Professional Documents
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ICF11e ch04
ICF11e ch04
12th Edition
by Jeff Madura
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4 Exchange Rate Determination
Chapter Objectives
2
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Measuring Exchange Rate Movements
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Exchange Rate Equilibrium
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Exhibit 4.2 Demand Schedule for British
Pounds
6
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Exhibit 4.3 Supply Schedule of British Pounds for
Sale
7
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Exhibit 4.4 Equilibrium Exchange Rate
Determination
8
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Exchange Rate Equilibrium
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Factors That Influence Exchange Rates
where
e percentage change in the spot rate
INF change in the differenti al between U.S. inflation
and the foreign country' s inflation
INT change in the differenti al between the U.S. interest rate
and the foreign country' s interest rate
INC change in the differenti al between th e U.S. income level
and the foreign country' s income level
GC change in government controls
EXP change in expectatio ns of future exchange rates
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Factors That Influence Exchange Rates
Relative Inflation:
Increase in U.S.
inflation leads to
increase in U.S.
demand for foreign
goods, an increase
in U.S. demand for
foreign currency,
and an increase in
the exchange rate
for the foreign
currency. (See
Exhibit 4.5)
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Factors That Influence Exchange Rates
Relative Interest
Rates: Increase in
U.S. rates leads to
increase in demand
for U.S. deposits
and a decrease in
demand for foreign
deposits, leading to
a increase in
demand for dollars
and an increased
exchange rate for
the dollar. (See
Exhibit 4.6)
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Factors That Influence Exchange Rates
Fisher Effect:
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Factors That Influence Exchange Rates
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Exhibit 4.7 Impact of Rising U.S. Income Levels on the
Equilibrium Value of the British Pound
15
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Factors That Influence Exchange Rates
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Exhibit 4.8 Summary of How Factors Can Affect
Exchange Rates
Trade-Related
Factors
U.S. demand for foreign
1. Inflation goods, i.e. demand for
Differential foreign currency
2. Income
Differential Foreign demand for U.S.
3. Gov’t Trade goods, i.e. supply of Exchange
Restrictions foreign currency rate
between
foreign
Financial U.S. demand for foreign currency
Factors securities, i.e. demand and the
1. Interest Rate for foreign currency dollar
Differential Foreign demand for U.S.
2. Capital Flow securities, i.e. supply of
Restrictions foreign currency
19
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Factors that Influence Exchange Rates
Interaction of Factors:
The sensitivity of an exchange rate to the factors is
dependent on the volume of international transactions
between the two countries.
Large volume of international trade
relative inflation rates may be more influential
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Movements in Cross Exchange Rates
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Exhibit 4.9 Trends in the Pound, Euro, and
Pound/Euro
22
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Anticipation of Exchange Rate Movements
Borrows at 7.20%
for 30 days
1. Borrows 4. Holds
$20 million $20,912,320
Returns $20,120,000
Profit of $792,320
Exchange at Exchange at
$0.50/NZ$ $0.52/NZ$
Lends at 6.48%
2. Holds for 30 days 3. Receives
NZ$40 million NZ$40,216,000
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Speculating on Anticipated Exchange Rates
Borrows at 6.96%
for 30 days
1. Borrows 4. Holds
NZ$40 million NZ$41,900,000
Returns NZ$40,232,000
Profit of NZ$1,668,000
Exchange at or $800,640 Exchange at
$0.50/NZ$ $0.48/NZ$
Lends at 6.72%
2. Holds for 30 days 3. Receives
$20 million $20,112,000
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Speculating on Anticipated Exchange Rates
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SUMMARY (Cont.)
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