Slide 1 of 38 Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson.
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Transcript Slide 1 of 38 Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson.
Slide 1 of 38
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 2 of 38
Overview
Measure
exchange rates
Determine equilibrium exchange rates
Examine factors affecting exchange rates
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 3 of 38
Measuring Exchange Rate
Movements
Exchange
rate
– value of one currency in units of another
– eg. One dollar U.S. = 1.44 CDN
Fluctuating
value
– appreciation
increase
in currency value relative to another
– depreciation
decrease
in currency value relative to another
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 4 of 38
Exchange Rate Movement
Price
of a currency
, or,,,,,,,, how much a currency cost
“… an exchange rate at a given point in
time represents a price of a currency…”
page 106
price, like any product, is a function of
demand
demand relative to the supply
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
From GNED 119
Slide 6 of 38
Exchange Rate Equilibrium
Supply
for a currency
– e.g., supply of British pound
the
greater the price offered, the greater the supply
S
value
quantity
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
From GNED 119
Slide 8 of 38
Exchange Rate Equilibrium
Spot
exchange rate
– price of a currency at a specific time
price
Demand
set by supply and demand for the currency
for currency
– e.g., US demand for pound sterling
value
D
Slides developed by Jeff Madura, withquantity
additions and enhancements by Tim Richardson
From GNED 119
Slide 10 of 38
Exchange Rate Equilibrium
Exchange
rate reflects supply and demand
– lower $US means cheaper US goods for British
– increased demand for US goods implies greater
demand for $US
S
value
D
quantity
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 11 of 38
Factors Influencing Exchange
Rates
Relative
inflation rates
Relative interest rates
Relative income levels
Government controls
Expectations
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 12 of 38
Factors that influence
Exchange Rates
Relative
inflation rates page 109
changes in inflation rates can affect
international trade activity, which influences
the demand and supply of currencies
if inflation is high, price of products is rising fast and the
economy will have a lot of money to buy foreign products
if they buy foreign products, there is need for currencies
other than the currency they have, so demand is high
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 13 of 38
Factors that influence
Exchange Rates
Inflation
means the price of goods and
services rises quickly
a consequence is that people are also
making more money and relative to goods
and services from other countries, they can
afford to import more
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 14 of 38
Factors that influence
Exchange Rates
In
reality, “… the true equilibrium exchange
rate will reflect several factors
simultaneously…”
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 15 of 38
Factors that influence
Exchange Rates
1.
Relative Interest Rates
page 110
changes in relative interest rates affect
investment in foreign securities, which
influence the demand and supply of
currencies
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 16 of 38
Factors Influencing Exchange
Rates
Relative
inflation rates
– affects supply and demand for currency
– impacts international trade
– e.g., British inflation rises against US inflation
British goods become more expensive relative to US
decrease of US demand for pound sterling
increase in British demand for “cheaper” US goods
increase in British demand for $US
increase in supply of pounds on sale for $US
British pound declines in value against the $US
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 17 of 38
Factors that influence
Exchange Rates
if
interest rates in a country are low,
portfolio investments there will also be
proportionately low
therefore making ROI - return on
investments low
therefore people will sell the securities and
demand will decline
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 18 of 38
Factors that influence
Exchange Rates
Example
text page 110 - 111
the reunification of East and West Germany,
and the resulting rise in German interest
rates
U.S. investors invested in German
securities due to the higher ROI
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 19 of 38
Factors that influence
Exchange Rates
2.
Page 112
Real Interest Rates
“while a relatively high interest rate may
attract foreign inflows - high interest rate
might indicate high inflation
- which would scare people off by
discouraging them to invest
real interest rate = nominal interest rate inflation rate
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 20 of 38
Factors Influencing Exchange
Rates
Relative
interest real rates
– affects investment in foreign securities
– e.g., British interest rises relative to US interest
British
MNCs shift deposits to British banks
decline in British supply of pounds for sale for $US
increase in British MNC demand for pounds
pound rises in value relative to $US
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 21 of 38
Factors that influence
Exchange Rates
3.
Page 112
Relative Income Levels
if income in a country increases,
globalization will increase demand for
foreign products
demand for foreign products will increase
demand for the currency of the countries
where those products come from
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 22 of 38
Factors that influence
Exchange Rates
3.
Relative Income Levels
Page 112
in
the late 1980’s and early 1990’s, income
levels in North America caused massive
imports of Japanese consumer products,
making the Japanese yen rise very high
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 23 of 38
Factors Influencing Exchange
Rates
Relative
income levels
– e.g., British income rises relative to US income
demand
schedule for pound remains the same
supply of pounds for sale for $US should rise
– British buy more US goods
British
pound falls against the $US
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 24 of 38
Factors that influence
Exchange Rates
4.
Government Intervention
Reasons
Page 112
for intervention
– smooth exchange rate movements
– establish implicit exchange rate boundaries
– react to temporary disturbances
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 25 of 38
Factors Influencing Exchange
Rates
Government
–
–
–
–
controls
foreign exchange barriers
foreign trade barriers
central bank intervention
intervention may affect inflation, interest rates
and income levels
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 26 of 38
Factors that influence
Exchange Rates
4.
Government Intervention
Page 112
What will the government do ?
1 impose 4X barriers
2 impose foreign trade barriers
3 intervene by buying and selling currencies
4 do things to effect inflation rate and interest
rates
eg. Alter bank rate, or print money (monetary policy)
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 27 of 38
Factors that influence
Exchange Rates
5.
Expectations
Page 113
Market expectations of future rates
4X markets react to news that might effect
future events
eg. News of possible inflation in a country - due
to some crisis, may cause currency traders to
dump that currency before it declines in value
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 28 of 38
Factors that influence
Exchange Rates
5.
Expectations
Page 113
Institutional investors take currency
positions based on anticipated interest
rate movements
They do detailed research on many aspects of a
country to determine if the currency is going to be in
demand, or not, and if it is going to be in demand,
they buy large amounts and sell it for a profit days or
weeks in the future
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 29 of 38
Factors Influencing Exchange
Rates
Expectations
– e.g., news of potential increase in British
inflation
market
expects decline in value of pound
institutional traders sell pound sterling
value of pound declines against the $US
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 30 of 38
Factors Influencing Exchange
Rates
Factors
affecting demand for foreign goods
– inflation differential
– income differential
– government’s trade restrictions
Factors
affecting demand for foreign
securities
– interest rate differential
– government’s capital flow restrictions
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 31 of 38
Speculating on Anticipated
Rates
Speculating
on anticipated changes in rates
– e.g., a bank’s expectation on the British pound:
appreciate
from $1.635 to $1.650 in 30 days
develops a trading strategy based upon interest rate
differentials and expected exchange rate movement
Currency
Lending Rate Borrowing Rate
US dollars
6.50 %
7.00 %
Pound sterling
6.26 %
6.75 %
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 32 of 38
Speculating on Anticipated
Rates, an Example
Borrow
$30 million at 7.00 %
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 33 of 38
Speculating on Anticipated
Rates, an Example
Borrow
$30 million at 7.00 %
Convert $30 million to PS 18,348,624
– $30,000,000 / $1.635 = PS 18,348,624
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 34 of 38
Speculating on Anticipated
Rates, an Example
Borrow
$30 million at 7.00 %
Convert $30 million to PS 18,348,624
– $30,000,000 / $1.635 = PS 18,348,624
Lend
pounds at 6.26 % for 30 days
– PS 18,348,624 x [1+ (0.0626)(30/360)]
– bank has PS 18,444,349 in 30 days
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 35 of 38
Speculating on Anticipated
Rates, an Example
Borrow
$30 million at 7.00 %
Convert $30 million to PS 18,348,624
– $30,000,000 / $1.635 = PS 18,348,624
Lend
pounds at 6.26 % for 30 days
– PS 18,348,624 x [1+ (0.0626)(30/360)]
– bank has PS 18,444,349 in 30 days
Convert
British pounds to $US
– PS 18,444,349 x $1.650 = $30,433,176
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 36 of 38
Speculating on Anticipated
Rates, an Example
Repay
$US loan with proceeds from pound
– $30,000 x [1 + (0.07)(30/360)] = $30,174,990
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 37 of 38
Speculating on Anticipated
Rates, an Example
Repay
$US loan with proceeds from pound
– $30,000 x [1 + (0.07)(30/360)] = $30,174,990
Calculate
profit from speculation
– (assumes pound rises to $1.65 in 30 days)
– $30,433,176 - $30,174,990 = $258,186
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 38 of 38
Summary
Exchange
rate movements
– measured by percentage change in value
Equilibrium
exchange rate
– determined by supply and demand
economic
and governmental factors affect
exchange rates
– inflation and interest rates are factors most
closely monitored by financial markets
all
factors interact to affect exchange rates
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson