Lec%2034_Full(1)

Lec%2034_Full(1) - IE 343 Engineering Economics Lecture 34:...

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IE 343 Engineering Economics Lecture 34: Chapter 9 – Replacement Analysis Instructor: Tian Ni Nov.18, 2011 IE 343 Fall 2011 1
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Foreign Exchange Rates and Purchasing Power Concepts IE 343 Fall 2011 2
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We have already known that the inflation/deflation will affect your purchasing power. When doing international trading between countries, changes in exchange rates will also affect your purchasing power. IE 343 Fall 2011 3
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If one dollar goes from being worth 1.0 euros to 0.8 euros (in this situation the dollar is weakening), 1,000 euros worth of goods from a European company that previously cost a U.S. purchaser $1,000 must now be bought for 1,000 euros / 0.8 = $1,250. The purchasing power of the U.S. purchaser is reduced due to the weaken of U.S. to euros exchange rate.(from 1 dollar:1.0 euros to 1 dollar:0.8 euros ) IE 343 Fall 2011 Foreign Exchange Rates - Simple Example 4
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Changes in the exchange rate between two currencies over time are analogous to changes in the general inflation rate because the relative purchasing power between the two currencies is changing similar to the relative purchasing power between actual dollar amounts and real dollar amounts. IE 343 Fall 2011 Foreign Exchange Rates VS Inflation 5
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i us = rate of return in terms of a market interest rate relative to US dollars i fm = rate of return in terms of a market interest rate relative to the currency of a foreign country f e = annual devaluation rate between foreign currency and US dollar If f e positive, foreign currency devalued relative to US dollar If f e negative, US dollar devalued relative to foreign currency IE 343 Fall 2011 Foreign Exchange Rates – Terminology 6
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In inflation/deflation we have the relationship for i r , i m and f IE 343 Fall 2011 Foreign Exchange Rates VS Inflation 7 f i i i f i m r r m + + = + => + + = + 1 1 1 ) 1 )( 1 ( 1
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In foreign exchange rates, we have a similar relationship between i us , i fm and f e IE 343 Fall 2011 Foreign Exchange Rates VS Inflation 8 e e fm us us e e us fm e fm us e us fm f f i i i f f i i f i i f i i + = + + = + + = + => + + = + 1 or ) ( or 1 1 1 ) 1 )( 1 ( 1
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The monetary (currency) unit of another country, A, has a present exchange rate of 10.7 units per U.S. dollar. (a) If the average devaluation of currency A in the international market is estimated to be 4.2% per year (for the next five years) relative to the U.S. dollar, what would be the exchange rate three years from now? IE 343 Fall 2011
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Lec%2034_Full(1) - IE 343 Engineering Economics Lecture 34:...

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