Transcript The Determination of Exchange Rates

Useful Financial Website
www.oanda.com
Currency
converter
FX History
FX Trading Simulation
Guess Shifts Apparel-Making
to Mexico From Los Angeles ...
[Wall Street Journal, January 14, 1997]
“Jeans
maker Guess, Inc., dogged
by allegations of illegal labor
practices, is quietly moving most
of its U. S. manufacturing to
Mexico and other countries south
of the border.”
Guess Shifts Apparel-Making
to Mexico From Los Angeles ...
[Wall Street Journal, January 14, 1997]
“…
the percentage of Guess
garments sewn in Los Angeles will
drop to 35% next month from 75%
five months ago. Mr. Marciano
said the shift was mainly a
‘commercial decision’ to ‘stay
competitive’ and ‘lower costs.’
Guess Shifts Apparel-Making
to Mexico From Los Angeles ...
[Wall Street Journal, January 14, 1997]
“Mr.
Marciano said Guess saves
$1.50 to $2 a garment by sending
cut fabric to five sewing factories
in Mexico as well as plants in Peru
and Chile. He declined for
competitive reasons to discuss the
total production cost of a garment.
Guess Shifts Apparel-Making
to Mexico From Los Angeles ...
[Wall Street Journal, January 14, 1997]
“Unite
estimates that less than $5
of the cost of a $48 pair of jeans
goes for fabric and labor. Guess
said its manufacturing shift affects
‘several million units a year’ with a
wholesale value of $300 million to
$325 million.”
The Determination of
Exchange Rates
[Shapiro - Chapter 2]
Problems – Chapter 2
2.2
2.3
2.5
Foreign Exchange Rates
Exchange
Rate: “number of
units of one currency that can
be purchased for one unit of
another currency”
Exchange Rate
“…
market-clearing prices that
equilibrate supplies and
demands in foreign exchange
markets.”
Exchange Rate Terminology
Revaluation
- increase in stated
par value of a pegged currency
Devaluation - decrease in stated
par value of a pegged currency
Exchange Rate Terminology
Depreciation
- loss in value of a
floating currency
Appreciation - gain in value of
a floating currency
Exchange Rate Terminology
Spot
Rate - price of foreign
exchange with same day
payment
Forward Rate - rate quoted
today for delivery at a fixed
future date (30, 90, 180 days)
Fluctuating Value of the Yen
[¥ per $,1954 - 2009]
400
361363
350
278
300
233
250
200
150
130
117
100 80 108
116
103
109
122 119
118 110 112 114 121 110
100
50
19
5
19 4
64
19
7
19 4
8
19 4
88
19
9
19 4
9
19 5
96
19
9
19 7
9
19 8
99
20
0
20 0
01
20
0
20 2
0
20 3
04
20
0
20 5
0
20 6
07
20
0
20 8
09
0
90
Foreign Exchange Example
[“Let’s do lunch!”]
$1
= Lit. 1.680 (Jan., 1994)
Lit. 51.500 / 1.680 = $30.65
$1 = Lit. 1.600 (June 1994)
Lit. 51.500 / 1.600 = $32.19
$1.54 / $30.65 = +5%
Exchange Rate Impact
Profit in
Lire
Exchange
Rate
Profit in
$US
Exchange Rate Impact
Profit in
Lire
500,000,000
Exchange
Rate
1,680
Profit in
$US
297,619
Exchange Rate Impact
Profit in
Lire
500,000,000
Exchange
Rate
1,680
Profit in
$US
297,619
500,000,000
1,600
312,500
Exchange Rate Impact
Profit in
Lire
500,000,000
Exchange
Rate
1,680
Profit in
$US
297,619
500,000,000
1,600
312,500
500,000,000
1,790
279,330
Taxes account for about two-thirds of the
price of gas in Europe, compared with about
20 percent of the price in the United States.
7
6
$ Gallon
5
4
Tax
W/O Tax
3
2
1
0
U. S.
France Germany
Britain
Italy
Changing Exchange Rates
Foreign
currency appreciation
(depreciation) is computed as
the fractional increase or
decrease in the dollar value of a
foreign currency.
“Two-Percent Bag”
Important
topics
Essential Calculations
Potential Exam Questions
Changing Exchange Rates
[Appreciation of the Pound]
(e1  e0 )
Appreciation 
e0
Changing Exchange Rates
[Appreciation of the Pound]
(e1  e0 )
Appreciation 
e0
$1.9586 $1.7188
Appreciation 
 13.95%
$1.7188
Changing Exchange Rates
[Depreciation of the Dollar]
e0  e1
Depreciation($) 
e1
Changing Exchange Rates
[Depreciation of the Dollar]
1  1
e1
e0
Depreciati on($) 
1
e0
e0  e1
Depreciati on($) 
e1
Changing Exchange Rates
[Depreciation of the Dollar]
1
1
Depreciation($)  1.9586 1.7188
1
1.7188
0.51  0.58
Depreciation($) 
 12.07%
0.58
Won/Dollar($)
800
900
1,000
1,100
1,200
1,300
1,400
1,500
1,600
1,700
1,800
10
10
10
10
10
10
10
10
10
10
10
10
/1
7
/1
7
/1
7
/1
7
/1
7
/1
7
/1
7
/1
7
/1
7
/1
7
/1
7
/1
7
/0
8
/0
7
/0
6
/0
5
/0
4
/0
3
/0
2
/0
1
/0
0
/9
9
/9
8
/9
7
Collapse and Recovery of the
S. Korean Won, 1997-2008!
Exchange Rate Impact
Cost in
Won(W)
500,000,000
Exch. Rate
W/$1
900
Cost in
$US
555,555
500,000,000
1,700
294,118
500,000,000
1,202
415,973
500,000,000
1,115
448,430
Currency Boards
No
central bank; no discretionary
monetary policy
Currency is convertible at a fixed rate
into a foreign reserve currency,
frequently the U. S. $
Board holds foreign securities as
reserves; 100%+
Dollarization
Replacement
of the local currency
with the U. S. dollar
Panama (1904); Ecuador (2000)
Expectation of price stability
Sacrifice of national identity and
pride
Determining Exchange Rates
Economic
Factors
Political Factors
Social Factors
Economic Factors
Relative
rate of inflation
Interest rate differentials
Economic growth
Central bank behavior
Political Factors
Government
stability
Government spending
Taxation
Social Factors
Population
growth
Cultural values
–Health care
–Education
–Retirement
Social Factors
“According
to the latest Istat
statistics, the median age of
marriage in Italy was 32 years for
men and 30 years for women. In
recent years, the average age has
increased by 4 years for men and 6
years for women.”
• La Republicca, Summer, 2006
Shapiro: Problem 2.2.a
2002:
US$ 1 = ¥ 125
2006: US$ 1 = ¥ 115
a. Dollar value of ¥ 1 in 2002;
2006?
2002: US$ 1 ÷ ¥ 125 = $0.008
2006: US$ 1 ÷ ¥ 115 = $0.0087
Shapiro: Problem 2.2.b
b.
% change in ¥ between 2002
and 2006?
(e1 – e0) ÷ e0
(.0087 – .008) ÷ .008 = +8.75%
Shapiro: Problem 2.2.c
c.
% change in US$ between
2002 and 2006?
(e0 – e1) ÷ e1
(115 – 125) ÷ 125 = -8.0%
Shapiro: Problem 2.3
1: € = $1.2966
May 1:
€ = $1.3634
Has the Euro (€) appreciated or
depreciated against the dollar?
By what percent has the Euro
appreciated or depreciated?
February
Shapiro: Problem 2.3
(€): (e1 – e0) / e0 = ?
(1.3634 – 1.2966) / 1.2966 =
+5.15%
Depreciation ($): (e0 – e1) / e1 = ?
(1/1.3634 – 1/1.2966) / 1/1.2966 =
-4.9%
Appreciation
Shapiro: Problem 2.5
3/29/07:
Rupee(Rs) = $0.02327
3/30/07: Rupee(Rs) = $0.02298
Depreciation of the Rupee?
(0.02298 – 0.02327) / 0.02327=
-1.25%
Shapiro: Problem 2.5
3/29/07:
Rupee(Rs) = $0.02327
3/30/07: Rupee(Rs) = $0.02298
Appreciation of the Dollar?
(1/0.02298 – 1/0.02327) /
1/0.02327= +1.262%