Unformatted text preview: CHAPTER 4
Exchange Rate Determination Chapter Overview
A. Measuring Exchange Rate Movements
B. Exchange Rate Equilibrium
C. Factors That Influence Exchange Rates
D. Government Controls
F. Speculating on Anticipated Exchange Rates Chapter 4 Objectives
This chapter will:
A. Explain how exchange rate movements are measured
B. Explain how the equilibrium exchange rate is determined
C. Examine factors that determine the equilibrium exchange rate A. Measuring Exchange Rate
1. Basic Movements in Rates
when one currency depreciates against another, the other must appreciate.
Let St1 = the original rate S = the current rate
b. Depreciation B. Exchange Rate Equilibrium
How exchange rates reach equilibrium?
1. Demand for a Currency a. derived from the local buyers who are willing and able to purchase foreign goods but who must convert their local currencies.
b. An indirect relationship exists between the cost of foreign currency and amount demanded.
c. Graphically, a downwardsloping demand curve Demand Schedule for British Pounds Exhibit 4.2 page 87 B. Exchange Rate Equilibrium
2. Supply of a Currency for Sale a. derived from the foreigners who are willing and able to supply foreign currency that must be converted in order to purchase local goods.
b. A direct relationship exists between cost of the foreign currency and the amount supplied.
c. Graphically, an upwardsloping supply curve first Supply Schedule of British Pounds for Sale Exhibit 4.3 page 88 B. Exchange Rate Equilibrium
3. Equilibrium Equilibrium Exchange Rate Determination Exhibit 4.4 page 89 C. Factors That Influence
1. Relative Inflation Rates
2. Relative Interest Rates
a. Real Interest Rates
3. Relative Income Levels D. Government Controls
Governments influence the equilibrium exchange
rate in many ways, including
1. imposing foreign exchange barriers,
2. imposing foreign trade barriers,
3. intervening (buying and selling
currencies) in the foreign exchange
4. affecting macro variables such as
inflation, interest rates, and income levels. E. Expectations
1. The Role of Information
a. Impact of Signals on Currency Speculation
1.) commonly driven by signals of future interest rate movements
2.) by other factors such as signals of the future economic conditions that affect exchange rates 2. Interaction of Factors F. Speculating on Anticipated
Many commercial banks attempt to capitalize on their forecasts of anticipated exchange rate movements in the foreign exchange market ...
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