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EXCHANGE RATE
DETERMINATION
1
Exchange Rate Movement:
Measurement
Movements:
Depreciation
A decline in a currency’s value.
Appreciation
An increase in a currency’s value.
2
Exchange Rate Movement:
Measurement (cont.)
Percent ∆ in S - St-1
foreign =
currency value St-1
Where:
S = spot rate as of the more recent date
St-1 = spot rate as of the earlier date
3
Exchange Rate Equilibrium
Exchange rate equilibrium is determined by the
demand for a currency relative to supply.
Demand for a Currency
4
Exchange Rate Equilibrium (cont.)
5
Exchange Rate Equilibrium (cont.)
6
Factors that Influence Exchange
Rates
7
Factors that Influence Exchange
Rates (cont.)
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Factors that Influence Exchange
Rates (cont.)
Government Control
Through:
1. The imposition of foreign exchange barriers.
2. The imposition of foreign trade barriers.
3. Intervening (buying and selling currencies) in the
foreign exchange markets.
4. Affecting macro variables, such as inflation, interest
rate, income level.
14
Factors that Influence Exchange
Rates (cont.)
Expectation
Market expectations of future exchange rates
can affect the demand and supply of
currencies.
Ex. Any news of a potential surge in US inflation may
cause currency traders to sell dollars. They try to
anticipate a future decline in the dollar’s value.
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Factors that Influence Exchange
Rates (cont.)
Interaction of Factors
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