The Determination of Exchange Rates

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The Determination of Exchange Rates

• Chapter 2

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CHAPTER 2 THE DETERMINATION OF EXCHANGE RATES

• CHAPTER OVERVIEW
• I. EQUILIBRIUM EXCHANGE RATES??????
• II. ROLE OF CENTRAL BANKS??????.

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• ?????????????????(????????reference
  currency)????????
• ????(spot rate)??????????????
• ????(forward rate)?????????????????????

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Equilibrium Exchange Rates

• B. How Americans Purchase German Goods
• 1. Foreign Currency Demand
• -derived from the demand for a foreign
  countrys goods, services, and financial
  assets.
• e.g. The demand for German goods by Americans

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The Demand for in the U.S.

• /

D
.50
Qty
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Equilibrium Exchange Rates

• B.2. Foreign Currency Supply
• a. derived from the foreign countrys
  demand for local goods.
• b. They must convert their currency to
  purchase.
• e.g. German demand for US goods means
  Germans convert euros to US in order
  to buy.

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The Supply of in the U.S.

• /

S
.50
Qty
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Equilibrium Exchange Rates

• B.3. Equilibrium Exchange Rate
• occurs where the quantity supplied equals
  the quantity demanded of a foreign currency
  at a specific local price.

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The / Equilibrium Rate

• /

Equilibrium
D

S
.50
Qty
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Equilibrium Exchange Rates

• C. How Exchange Rates Change
• 1. Increased demand
• as more foreign goods are demanded, more
  of the foreign currency is demand.
• 2. In other words, the price of the foreign
  currency in local currency increases.

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Equilibrium Exchange Rates

• C.3. Home Currency Depreciation a.
  Foreign currency grows more valuable than
  the home currency.
• b. The foreign currencys value has
  appreciated against the home currency.

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The US Depreciates When
D

• /

D
.65
S
.50
Qty
Q1
Q2
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• ????(real interest rate)???????????????
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Equilibrium Exchange Rates

• C.5 Currency Appreciation
• (e1 - e0)/ e0
• where e0 old currency value
• e1 new currency value

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Equilibrium Exchange Rates

• EXAMPLE Appreciation
• If the dollar value of the goes from 0.50
  (e0) to 0.65 (e1), then the has appreciated by
• (.65 - .50)/ .50 30

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Equilibrium Exchange Rates

• C.4. Calculating a Depreciation
• (e0 - e1)/ e1
• where e0 old currency value
• e1 new currency value

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Equilibrium Exchange Rates

• EXAMPLE US Depreciation
• Use the formula
• (e0 - e1)/ e1
• substituting
• (.50 - .65)/ .65 - 23.1
• is the US depreciation.
• ??????????????????,??????????,??????????????????

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Equilibrium Exchange Rates

• D. THE FACTORS AFFECTING EXCHANGE RATES
• 1. Inflation rates
• 2. Interest rates
• 3. GNP growth rates

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Sample Problem

• Suppose the U.S. dollar appreciates against the
  Russian ruble by 500. How much did the ruble
  depreciate against the dollar?
• To solve the problem, you can approach it in two
  steps
• Solve for e1
• Substitute and solve for the depreciation (x)

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U.S. APPRECIATION
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RUBLE DEPRECIATION

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SOLUTION Step 1 Solve for e1
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SOLUTION Step 2 Substitute and solve for x
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SOLUTION

• When the dollar appreciated by 500 against the
  ruble, the ruble depreciated 83 against the
  dollar.

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