Ch.

14: Exchange Rates and

the Foreign Exchange
Market: An Asset Approach

Germany U.K.
.9
4

.8
3.5
Exchange Rate

Exchange Rate
.7
3

.6
2.5

.5
2

.4
1.5

1960m1 1970m1 1980m1 1990m1 2000m1 2010m1 1960m1 1970m1 1980m1 1990m1 2000m1 2010m1
date2 date2

Sweden Canada
12

1.6
10

1.4
Exchange Rate

Exchange Rate
8

1.2
6

1
4

1960m1 1970m1 1980m1 1990m1 2000m1 2010m1 1960m1 1970m1 1980m1 1990m1 2000m1 2010m1
date2 date2

1
 Oman El Salvador China

.42

10

10
8
.4

8
Exchange Rate

Exchange Rate

Exchange Rate
6
.38

4
.36

2
.34

2
1960m1 1970m1 1980m1 1990m1 2000m1 2010m1 1960m1 1970m1 1980m1 1990m1 2000m1 2010m1 1960m1 1970m1 1980m1 1990m1 2000m1 2010m1
date2 date2 date2

India Mexico Nigeria

150
50

15
40

100
10
Exchange Rate

Exchange Rate

Exchange Rate
20 30

50
5
10
0

0
1960m1 1970m1 1980m1 1990m1 2000m1 2010m1 1960m1 1970m1 1980m1 1990m1 2000m1 2010m1 1960m1 1970m1 1980m1 1990m1 2000m1 2010m1
date2 date2 date2

Argentina Egypt Jordan

4

.7
6
3

.6
Exchange Rate

Exchange Rate

Exchange Rate
4

.5
2

.4
1

.3
0

1960m1 1970m1 1980m1 1990m1 2000m1 2010m1 1960m1 1970m1 1980m1 1990m1 2000m1 2010m1 1960m1 1970m1 1980m1 1990m1 2000m1 2010m1
date2 date2 date2

Table 4: Today’s Dollar/Euro Exchange Rate and the Expected Dollar

Return on Euro Deposits When Ee$/€ = $1.05 per Euro

2
Figure 3: The Relation Between the Current Dollar/Euro Exchange Rate
and the Expected Dollar Return on Euro Deposits

Today’s dollar/euro
exchange rate, E$/€

1.07

1.05

1.03
1.02

1.00
0.031 0.050 0.069 0.079 0.100
Expected dollar return on
euro deposits, R€ + (Ee$/€ -
E$/€)/(E$/€)

Figure 4: Determination of the Equilibrium Dollar/Euro Exchange Rate

Exchange rate, E$/€

Return on
dollar deposits

E2$/€ 2

E1$/€ 1
3
E3$/€

Expected return
on euro deposits

R$ Rates of return
(in dollar terms)