1 Multinational Financial Management Alan Shapiro 7 th Edition J.Wiley & Sons Power Points by Joseph F. Greco, Ph.D. California State University, Fullerton
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Multinational Financial Management Alan Shapiro 7th EditionJ.Wiley & SonsPower Points byJoseph F. Greco, Ph.D.California State University, Fullerton
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CHAPTER 2
THE DETERMINATION OF EXCHANGE RATES
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CHAPTER 2 OVERVIEW:
I. EQUILIBRIUM EXCHANGE RATES
II. ROLE OF CENTRAL BANKSIII. EXPECTATIONS AND THE
ASSET MARKET MODEL
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Part I. Equilibrium Exchange Rates
I. SETTING THE EQUILIBRIUM A. Exchange Rates
market-clearing prices that equilibrate the
quantities supplied and demanded of foreign currency.
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Equilibrium Exchange RatesB. How Americans Purchase
German Goods1. Foreign Currency Demand
-derived from the demand for foreign country’s goods,
services, and financial assets.
e.g. The demand for German goods by Americans
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Equilibrium Exchange Rates2. Foreign Currency Supply:
a. derived from the foreign country’s demand for local goods. b. They must convert their currency to purchase.
e.g. German demand for US goods means Germans convert
DM to US $ in order to buy.
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Equilibrium Exchange Rates
3. Equilibrium Exchange Rate:occurs when the quantity
supplied equals the quantity demanded of a foreign currency at a specific local
price.
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Equilibrium Exchange Rates
C. How Exchange Rates Change1. Increased demand
as more foreign goods are demanded, the price
of the foreign currency in local currency increases and vice versa.
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Equilibrium Exchange Rates
2. Home Currency Depreciation
a. Foreign currency becomes more valuable than the
home currency.b. The foreign currency’s
value has appreciated against the home currency.
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Equilibrium Exchange Rates
3. Calculating a Depreciation:
Currency Depreciation
where e0 = old currency value
e1 = new currency value
Note: Resulting sign is always negative
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e
ee
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Equilibrium Exchange Rates
Currency Appreciation
0
01
e
ee
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Equilibrium Exchange RatesEXAMPLE: dm AppreciationIf the dollar value of the dm goes from $0.64 (e0) to $0.68 (e1), then the dm has appreciated by
0
01
e
ee
= (.68 - .64)/ .64 = 6.25%
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Equilibrium Exchange Rates
EXAMPLE: US$ Depreciation
We use the first formula,(e0 - e1)/ e1
substituting(.64 - .68)/ .68 = - 5.88%
which is the value of the US$ depreciation.
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Equilibrium Exchange Rates
D. FACTORS AFFECTING EXCHANGE RATES:
1. Inflation rates2. Interest rates3. GNP growth rates
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I. FUNDAMENTALS OF CENTRAL BANK INTERVENTIONA. Role of Exchange
Rates:LINKS BETWEEN THE
DOMESTIC AND THE WORLD ECONOMY
PART II. THE ROLE OF CENTRAL BANKS
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B. THE IMPACT OF EXCHANGE RATE CHANGES1. Currency Appreciation:
-domestic prices increase relative to foreign prices.
- Exports: less price competitive
- Imports: more attractive
THE ROLE OF CENTRAL BANKS
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THE ROLE OF CENTRAL BANKS
2. Currency Depreciation
- domestic prices fall relative to foreign prices.
- Exports: more price competitive.
- Imports: less attractive
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THE ROLE OF CENTRAL BANKS
C. Foreign Exchange Market Intervention1. Definition: the official
purchases and sales of currencies through the central bank to influence the home exchange rate.
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THE ROLE OF CENTRAL BANKS
2. Goal of Intervention: -to alter the demand for
onecurrency by changing the
supply of another.
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THE ROLE OF CENTRAL BANKS
D. The Effects of Foreign Exchange Intervention
1. Effects of Intervention: - either ineffective or
irresponsible2. Lasting Effect:
- If permanent, change results
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Part III. EXPECTATIONSI. WHAT AFFECTS A
CURRENCY’S VALUE?
A. Current eventsB. Current supplyC. Demand flowsD. Expectation of
future exchange rate
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EXPECTATIONS
II. Role of Expectations :A. Currency = financial
assetB. Exchange rate =
simple relation of two financial assets
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EXPECTATIONS
III. Demand for Money and Currency Values: Asset
Market ModelA. Exchange rates reflect the
supply of and demand for foreign-currency denominated assets.
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EXPECTATIONS
B. Soundness of a Nation’s Economic Policies
- a nation’s currency tends to strengthen with sound economic policies.
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EXPECTATIONS
IV. EXPECTATIONS AND CENTRAL BANK BEHAVIOR
- exchange rates also influenced by
expectations of central bank behavior.
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EXPECTATIONS
A. Central Bank Reputations
B. Central Bank Independence
C. Currency Boards