currencies more attractive. They also need to insure bank deposits so that foreign investors who invest in large bank deposits do not need to worry about default risk. In addition, they could impose capital restrictions on local investors to prevent capital outflows. COUNTER-POINT: Some Latin American countries have had high inflation, which encourages local firms and consumers to purchase products from the U.S. instead. Thus, these countries could relieve the downward pressure on their local currencies by reducing inflation. To reduce inflation, a country may have to reduce economic growth temporarily. These countries should not raise their interest rates in order to attract foreign investment, because they will still not attract funds if investors fear that there will be large capital outflows upon the first threat of continued depreciation. WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support? Offer your own opinion on this issue.
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