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International Exam 2

Terms in this set (12)

Which would you rather?
1. Rich country with a trade deficit, or
2. poor country with a trade surplus
BOP and Currency Values
Fixed Exchange Rate Countries: BOP must be zero to maintain equilibrium of exchange rate price

What If: Balance > Zero
--> There is a shortage of that currency in the world market
--> central bank must sell domestic currency to balance the BOP, to maintain fixed exchange rate
Trade Surplus -> Currency Strengthen -> demand increase

What if: Balance < Zero
--> there is a surplus of that currency in the market
--> so, the central bank must buy domestic currency to eliminate pressure on rates, and maintain fixed exchange rate system
Floating Rate Country - Market Driven
-> no responsibility by government to balance the BOP
-> currency must self-correct to find equilibrium
--> What do officials do when the market changes the currency rate? NOTHING!

exporters like a WEAK currency
--> it makes things cheaper for them
ALWAYS REMEMBER
-> weak or depreciating currency values benefit exporters
-> strong or appreciating currency values benefit importers

so do you prefer an appreciating or depreciating currency value?
Foreign Exchange Market
Geography and Size of Currency Markets
--> 24 hour market

Currency Exchange Market
--> 5-6 trillion daily volume
Major International Currencies
US $ - 87% of all trades include the $

Euro - 33%

Yen - 23%

UK has 41% of daily trading
United States is 19%
The Foreign Exchange Market
Two Levels of Trading Markets
1. interbank (whole sale) market
--> huge sums of currency changing hands every day
2. Client (retail) Market
--> Transactions between banks and their customers
What determines exchange rates/currency values?
1. parity conditions: economic conditions that link exchange rates and price levels
--> inflation rates
--> interest rates
2. other factors that affect exchange rates
--> type of forex system - fixed, floating or mixed
--> monetary policies
3. Infrastructure - Modernized?
--> banking
--> securities
4. Politics and economic controls
--> capital flow controls: limiting the ability to move money
--> black market currencies: means their currency is weak
5. Cross Boarder Investment
--> direct investment
--> portfolio investments

Law of one price = identical goods should cost the same in different markets
Parity
Effects Currency Value
- Inflation Rates
- Interest Rates
International Law of One Price
Purchasing Power Parity
--> internationally, traded goods should be the same price in every country

*exchange rate between the two countries/currencies should be a ratio of product prices between the two
Absolute Purchasing Power Parity
Currency application of law of one price
--> the spot exchange rate could be found by the relative prices of goods and services

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Spot Price Forward Price

Forward price is affected by:
-Inflation rates
-Interest rates
Exchange Rate Equation
Example:
Japanese expected inflation: 20%
U.S. Expected Inflation: 10%
Current Exchange rate: Yen 100/$
What should the future spot rate be? Yen 110/$
--> 20% - 10% = 10%
--> 100 + (100 x 10%) = 110

F(x) Y/$ = S(x) Y/$ * [ (1+Y^int) / (1+$^Int)

= [ (1+ .20) / (1+.10) ] x 100
= F(x) = 110Y
Precise = 109.1Y

Informally:
% change in exchange rate = %change in U.S. Prices - % change in Japanese prices
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