Foreign exchange is now conducted in the foreign

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- Foreign exchange is now conducted in the foreign exchange market under a Floating System, but in essence the world still uses the U.S dollar as a reserve currency.
Exchange Rates Digression56Ch 8 - RTA- Example of how exchange rates affect foreign tradeU.S. exporter agrees to sell $300,000 worth of computers to a British firm. Assume the for the moment that the U.S. - U.K. exchange rate is £1 = $2. To keep this simple, let’s assume to pay for the computers, the British firms writes a £150,000 check and sends it the U.S. exporter. The exchange and sale are made.The U.S. exporter sells the £150,000 check to a bank in NYC for $300,000. The NYC bank charges a fee for the currency exchange. The bank then debits the account of the British firm for £150,000 and deposits this in the bank’s vault for a future sale to some U.S. buyerthat needs pounds.
Foreign Exchange Rates Digression57Ch 8 - RTAWhy would a bank in NYC be willing to buy pounds for dollars? As just indicated, they are a dealer in foreign exchange. They are in the business of buying (for a fee) and selling (for a fee) one currency for another.Example continued: Suppose a U.S. retail firm wants to import £150,000 of compact disks produced in Britain. The U.S. firm writes a check for $300,000 and the process works in reverse (i.e., the importer buys the pounds in the vault).So if the British firm wants to be paid in pounds, the U.S. importer would have to go to the bank in NYC and purchase the £150,000 for $300,000 (plus a fee) and directly send this to the British firm.
Foreign Exchange Rates Digression58Ch 8 - RTA- So from a U.S. perspectiveIn a sense, U.S. exports create a foreign demand for U.S. dollars, and the fulfillment of that demand increases the quantity supplied(not supply) of foreign currency (pounds) owned by U.S. banks and available to U.S. buyersLikewise, U.S. imports create a domestic demand for foreign currency (pounds), and the fulfillment of that demand reduces the quantity supplied of foreign currency (pounds) owned by U.S. banks and available to U.S. consumers.Both of the above will affect (i.e., appreciate and depreciate) the exchange rate.
0Dollar Price of one PoundQuantity of PoundsForeign Exchange Rates DigressionThe Market for Foreign Currency (Pounds)D1S1ExchangeRate: $2 = £1$2$3$1Q1The demand curve for foreign currency arises in the course of importing goods from abroad. The demand curve for domestic currency arises in the course of exporting goods.59Ch 8 - RTAAssuming the quantity of money is fixed at a point in time.
0Dollar Price of one PoundQuantity of PoundsForeign Exchange Rates DigressionThe Market for Foreign Currency (Pounds)D1S1ExchangeRate: $2 = £1$2$3$1Q1D2ExchangeRate: $3 = £160Ch 8 - RTAAssuming the quantity of money is fixed at a point in time.

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