Chapter 4 - Exchange rate determination. The objectives of this chapter are: to present some stylised facts about the observed behaviour of exchange rates, to identify the factors that lead to changes in the supply of and demand for foreign exchange and, consequently, the exchange rate, . | Lecture International finance An analytical approach 3 e Chapter 4 - Imad A. Moosa Chapter 4 Exchange Rate Determination Objectives To identify the factors causing changes in the exchange rate. To describe purchasing power parity and the monetary model of exchange rates. To explain how the bid-offer spread and the forward spread are determined. To examine the factors affecting the AUD exchange rate. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t a International Finance An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 4-2 Some stylised facts The exchange rate follows approximately a random walk with little or no drift. The spot and forward rates tend to move in the same direction and by approximately the same amount. There is no correspondence between exchange rates and prices. cont. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t a International Finance An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 4-3 Some stylised facts cont. The relation between the exchange rate and the current account is not strong . Rapid monetary expansion leads to rapid currency depreciation. cont. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t a International Finance An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 4-4 Some stylised facts cont. The behaviour of exchange rates is often described as bubbles followed by crashes . Volatility clustering. Periods of calm are followed by periods of calm and periods of turbulence are followed by periods of turbulence. Exchange rates move in cycles with significant random variation. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t a International Finance An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 4-5 The equilibrium exchange rate S d f Sf S0 Df Q f Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t a International Finance An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 4-6 Factors affecting the supply
