Chapter_10_Exchange_Rates_and_Foreign_Ex

The dollar has depreciated by about 18 against the

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The dollar has depreciated by (about) 18% against the euro.
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Multilateral Exchange Rates The bilateral exchange rate, as seen above, shows the price at which one currency is exchanged for another. In practice, it is possible for one currency to appreciate relative to one currency, while depreciating relative to another. In order to understand the “average” change in the value of a currency, we need to use a multilateral exchange rate.
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Multilateral Exchange Rates The nominal effective exchange rate (NEER) is calculated as the sum of the trade shares multiplied by the exchange rate changes for each country. The dollar weight of each currency in the basket (in a base year) is given by the share of that country in U.S. trade. Changes in the dollar price of this basket tell us how the value of the dollar has changed “on average” against the entire basket of currencies. The NEER shows these changes against all foreign currencies “on average”.
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Computing the NEER If the home country trades with countries 1, …,N then the fractional (%) change in NEER relative to the base year is given by finding the trade-weighted average change in each bilateral exchange rate: Multilateral Exchange Rates
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How Much Has the Dollar Fallen? The U.S. dollar depreciated against some key currencies between 2002-2004. This depreciation was not as pronounced when measured against major U.S. trading partners. The major trading partners were mostly floating countries, like U.K., Japan, Canada. The others included countries with more fixed exchange rates, like China, India.
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How Much Has the Dollar Fallen?
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Example: Using Exchange Rates to Compare Prices in a Common Currency Why are exchange rates useful? Suppose you wish to compare the prices of a good sold in two locations. It sells in the UK for PUK expressed in £. It sells in the US for PUS expressed in $. The currency units differ. The only meaningful way to compare the prices in different countries is to convert prices into a common currency. The UK price in dollar terms is E$/£ PUK. Always check units. For example, here: $/£ times £ = $.
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Example: Using Exchange Rates to Compare Prices in a Common Currency This table shows how the hypothetical cost of James Bond’s next tuxedo in different locations depends on the exchange rates that prevail. Local prices are £2000, HK$30000, $4000. Convert to £.
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Example: Using Exchange Rates to Compare Prices in a Common Currency Scenario 1: Indifferent between three markets Hong Kong: HK$30,000/15 HK$ per £ = £2,000 New York: $4,000/ $2 per £ = £2,000 Scenario 2: Buy tuxedo in Hong Kong Hong Kong: HK$30,000/16 HK$ per £ = £1,875 New York: $4,000/ $1.9 per £ = £2,105 Scenario 3: Buy tuxedo in New York Hong Kong: HK$30,000/14 HK$ per £ = £2,143 New York: $4,000/ $2.1 per £ = £1,905 Scenario 4: Buy tuxedo in London Hong Kong: HK$30,000/14 HK$ per £ = £2,143 New York: $4,000/ $1.9 per £ = £2,105
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Example: Using Exchange Rates to Compare Prices in a Common Currency Lessons
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  • Spring '10
  • BALLIE
  • Exchange Rate, Foreign exchange market, Market for Foreign Exchange

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