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Chapter 20 - Chapter 20-The Foreign Exchange Market Foreign...

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Chapter 20-The Foreign Exchange Market Foreign Exchange I •Exchange rate: price of one currency in terms of another •Foreign exchange market: the financial market where exchange rates are determined •Spot transaction: immediate (two-day) exchange of bank deposits –Spot exchange rate •Forward transaction: the exchange of bank deposits at some specified future date –Forward exchange rate Foreign Exchange II •Appreciation: a currency rises in value relative to another currency •Depreciation: a currency falls in value relative to another currency •When a country’s currency appreciates, the country’s goods abroad become more expensive and foreign goods in that country become less expensive and vice versa •Over-the-counter market mainly banks Exchange Rates in the Long Run •Law of one price •Theory of Purchasing Power Parity assumptions: –All goods are identical in both countries –Trade barriers and transportation costs are low
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