notes on exchange rate

7/28/2019 Notes on Exchange Rate

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CHAPTEREXCHANGE RATES AND

Foreign-Exchange MarketsInternational currencies are traded in foreign-exc

exchange markets are over-the-counter market, that iswhich traders gather to exchange currencies. Computer in many countries. Most foreign exchange trading takewith secondary centers in Hong Kong, Singapore, aexchanged by transactions in the foreign exchange markconducted in foreign exchange markets. In spot marketare exchanged immediately. In forward transactionsvb.


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Nominal exchange rates set the value of a currennot reflect the purchasing power, or the real exchange rateif the dollar is worth K800, the kyat price of the camera eLer tequal.yat and the purchasing power of Icyzil are qual. If the kyapurchasing power of a kyat is less than the purchasingexchange rates are different concepts, but they can be comthat a camera costs $800 in America and K1,000,000 iexchange market, the real exchange rate , or relative purccameras in dollar terms.LetX = nominal exchange in foreign currency per k


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the dollar. But if, at going exchange rates. Myanmar clfor kyat to buy Myanmar cloth would rise, pushing up t

If the exchange rate were K4 per dollar, in Myais cheaper than K50 charged by Myanmar manufacturefor $12.50 per yard which is more expensive than U.S. no demand for U.S. cloth and the demand for kyat to bthe value- of kyat. However, if the exchange rate werwould sell for K60 whereas in the U.S. Myanmar clothkyat would fall, pushing down valtre of kyat. As long asprice of Myanmar cloth remain constant, the exchange ra

The law of one price holds when the interna


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to compare the return with that from the U.S. bond. Supposrate is 100/$ and that the exchange rate is expected to apprecThe e xpected future e xchange rate EX' is (f 100)(1.05)/$ = Y when $1000 is converted into yen, l00,000 will be availab5% interest re turn, inv estment is now worth y105,000 after athat time is Y105/$, so the expected &liar value investmenHence, even though the Japanese bond pays the same statedbill, it carries a lower expected return.

In gene ral, for each dollar inv estme nt in a U.S. Tr easu$1a r n sielding

(1+i). Inv esting $1 in a Japaneinterest


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A graph of R against the current yen/dollar exchanthe re turn on a U.S. asset in dollar ter ms is the same regadollars. The diagram is based on a U.S. interest raexchange rate it is necessary to specify the expected yenallows calculating the dollar's expe cted rate of appreciatiocurrent yen/dollar exchange rate e xceeds that expected fudollar is usually strong and that i t ev entually will commandollar to depreciate. Thus, for an expected level of the excurrent e xchange rate slopes upward. A s the yen/dollar exrate of appreciation falls, pushing up R f.


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Figure 6.2Effect of a Change in the D omestic R(a)b )


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Effect of a Change in the Foreign Interesi RateThe expected rate of return for foreign assets dep

the expected change in the exchange rate. Figure 6.4 (a) sinterest rate shifts the foreign expected rate of return exchange rate, the foreign rate of return increases.

Figure 6.4Effect of a Change in the Foreig

(a)R


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to exchange foreign currency for more units of domestichigher e xpected rate of re turn, R tD shifts to the right in FiA n increase or decre ase in the expected future excof the underlying determinants of the exchange rateprefere nces for dome stic or foreign goods, difference s intrade barriers-as well as changes in expected future iexpected future exchange rate shift the foreign expectedomestic currency to appreciate. Factors that decrease thforeign expecte d rate of return to the right and cause the d

notes on exchange rate

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