Topic 12 - Exchange Rates

Topic 12 - Exchange Rates - BUAD 350 Topic 12 Exchange...

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BUAD 350 Topic 12 – Exchange Rates
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Keywords Exchange Rates Supply-and-Demand Analysis for Exchange Rates Fixed Exchange Rates
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The US currency weakened steadily against the Euro throughout much of last year, sparking fears in Eurozone capitals that the trend would make European exports more expensive and less competitive and thereby impede growth While US officials have repeatedly pledged their commitment to a strong dollar, many economists and analysts suspect that the Bush administration is not unhappy with a softer currency, seeing it as a means of reducing the gaping US trade deficit. US wants 'strong dollar' Yahoo! News , Sun, Mar 13, 2005
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Exchange Rates Nominal exchange rate (e nom ) The nominal exchange rate tells you how much foreign currency you can obtain with one unit of the domestic currency Example: If the nominal exchange rate is 110 yen per dollar, one dollar can be exchanged for 110 yen Transactions between currencies take place in the foreign exchange market Denote the nominal exchange rate as e nom in units of the foreign currency per unit of domestic currency
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Exchange Rates (contd.) Nominal exchange rate (e nom ) Under a flexible-exchange-rate system or floating- exchange-rate system , exchange rates are determined by supply and demand; this is the current system for major currencies In the past, many currencies operated under a fixed-exchange- rate system (exchange rates determined by governments) Exchange rates were fixed because the central banks offered to buy or sell the currencies at the fixed exchange rate Examples include the gold standard , which operated in the late 1800s and early 1900s, and the Bretton Woods system , which was in place from 1944 until the early 1970s Major currencies are in a flexible-exchange-rate system, however some smaller countries fix their exchange rates
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Exchange Rates (contd.) Real exchange rate (e) The real exchange rate tells you how much of a foreign good you can get in exchange for one unit of a domestic good Example: If the nominal exchange rate is 110 yen per dollar, and it costs 1100 yen to buy a hamburger in Tokyo compared to 2 dollars in New York, the price of a U.S. hamburger relative to a Japanese hamburger is 0.2 Japanese hamburgers per U.S. hamburger
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Exchange Rates (contd.) Real exchange rate (e) = price of domestic goods relative to foreign goods Formula: e = e nom (P/ P For ) where P is the price of the good in the U.S, P for is the price of the foreign good in foreign currency, and e nom is the (fc/$) exchange rate e appreciation US goods are more expensive
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Exchange Rates (contd.) Appreciation and depreciation In a flexible-exchange-rate system: When e nom falls, the domestic currency has undergone a nominal depreciation , or has become weaker When e nom rises, the domestic currency has undergone a nominal appreciation, i.e. has become stronger In a fixed-exchange-rate system: A weakening of the currency is called a devaluation
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