INTERNATIONAL FINANCIAL

MANAGEMENT

BIB 3064

(GROUP 3)

TOPIC : EXCHANGE RATE

DETERMINATION

Presenters: Kuhen, Keertan, &

Darshini
 Known as foreign-exchange rate or forex rate between two
currencies is the rate at which one currency will be exchanged for
another

WHAT IS
EXCHANGE RATE? Determined in foreign exchange market where currency
trading is continuous

Current exchange rate referred as spot exchange rate

Forward exchange rate referred as quoted rate & exchanged
today, but delivery & payment made in future
Exchange rate is used to measures one currency’s value in units
of another currency
Exchange rate variations have an influence on an MNC’s value
 Currency appreciation – value of currency increase
 Currency depreciation – value of currency decrease
MEASURING
EXCHANGE RATE
MOVEMENTS
The formula below can be used to calculate the percentage change
(%) in the foreign currency’s value:

A positive percentage change implies the foreign currency has

appreciated, whereas a negative percentage change implies it has
depreciated.
 Intersection of demand & supply curves graphically indicates the
foreign currency's equilibrium exchange rate

 Rate of foreign exchange must be such that the quantity required

of foreign currency is equal to the quantity supplied of that EXCHANGE
currency at any given time
RATE
EQUILIBRIUM

Exchange Rate Equilibrium

 -This enables and predicts trade and investment between the two
countries, which is especially beneficial for small economies
Fixed • Currency’s value is fixed against the value of another where external trade accounts for a significant portion of GDP.
exchange single currency, to a basket of other currencies - Fixed rates help the government maintain low inflation, which,
rate • Used to keep the value of a currency stable in the long run, keep interest rates down and stimulates trade and
investment.

-Floating exchange rates, according to many economists, are the

• Value of a currency allowed to fluctuate in best possible exchange rate regime because they automatically
Floating accordance with foreign exchange market adjust to economic conditions.
exchange • Automatically adjust to economic conditions -These regimes allow a country to mitigate the effects of shocks
and foreign business cycles, as well as avoid a balance of
rate • Mitigate effects of shocks, foreign business cycles &
payments crisis.
avoid balance of payment issues
- These currencies are chosen based on which countries th
• Combines elements of both floating & fixed exchange has the smaller economy does a lot of trade with the
Pegged rates currency in which the country's debt is denominated.
exchange • Smaller economies are more vulnerable to currency - For example, if a small country that does a lot of busines
with the United States decides to peg its currency to the U
rate changes, so "peg" their currency to single major
dollar, its currency will fluctuate in value in a similar way
currency
to the USD.
- Basically, in managed floating exchange the monetary authority
• Exchange rates fluctuate from day to day & central influences the movements of the exchange rate through active
banks attempt to influence their countries’ exchange intervention in the foreign market without specifying, or
Managed rates by buying & selling currencies recommitting to, a preannounced path for the exchange rate
float • Central banks and governments act to control value - The central bank intervenes only to smooth fluctuations. Some
governments impose bands within which the exchange rate can
of their currencies fluctuate, which is one of the reasons for calling this approach
“dirty.”
1) Relative Inflation Rate
 Value of a country's currency is affected by inflation rates
 Low inflation rate, value of currency appreciates
 High inflation rate, value of currency depreciates
 E.g.: when the relative inflation rate of U.S. increases, this will
U.S. demand for British goods increase & also increase on
demand for British pounds. Therefore, this will decrease British
desire for U.S. goods and reduce the supply of British pounds FACTORS THAT
INFLUENCE
EXCHANGE RATES

Effects of Relative Inflation Rate

2) Relative Interest Rate
 Related to a country's real interest rate and can have a
significant impact on the economy's direction and stability
 A prediction made by buyers and sellers in the international
market
 E.g. :- when U.S. is having relative increasing in interest rates,
the U.S. demand for British bank deposits & British pounds
will drop. However, the British desire for U.S. bank deposits
will increase that also increase the supply of pounds. FACTORS THAT
INFLUENCE
EXCHANGE RATES

Effects of Relative Interest Rates

3) Relative Income Level
 Exchange rates can be affected by income since it influences
the amount of imports demanded
 E.g.:- when U.S. has a relatively high income level, it will
increase demand for British goods and the demand for the
British pound. In this situation, no changes in the supply of
pounds are expected.

FACTORS THAT
INFLUENCE
EXCHANGE RATES

Effects of Relative Income Level

4) Government Controls
 Foreign exchange and foreign trade barriers are imposed
 intervenes in the foreign exchange market
 Affects the macro variables discussed earlier, such as inflation,
interest rates, and income levels.

5) Expectations FACTORS THAT

 Institutional investors take currency investments based on INFLUENCE
expected interest rate fluctuations in different countries EXCHANGE RATES
 When economic signals cause exchange rates to fluctuate
rapidly, investors will initially overemphasize & look for ways
to fix the situation.
 Investment on developing market currencies will almost
certainly affect exchange rates.
THANK YOU