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Lecture International financial management - Chapter 4: Exchange rate determination

In this chapter: Explain how exchange rate movements are measured, explain how the equilibrium exchange rate is determined, examine factors that determine the equilibrium exchange rate, explain the movement in cross exchange rates, explain how financial institutions attempt to capitalize on anticipated exchange rate movements. | 1 Instructor: Ajab K. Burki MBA (Fin)- IBA Karachi, BSIT(Hons), BA (Economics) 1 2 4 Exchange Rate Determination Explain how exchange rate movements are measured. Explain how the equilibrium exchange rate is determined. Examine factors that determine the equilibrium exchange rate. Explain the movement in cross exchange rates. Explain how financial institutions attempt to capitalize on anticipated exchange rate movements. 2 Chapter Objectives 2 3 Measuring Exchange Rate Movements Depreciation: decline in a currency’s value Appreciation: increase in a currency’s value Comparing foreign currency spot rates over two points in time, S and St-1 A positive percent change indicates that the currency has appreciated. A negative percent change indicates that it has depreciated. 4 Exhibit 4.1 How Exchange Rate Movements and Volatility Are Measured 5 Exchange Rate Equilibrium The exchange rate represents the price of a currency, or the rate at which one currency can be exchanged for another. Demand for a currency increases when the value of the currency decreases, leading to a downward sloping demand schedule. (See Exhibit 4.2) Supply of a currency increases when the value of the currency increases, leading to an upward sloping supply schedule. (See Exhibit 4.3) Equilibrium equates the quantity of pounds demanded with the supply of pounds for sale. (See Exhibit 4.4) In liquid spot markets, exchange rates are not highly sensitive to large currency transactions. 6 Exhibit 4.2 Demand Schedule for British Pounds 6 6 7 Exhibit 4.3 Supply Schedule of British Pounds for Sale 7 7 8 Exhibit 4.4 Equilibrium Exchange Rate Determination 8 8 9 Factors That Influence Exchange Rates The equilibrium exchange rate will change over time as supply and demand schedules change. 10 Factors That Influence Exchange Rates Relative Inflation: Increase in U.S. inflation leads to increase in U.S. demand for foreign goods, an increase in U.S. demand for foreign currency, and an increase in the exchange . | 1 Instructor: Ajab K. Burki MBA (Fin)- IBA Karachi, BSIT(Hons), BA (Economics) 1 2 4 Exchange Rate Determination Explain how exchange rate movements are measured. Explain how the equilibrium exchange rate is determined. Examine factors that determine the equilibrium exchange rate. Explain the movement in cross exchange rates. Explain how financial institutions attempt to capitalize on anticipated exchange rate movements. 2 Chapter Objectives 2 3 Measuring Exchange Rate Movements Depreciation: decline in a currency’s value Appreciation: increase in a currency’s value Comparing foreign currency spot rates over two points in time, S and St-1 A positive percent change indicates that the currency has appreciated. A negative percent change indicates that it has depreciated. 4 Exhibit 4.1 How Exchange Rate Movements and Volatility Are Measured 5 Exchange Rate Equilibrium The exchange rate represents the price of a currency, or the rate at which one currency can be exchanged for another. .