The Foreign Exchange Market

and Exchange Rates

Nominal exchange rate-

The value of one country’s
currency in terms of another
country’s currency.

0
Which of the following determines how many of
units of a foreign currency you can purchase
with one dollar?
a. The real exchange rate.
b. The nominal exchange rate.
c. The Federal Reserve.
d. The purchasing power parity of one dollar.

1
Which of the following determines how many of
units of a foreign currency you can purchase
with one dollar?
a. The real exchange rate.
b. The nominal exchange rate.
c. The Federal Reserve.
d. The purchasing power parity of one dollar.

2
 Making
the ▪Exchange Rates in the
Connection Financial Pages

EXCHANGE RATE BETWEEN THE DOLLAR AND THE

INDICATED CURRENCY

UNITS OF FOREIGN
CURRENCY U.S. DOLLAR PER UNIT
CURRENCY PER U.S. DOLLAR OF FOREIGN CURRENCY
Canadian dollar 1.067 0.937
Japanese yen 122.650 0.008
Mexican peso 10.919 0.092
British pound 0.507 1.972
Euro 0.752 1.330
The financial pages
of most newspapers
provide information
on exchange rates.

3
The Foreign Exchange Market and
Exchange Rates
There are three sources of foreign currency demand for the
U.S. dollar:

1 Foreign firms and households who want to buy goods

and services produced in the United States.
2 Foreign firms and households who want to invest
in the United States either through foreign direct
investment-buying or building factories or other
facilities in the United States-or through foreign
portfolio investment-buying stocks and bonds
issued in the United States.
3 Currency traders who believe that the value of the
dollar in the future will be greater than its value today.

4
Which of the following are sources of foreign
demand for U.S. dollars?
a. Foreign firms and consumers who want to
buy goods and services produced in the
United States.
b. Foreign firms and consumers who want to
invest in the United States.
c. Currency traders who believe that the value
of the dollar in the future will be greater than
its value today.
d. All of the above.

5
Which of the following are sources of foreign
demand for U.S. dollars?
a. Foreign firms and consumers who want to
buy goods and services produced in the
United States.
b. Foreign firms and consumers who want to
invest in the United States.
c. Currency traders who believe that the value
of the dollar in the future will be greater than
its value today.
d. All of the above.

6
When the exchange rate is above the equilibrium
exchange rate, there is a ______ of dollars,
and consequently ____________ pressure on
the exchange rate.
a. surplus; upward
b. surplus; downward
c. shortage; upward
d. shortage; downward

7
When the exchange rate is above the equilibrium
exchange rate, there is a ______ of dollars,
and consequently ____________ pressure on
the exchange rate.
a. surplus; upward
b. surplus; downward
c. shortage; upward
d. shortage; downward

8
The Foreign Exchange Market and
Exchange Rates
Equilibrium in the Market for Foreign Exchange
Currency appreciation An increase in
the market value of one currency relative
to another currency.

Currency depreciation A decrease in

the market value of one currency relative
to another currency.

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 What Are Exchange Rates?
• Exchange Rate Determination in the Short Run
$/¥
Supply of Yen

Exchange rate is
determined
by supply and
demand just
$0.0085
like any other
commodity.

Demand for Yen

Market for Yen Quantity of Yen

10
The Foreign Exchange Market and Exchange
Rates
Equilibrium in the Market for Foreign Exchange

Equilibrium in
the Foreign
Exchange
Market

11
 What Are Exchange Rates?
• Factors that Shift the Demand Curve
1. An increase (decrease) in the demand for a
country’s exports increases (decreases) the
value of its currency.
2. The more desirable (undesirable) a country is
for foreign investment, the higher (lower) the
value of that country’s currency.
3. An increase in the demand to hold dollar
reserves boosts the value of the dollar.
• Let’s use the supply and demand model to
illustrate each of these…

12
 What Are Exchange Rates?
1a. U.S. residents order more Toyotas
$/¥
Supply of yen

↑ demand for Japan’s

exports → ↑ value of
the yen
$0.0090
$0.0085 Demand for yen
w/↑ orders of
Toyotas

Demand for yen

Market for Yen Quantity of Yen

13
 What Are Exchange Rates?
1b. U.S. residents order fewer Toyotas
$/¥
Supply of yen

↓ demand for Japan’s

exports → ↓ value of
the yen

$0.0085 Demand for yen

$0.0080 w/↓ orders of
Toyotas

Demand for yen

Market for Yen Quantity of Yen

14
 What Are Exchange Rates?
2. Mexico becomes a better investment
$/peso
Supply of pesos

The Mexican peso

↑ in value
0.090

0.075 Demand for peso

w/↑ foreign
investment

Demand for pesos

Market for Pesos Quantity of Pesos

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