ECW3121 International Trade and Finance Lecture 9

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ECW3121International Trade and FinanceLecture 9
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International Finance
Balance Of Payments
Foreign Exchange Markets
Interest Arbitrage
Finance Study Guide 3
Exchange rate theorems
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Reading
International Finance
Foreign Exchange Market

• Salvatore - Chapter 14

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International Finance
Foreign Exchange Market

• Real Sector, Monetary Sector.
• Monetary sector supports real activities.
• In real international trade currency is used
  instead of relative prices.
• Foreign exchange market central to international
  finance.
• Foreign exchange market(s) is (are) required for
  dealing with international transactions in
  different currencies.

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Foreign Exchange
International Finance
Foreign Exchange Market

• Foreign Exchange
• Floating or Fixed Exchange Rate
• Price or Volume Quote

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Foreign Exchange
International Finance
Foreign Exchange Market
Foreign Exchange Currency and money claims, such
as bank balances and bank drafts, expressed in
the equivalent value in foreign money. The use of
foreign exchange arises because different nations
have different monetary units, and the currency
of one country cannot be used for making payments
in another country.
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Floating or Fixed Exchange Rate
International Finance
Foreign Exchange Market
Floating Exchange Rate
Fixed Exchange Rate
Exchange rate responds to market demand and
supply and is efficient if includes all available
information in the market place.
A central authority decides on/regulates/controls
the exchange rate. By international agreement
fixed exchange rates with a narrow margin of
fluctuation existed until 1971.
Currency board mixture of floating and fixed
exchange rate mechanisms. Periodic adjustment of
money supply.
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Foreign Exchange
International Finance
Foreign Exchange Market

• Exchange Rate (R) - one currency in terms of
  another
• The ratio of two currencies.
• Two ways of quoting an exchange rate
• Direct (Price) Quote
• R AUD/USD
• Indirect (Volume) Quote
• R USD/AUD

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1. Direct (Price) Quote
International Finance
Foreign Exchange Market

• Gives price of Foreign currency in terms of Local
  currency
• Australian Dollar Equivalent of one unit of
  foreign currency.
• Australian Dollars per US dollar.
• How many Australian dollars required to purchase
  one US dollar?
• ie. 1.45 AUD 1 USD
• R AUD/USD 1.45/1 1.54
• Price of 1 USD is 1.45 Australian

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1. Direct (Price) Quote
International Finance
Foreign Exchange Market
MARKET FOR US DOLLARS
P RAUD/USD
S USD
1.45
D USD
0
50
Million USD per day
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2. Indirect (Volume) Quote
International Finance
Foreign Exchange Market

• Gives volume of foreign currency that can be
  purchased with one unit of local currency.
• Foreign Currency equivalent of one Australian
  Dollar
• US Dollars per Australian Dollar.
• How many US dollars will one Australian Dollar
  buy?
• ie 1 AUD 0.69 USD
• R USD/AUD 0.69/1 0.69 1/1.45
• USD price of one Australian Dollar

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2. Indirect (Volume) Quote
International Finance
Foreign Exchange Market
MARKET FOR AUSTRALIAN DOLLARS
P RUSD/AUD
S AUD
0.69
D AUD
0
50
Million AUD per day
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Appreciation and Depreciation
International Finance
Foreign Exchange Market

• Appreciation value of local currency increases
  relative to another.
• Price Quote falls now requires less Australian
  dollars to purchase one USD.
• Volume Quote increases one Australian dollar is
  now worth more USD.
• Depreciation value of local currency falls
  relative to another.
• Price Quote increases now requires more
  Australian dollars to purchase one USD.
• Volume Quote falls one Australian dollar is now
  worth less USD.

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International Finance
Foreign Exchange Market
Appreciation (in Volume Quote terms)
MARKET FOR AUSTRALIAN DOLLARS
P RUSD/AUD
S AUD
0.69
D AUD
D AUD
0
50
Million AUD per day
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International Finance
Foreign Exchange Market
Appreciation (in Volume Quote terms)
MARKET FOR AUSTRALIAN DOLLARS
P RUSD/AUD
S AUD
Appreciation of Australian Dollar against US
Dollar
0.73
0.69
shortage
D AUD
D AUD
0
50
Million AUD per day
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International Finance
Foreign Exchange Market
Appreciation (in Price Quote terms)
MARKET FOR US DOLLARS
P RAUD/USD
S USD
1.45
D USD
D USD
0
50
Million USD per day
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International Finance
Foreign Exchange Market
Appreciation (in Price Quote terms)
MARKET FOR US DOLLARS
P RAUD/USD
S USD
surplus
1.45
D USD
D USD
0
50
Million USD per day
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International Finance
Foreign Exchange Market
Appreciation (in Price Quote terms)
MARKET FOR US DOLLARS
P RAUD/USD
S USD
Australian Dollar appreciates against US Dollar
1.45
1.37
D USD
D USD
0
50
Million USD per day
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Two sides of the same market
International Finance
Foreign Exchange Market
Appreciation (in Price Quote terms)
Appreciation (in Volume Quote terms)
MARKET FOR US DOLLARS
MARKET FOR AUST DOLLARS
S AUD
S USD
P RAUD/USD
P RUSD/AUD
MARKET FOR AUSTRALIAN DOLLARS
0.73
0.69
1.45
1.37
D USD
D AUD
0
0
50
50
Million USD per day
Million AUD per day
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What influences demand for and supplyof
currencies?
International Finance
Foreign Exchange Market

• Flows of goods and services
• Capital Flows, interest rates
• Political Stability
• Travel, tourism
• Supply of money (currency)
• Confidence, risk assessment