1、Slide 13-1Copyright 2003 Pearson Education,Inc.IntroductionExchange Rates and International TransactionsThe Foreign Exchange MarketThe Demand for Foreign Currency AssetsEquilibrium in the Foreign Exchange MarketInterest Rates,Expectations,and EquilibriumSummaryChapter OrganizationSlide 13-2Copyright
2、 2003 Pearson Education,Inc.IntroductionExchange rates are important because they enable us to translate different counties prices into comparable terms(function of purchase power transfer).Exchange rates are determined in the same way as other asset prices.The general goal of this chapter is to sho
3、w:How exchange rates are determinedThe role of exchange rates in international tradeSlide 13-3Copyright 2003 Pearson Education,Inc.Exchange Rates and International TransactionsAn exchange rate can be quoted in two ways:Direct;-The price of the foreign currency in terms of dollarsIndirect The price o
4、f dollars in terms of the foreign currencyAccording the bank business exchange rate can be divided into buying and selling rates.-Example:USD/RMB 8.2740/70;GBP/USD 1.4890/00折算率表.doc Slide 13-4Copyright 2003 Pearson Education,Inc.Exchange Rates and International TransactionsTable 13-1:Exchange Rate Q
5、uotationsSlide 13-5Copyright 2003 Pearson Education,Inc.Domestic and Foreign PricesIf we know the exchange rate between two countries currencies,we can calculate the price of one countrys exports in terms of the other countrys money.Example:The dollar price of a 50 sweater with a dollar exchange rat
6、e of$1.50 per pound is(1.50$/)x(50)=$75.Exchange Rates and International TransactionsSlide 13-6Copyright 2003 Pearson Education,Inc.Two types of changes in exchange rates:Depreciation(devaluation)of home countrys currency A rise in the home currency prices of a foreign currency It makes home goods c
7、heaper for foreigners and foreign goods more expensive for domestic residents.Appreciation(revaluation)of home countrys currency A fall in the home price of a foreign currency It makes home goods more expensive for foreigners and foreign goods cheaper for domestic residents.Exchange Rates and Intern
8、ational TransactionsSlide 13-7Copyright 2003 Pearson Education,Inc.The calculation of de-and appreciationThe foreign countrys _(E E0)/E0*100%The home countrys _(E0 E)/E*100%.case.pptDe-and appreciation.pptSlide 13-8Copyright 2003 Pearson Education,Inc.Exchange Rates and Relative PricesImport and exp
9、ort demands are influenced by relative prices.Appreciation of a countrys currency:Raises the relative price of its exports Lowers the relative price of its importsDepreciation of a countrys currency:Lowers the relative price of its exports Raises the relative price of its importsExchange Rates and I
10、nternational TransactionsSlide 13-9Copyright 2003 Pearson Education,Inc.The price effect of exchange rates on tradeExport with foreign currencyP v import with foreign currencyP v export with home currencyP v import with home currencyP vSlide 13-10Copyright 2003 Pearson Education,Inc.The Foreign Exch
11、ange MarketExchange rates are determined in the foreign exchange market.The market in which international currency trades take placeThe market is an invisible one The ActorsThe major participants in the foreign exchange market are:Commercial banks International corporations Nonbank financial institu
12、tions Central banks.case.pptthe case for international finance.pptSlide 13-11Copyright 2003 Pearson Education,Inc.Interbank trading Foreign currency trading among banks It accounts for most of the activity in the foreign exchange market.Exchange Rates and International TransactionsSlide 13-12Copyrig
13、ht 2003 Pearson Education,Inc.Characteristics of the MarketThe worldwide volume of foreign exchange trading is enormous,and it has ballooned in recent years.New technologies,such as Internet links,are used among the major foreign exchange trading centers(London,New York,Tokyo,Frankfurt,and Singapore
14、).The integration of financial centers implies that there can be no significant arbitrage.The process of buying a currency cheap and selling it dearExchange Rates and International TransactionsSlide 13-13Copyright 2003 Pearson Education,Inc.Three points arbitragePrinciple:When E1.2 E2.3 *E3,1=1,the
15、exchange rates between 3 points are in equilibriumExample:assume the market rates in IN NEW YORK,IN LONDON,and IN FRANKFURT are 1GBP=2USD,1GBP=5 MARK and 1USD=2.5MARKResult 1GBP/2USD*0.2GBP/1MARK*2.5MARK/1USD=1 NO POSSIBLE.BUT IF 1GBP=1.96USD in NEW YORK,it is possible to arbitrage between 3 points,
16、namely sell USD IN NEW YORK,GBP IN LONDON,MARK IN FRANKFURTSlide 13-14Copyright 2003 Pearson Education,Inc.Vehicle currency A currency that is widely used to denominate international contracts made by parties who do not reside in the country that issues the vehicle currency.-Example:In 2001,around 9
17、0%of transactions between banks involved exchanges of foreign currencies for U.S.dollars.A vehicle currency is that through which we can calculate the cross rates Principle and Calculation of cross rates.case.pptthe case for international finance.pptExchange Rates and International TransactionsSlide
18、 13-15Copyright 2003 Pearson Education,Inc.Structure of trading in foreign exchange markets 2004Slide 13-16Copyright 2003 Pearson Education,Inc.Spot Rates and Forward RatesSpot exchange rates Apply to exchange currencies“on the spot”Forward exchange rates Apply to exchange currencies on some future
19、date at a prenegotiated exchange rateForward and spot exchange rates,while not necessarily equal,do move closely together.Exchange Rates and International TransactionsSlide 13-17Copyright 2003 Pearson Education,Inc.Figure 13-1:Dollar/Pound Spot and Forward Exchange Rates,1981-2001Exchange Rates and
20、International TransactionsSlide 13-18Copyright 2003 Pearson Education,Inc.Calculation of forward ratesQuotation:show the whole forward rates and the points of premium and discount,for example S:EUR/USD=1.2350/60;F,3 month 40/60,6 month 50/30Calculation:great/small-;small/great+,for example:F,3 month
21、 1.2390/20,6 month 1.2300/30Slide 13-19Copyright 2003 Pearson Education,Inc.Foreign Exchange SwapsSpot sales of a currency combined with a forward repurchase of the currency.They make up a significant proportion of all foreign exchange trading.They can be used to cover the open position of business
22、institutePure-and engineered swap Exchange Rates and International TransactionsSlide 13-20Copyright 2003 Pearson Education,Inc.中国工商银行人民币远期外汇牌价中国工商银行人民币远期外汇牌价Slide 13-21Copyright 2003 Pearson Education,Inc.Slide 13-22Copyright 2003 Pearson Education,Inc.Slide 13-23Copyright 2003 Pearson Education,Inc
23、.The demand for a foreign currency bank deposit is influenced by the same considerations that influence the demand for any other asset.Assets and Asset ReturnsDefining Asset Returns The percentage increase in value an asset offers over some time period.The Real Rate of Return The rate of return comp
24、uted by measuring asset values in terms of some broad representative basket of products that savers regularly purchase.The Demand for Foreign Currency AssetsSlide 13-24Copyright 2003 Pearson Education,Inc.Risk and LiquiditySavers care about two main characteristics of an asset other than its return:
25、Risk The variability it contributes to savers wealth Liquidity The ease with which it can be sold or exchanged for goodsThe Demand for Foreign Currency AssetsSlide 13-25Copyright 2003 Pearson Education,Inc.Slide 13-26Copyright 2003 Pearson Education,Inc.Slide 13-27Copyright 2003 Pearson Education,In
26、c.Interest RatesMarket participants need two pieces of information in order to compare returns on different deposits:How the money values of the deposits will change How exchange rates will changeA currencys interest rate is the amount of that currency an individual can earn by lending a unit of the
27、 currency for a year.Example:At a dollar interest rate of 10%per year,the lender of$1 receives$1.10 at the end of the year.The Demand for Foreign Currency AssetsSlide 13-28Copyright 2003 Pearson Education,Inc.Exchange Rates and Asset ReturnsThe returns on deposits traded in the foreign exchange mark
28、et depend on interest rates and expected exchange rate changes.In order to decide whether to buy a euro or a dollar deposit,one must calculate the dollar return on a euro deposit.The Demand for Foreign Currency AssetsSlide 13-29Copyright 2003 Pearson Education,Inc.A Simple RuleThe dollar rate of ret
29、urn on euro deposits is approximately the euro interest rate plus the rate of depreciation of the dollar against the euro.The rate of depreciation of the dollar against the euro is the percentage increase in the dollar/euro exchange rate over a year.The Demand for Foreign Currency AssetsSlide 13-30C
30、opyright 2003 Pearson Education,Inc.The expected rate of return difference between dollar and euro deposits is:R$-R+(Ee$/-E$/)/E$/=R$-R-(Ee$/-E$/)/E$/(13-1)where:R$=interest rate on one-year dollar deposits R=todays interest rate on one-year euro deposits E$/=todays dollar/euro exchange rate(number
31、of dollars per euro)Ee$/=dollar/euro exchange rate(number of dollars per euro)expected to prevail a year from todayThe Demand for Foreign Currency AssetsSlide 13-31Copyright 2003 Pearson Education,Inc.When the difference in Equation(13-1)is positive,dollar deposits yield the higher expected rate of
32、return.When it is negative,euro deposits yield the higher expected rate of return.The Demand for Foreign Currency AssetsSlide 13-32Copyright 2003 Pearson Education,Inc.Table 13-3:Comparing Dollar Rates of Return on Dollar and Euro DepositsThe Demand for Foreign Currency AssetsSlide 13-33Copyright 20
33、03 Pearson Education,Inc.Return,Risk,and Liquidity in the Foreign Exchange MarketThe demand for foreign currency assets depends not only on returns but on risk and liquidity.There is no consensus among economists about the importance of risk in the foreign exchange market.Most of the market particip
34、ants that are influenced by liquidity factors are involved in international trade.Payments connected with international trade make up a very small fraction of total foreign exchange transactions.Therefore,we ignore the risk and liquidity motives for holding foreign currencies.The Demand for Foreign
35、Currency AssetsSlide 13-34Copyright 2003 Pearson Education,Inc.Equilibrium in the Foreign Exchange MarketInterest Parity:The Basic Equilibrium ConditionThe foreign exchange market is in equilibrium when deposits of all currencies offer the same expected rate of return.Interest parity condition The e
36、xpected returns on deposits of any two currencies are equal when measured in the same currency.It implies that potential holders of foreign currency deposits view them all as equally desirable assets.The expected rates of return are equal when:R$=R+(Ee$/-E$/)/E$/(13-2)Slide 13-35Copyright 2003 Pears
37、on Education,Inc.How Changes in the Current Exchange Rate Affect Expected ReturnsDepreciation of a countrys currency today lowers the expected domestic currency return on foreign currency deposits.Appreciation of the domestic currency today raises the domestic currency return expected of foreign cur
38、rency deposits.Equilibrium in the Foreign Exchange MarketSlide 13-36Copyright 2003 Pearson Education,Inc.Table 13-4:Todays Dollar/Euro Exchange Rate and the Expected Dollar Return on Euro Deposits When Ee$/=$1.05 per EuroEquilibrium in the Foreign Exchange MarketSlide 13-37Copyright 2003 Pearson Edu
39、cation,Inc.Figure 13-3:The Relation Between the Current Dollar/Euro Exchange Rate and the Expected Dollar Return on Euro DepositsExpected dollar return on euro deposits,R+(Ee$/-E$/)/(E$/)Todays dollar/euro exchange rate,E$/1.021.031.051.070.0310.0500.0690.079 0.1001.00Equilibrium in the Foreign Exch
40、ange MarketSlide 13-38Copyright 2003 Pearson Education,Inc.The Equilibrium Exchange RateExchange rates always adjust to maintain interest parity.Assume that the dollar interest rate R$,the euro interest rate R,and the expected future dollar/euro exchange rate Ee$/,are all given.Equilibrium in the Fo
41、reign Exchange MarketSlide 13-39Copyright 2003 Pearson Education,Inc.R$Return on dollar depositsFigure 13-4:Determination of the Equilibrium Dollar/Euro Exchange RateRates of return(in dollar terms)Exchange rate,E$/E2$/21E1$/E3$/3Expected return on euro depositsEquilibrium in the Foreign Exchange Ma
42、rketSlide 13-40Copyright 2003 Pearson Education,Inc.The Effect of Changing Interest Rates on the Current Exchange RateAn increase in the interest rate paid on deposits of a currency causes that currency to appreciate against foreign currencies.A rise in dollar interest rates causes the dollar to app
43、reciate against the euro.A rise in euro interest rates causes the dollar to depreciate against the euro.Interest Rates,Expectations,and EquilibriumSlide 13-41Copyright 2003 Pearson Education,Inc.Dollar returnR2$R1$Figure 13-5:Effect of a Rise in the Dollar Interest RateRates of return(in dollar term
44、s)Exchange rate,E$/2E2$/11E1$/Expected euro return Interest Rates,Expectations,and EquilibriumSlide 13-42Copyright 2003 Pearson Education,Inc.Dollar returnR$Figure 13-6:Effect of a Rise in the Euro Interest RateRates of return(in dollar terms)Exchange rate,E$/1E1$/2E2$/Rise in euro interest rate Exp
45、ected euro return Interest Rates,Expectations,and EquilibriumSlide 13-43Copyright 2003 Pearson Education,Inc.The Effect of Changing Expectations on the Current Exchange RateA rise in the expected future exchange rate causes a rise in the current exchange rate.A fall in the expected future exchange r
46、ate causes a fall in the current exchange rate.CASE:FORWARGInterest Rates,Expectations,and EquilibriumSlide 13-44Copyright 2003 Pearson Education,Inc.SummaryExchange rates play a role in spending decisions because they enable us to translate different countries prices into comparable terms.A depreci
47、ation(appreciation)of a countrys currency against foreign currencies makes its exports cheaper(more expensive)and its imports more expensive(cheaper).Exchange rates are determined in the foreign exchange market.Slide 13-45Copyright 2003 Pearson Education,Inc.SummaryAn important category of foreign e
48、xchange trading is forward trading.The exchange rate is most appropriately thought of as being an asset price itself.The returns on deposits traded in the foreign exchange market depend on interest rates and expected exchange rate changes.Slide 13-46Copyright 2003 Pearson Education,Inc.SummaryEquili
49、brium in the foreign exchange market requires interest parity.For given interest rates and a given expectation of the future exchange rate,the interest parity condition tells us the current equilibrium exchange rate.A rise in dollar(euro)interest rates causes the dollar to appreciate(depreciate)against the euro.Todays exchange rate is altered by changes in its expected future level.
