M13_MISH1438_06_IM_C13

M13_MISH1438_06_IM_C13 - Chapter 13 The Foreign Exchange...

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Chapter 13 The Foreign Exchange Market Foreign Exchange Market What are Foreign Exchange Rates? Following the Financial News : Foreign Exchange Rates Why are Exchange Rates Important? How is Foreign Exchange Traded? Exchange Rates in the Long Run Law of One Price Theory of Purchasing Power Parity Why the Theory of Purchasing Power Parity Cannot Fully Explain Exchange Rates Factors That Affect Exchange Rates in the Long Run Exchange Rates in the Short Run Comparing Expected Returns on Domestic and Foreign Deposits Interest Parity Condition Demand Curve for Domestic Assets Supply Curve for Domestic Assets Equilibrium in the Foreign Exchange Market Explaining Changes in Exchange Rates Shift in the Demand for Domestic Assets Case : Changes in the Equilibrium Exchange Rate: Two Examples Changes in Interest Rates Changes in the Money Supply Exchange Rate Overshooting Case : Why are Exchange Rates So Volatile? Case : The Dollar and Interest Rates, 1973–2007 Case : The Euro’s First Nine Years Case : Reading the Wall Street Journal : The “Foreign Exchange” Column Following the Financial News : The “Currency Trading” Column The Practicing Manager: Profiting from Foreign Exchange Forecasts Overview and Teaching Tips Chapter 13 explains behavior in the foreign exchange market by using a modern asset-market approach to exchange rate determination. This asset-market approach is now the dominant method of analyzing exchange rate movements in the literature and it has major advantages over the more conventional treatment of the foreign exchange market typically found in financial markets and institutions textbooks.
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75 Mishkin/Eakins • Financial Markets and Institutions, Sixth Edition As the first case in the chapter indicates, the asset-market approach, in contrast to earlier approaches emphasizing import and export demand, can be used to explain a feature of the foreign exchange market that has received much attention in the press in recent years: the high volatility of exchange rates. This phenomenon is not well explained by the earlier flow approach because it does not predict that exchange rates should be highly volatile.
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Chapter 13 The Foreign Exchange Market 76 The asset-market approach is developed in several steps. First, the long-run determinants of the exchange rate are laid out, and then the information about the long-run determinants is embedded in a model of the short-run determination of exchange rates. The key idea that must be transmitted to the student is that the demand for domestic currency (say dollar) assets is determined by the relative expected return on these assets. To help students achieve an intuitive grasp of how the relative expected return on domestic assets, and hence the demand curve shifts, tell them to put themselves in the shoes of an investor who is thinking about putting his or her money into foreign or domestic assets. When a factor changes, have them ask themselves whether at the same exchange rate, they would earn a higher expected return on domestic
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This note was uploaded on 10/17/2011 for the course ECON 317 taught by Professor Guidry during the Spring '11 term at Nicholls State.

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M13_MISH1438_06_IM_C13 - Chapter 13 The Foreign Exchange...

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