Upload
mahbub-talukder
View
224
Download
0
Embed Size (px)
Citation preview
7/24/2019 IFM Chapter 04.ppt
1/44
Exchange Rate DeterminationChapter: 04
PowerPoint Lecture Presentationto accompany
International Financial anagementDr! "amiul Par#e$ %hme&' %ssistant Pro(essor' In&epen&ent )ni#ersity' *angla&esh
7/24/2019 IFM Chapter 04.ppt
2/44
Chapter +,-ecti#es
.o explain how exchange rate mo#ementsare measure&/
.o explain how the euili,rium exchangerate is &etermine&/ an&
.o examine the (actors that a((ect theeuili,rium exchange rate!
7/24/2019 IFM Chapter 04.ppt
3/44
easuring
Exchange Rate o#ements %n exchange ratemeasures the #alue o(
one currency in units o( another currency!
Depreciate
Appreciate
Mixed in trading
7/24/2019 IFM Chapter 04.ppt
4/44
easuring
Exchange Rate o#ements
where Stdenotes the spot rate at time t and St-1denotes exchange rate at an earlier period.
7/24/2019 IFM Chapter 04.ppt
5/44
easuring
Exchange Rate o#ements
% positi#e 1 represents appreciation o(
the (oreign currency' while a negati#e 1represents &epreciation!
Foreign exchange rate mo#ements ten& to,e larger (or longer time hori$ons!
7/24/2019 IFM Chapter 04.ppt
6/44
easuring
Exchange Rate o#ements
7/24/2019 IFM Chapter 04.ppt
7/44
Exchange Rate Euili,rium
%lthough it is easy to measure the percentage change in the #alue o(a currency' it is more &i((icult to explain why the #alue change& or to
(orecast how it may change in the (uture!
.o achie#e either o( these o,-ecti#es' the concept o( an euili,riumexchange rate must ,e un&erstoo&' as well as the (actors that a((ectthe euili,rium rate!
Deman& 2s! "upply
7/24/2019 IFM Chapter 04.ppt
8/44
Deman& (or a Currency: )!"! &eman&(or *ritish Poun&
7/24/2019 IFM Chapter 04.ppt
9/44
"upply o( a Currency (or "ale
Exhi,it 4!3 shows the uantity o( poun&s (orsale supplie& to the (oreign exchange mar5et
in exchange (or &ollars6 correspon&ing to
each possi,le exchange rate at a gi#en point
in time! see next sli&e6!
7/24/2019 IFM Chapter 04.ppt
10/44
"upply o( a Currency (or "ale
7/24/2019 IFM Chapter 04.ppt
11/44
Euili,rium
7/24/2019 IFM Chapter 04.ppt
12/44
Factors that In(luence Exchange Rates
.he euili,rium exchange rate will change o#er
time as supply an& &eman& sche&ules change!.he (ollowing euation summari$es the (actors
that can in(luence a currency7s spot rate:
7/24/2019 IFM Chapter 04.ppt
13/44
Factors: Relati#e In(lation Rates
Example: 8ol&ing all other (actors constant' )!"!in(lation su&&enly increase& su,stantially while
*ritish in(lation remaine& the same! %ssume
that ,oth *ritish an& )!"! (irms sell goo&s that
can ser#e as su,stitutes (or each other!6
7/24/2019 IFM Chapter 04.ppt
14/44
Factors: Relati#e Exchange Rates .he increase& )!"! &eman& (or poun&s an& the re&uce&
supply o( poun&s (or sale place upwar& pressure on the
#alue o( the poun&!
7/24/2019 IFM Chapter 04.ppt
15/44
Relati#e Interest Rates
Changes in relati#e interest rates a((ect in#estment in(oreign securities' which in(luences the &eman& (oran& supply o( currencies an& there(ore in(luences
exchange rates!
Example: %ssume that )!"! interest rates rise while*ritish interest rates remain constant! In this case' )!"!
in#estors will li5ely re&uce their &eman& (or poun&s'
since )!"! rates are now more attracti#e relati#e to
*ritish rates' an& there is less &esire (or *ritish ,an5
&eposits!
7/24/2019 IFM Chapter 04.ppt
16/44
Relati#e Interest Rates
R l i I R
7/24/2019 IFM Chapter 04.ppt
17/44
Relati#e Interest Rates
In some cases' an exchange rate ,etween two countries7currencies can ,e a((ecte& ,y changes in a thir& country7s
interest rate!
Example: 9hen the Cana&ian interest rate increases' it can,ecome more attracti#e to *ritish in#estors than the )!"! rate!
.his encourages *ritish in#estors to purchase (ewer &ollar
&enominate& securities! .hus' the supply o( poun&s to ,eexchange& (or &ollars woul& ,e smaller than it woul& ha#e ,een
without the increase in Cana&ian interest rates' which places
upwar& pressure on the #alue o( the poun& against the )!"!
&ollar!
R l I t t R t
7/24/2019 IFM Chapter 04.ppt
18/44
Real Interest Rates
%lthough a relati#ely high interest rate may attract(oreign in(lows to in#est in securities o((ering high
yiel&s6' the relati#ely high interest rate may re(lect
expectations o( relati#ely high in(lation! *ecause high
in(lation can place &ownwar& pressure on the local
currency' some (oreign in#estors may ,e &iscourage&
(rom in#esting in securities &enominate& in that
currency! For this reason' it is help(ul to consi&er the
real interest rate' which a&-usts the nominal interest rate
(or in(lation:
.his relationship is sometimes calle& the Fisher e((ect!
7/24/2019 IFM Chapter 04.ppt
19/44
Relati#e Income Le#el
% thir& (actor a((ecting exchange rates isrelati#e income le#els! *ecause income
can a((ect the amount o( imports&eman&e&' it can a((ect exchange rates!
7/24/2019 IFM Chapter 04.ppt
20/44
Relati#e Income Le#el Example: %ssume that the )!"! income le#el rises su,stantially
while the *ritish income le#el remains unchange&! Consi&er
the impact o( this scenario on 6 the &eman& sche&ule (or
poun&s' ;6 the supply sche&ule o( poun&s (or sale' an& 36 the
euili,rium exchange rate! First' the &eman& sche&ule (or
poun&s will shi(t outwar&' re(lecting the increase in )!"!
income an& there(ore increase& &eman& (or *ritish goo&s!"econ&' the supply sche&ule o( poun&s (or sale is not
expecte& to change! .here(ore' the euili,rium exchange rate
o( the poun& is expecte& to rise' as shown in Exhi,it 4!
7/24/2019 IFM Chapter 04.ppt
21/44
Relati#e Income Le#el
7/24/2019 IFM Chapter 04.ppt
22/44
=o#ernment Control
.he go#ernments o( (oreign countries canin(luence the euili,rium exchange rate in manyways' inclu&ing 6 imposing (oreign exchange
,arriers' ;6 imposing (oreign tra&e ,arriers' 36
inter#ening ,uying an& selling currencies6 in the(oreign exchange mar5ets' an& 46 a((ecting
macro #aria,les such as in(lation' interest rates'
an& income le#els!
7/24/2019 IFM Chapter 04.ppt
23/44
=o#ernment Control
Example: Recall the example in which )!"! interestrates rose relati#e to *ritish interest rates! .heexpecte& reaction was an increase in the *ritish
supply o( poun&s (or sale to o,tain more )!"!
&ollars in or&er to capitali$e on high )!"! moneymar5et yiel&s6! >et' i( the *ritish go#ernment
place& a hea#y tax on interest income earne& (rom
(oreign in#estments' this coul& &iscourage the
exchange o( poun&s (or &ollars!
7/24/2019 IFM Chapter 04.ppt
24/44
Expectations
% (i(th (actor a((ecting exchange rates is mar5etexpectations o( (uture exchange rates! Li5e other
(inancial mar5ets' (oreign exchange mar5ets
react to any news that may ha#e a (uture e((ect!?ews o( a potential surge su&&en increase6 in
)!"! in(lation may cause currency tra&ers to sell
&ollars' anticipating a (uture &ecline in the
&ollar7s #alue! .his response places imme&iate&ownwar& pressure on the &ollar!
7/24/2019 IFM Chapter 04.ppt
25/44
Expectations
Example: In#estors may temporarily in#est(un&s in Cana&a i( they expect Cana&ianinterest rates to increase! "uch a rise may
cause (urther capital (lows into Cana&a' which
coul& place upwar& pressure on the Cana&ian&ollar7s #alue! *y ta5ing a position ,ase& on
expectations' in#estors can (ully ,ene(it (rom
the rise in the Cana&ian &ollar7s #alue ,ecause
they will ha#e purchase& Cana&ian &ollars,e(ore the change occurre&!
7/24/2019 IFM Chapter 04.ppt
26/44
Expectations (based on information)
Factors that In(luence
Exchange Rates
Fed chairman suggests Fed is Strengthenedunlikely to cut U.S. interest rates
A possible decline in German Strengthened
interest ratesEuropean Central bank Weakened
epected to inter!ene
to boost the euro
Signal "mpact on #
$oor U.S. economic indicators Weakened
7/24/2019 IFM Chapter 04.ppt
27/44
Interaction Factors
9hen more than one (actors interact with each other! .ransactions within the (oreign exchange mar5ets
(acilitate either tra&e or (inancial (lows! .ra&e@relate&
e!g! Export@import6 (oreign exchange transactions
are generally less responsi#e to news signal6!Financial (low transactions are #ery responsi#e to
news' howe#er' ,ecause &ecisions to hol& securities
&enominate& in a particular currency are o(ten
&epen&ent on anticipate& changes in currency #alues!
7/24/2019 IFM Chapter 04.ppt
28/44
+#er a particular perio&' &i((erent(actors may place opposing
pressures on the #alue o( a
(oreign currency!
Interaction Factors
7/24/2019 IFM Chapter 04.ppt
29/44
Interaction Factors
Example: interaction ,etween increase in income an&
expectations
%n increase in income le#els sometimes associate& withexpectationso( higher interest rates e!g! in the local
capital mar5et6! "o' e#en though a higher income le#el can
result in more imports' it may also in&irectly attract more(inancial in(lows assuming interest rates increase6!
*ecause the (a#ora,le (inancial (lows may o#erwhelm the
un(a#ora,le tra&e (lows' an increase in income le#els is
(reuently expecte& to strengthen the local currency!
7/24/2019 IFM Chapter 04.ppt
30/44
Interaction Factors
Example: interaction ,etween in(lation rate an&interest rate
%ssume the simultaneous existence o( 6 a su&&enincrease in )!"! in(lation an& ;6 a su&&en increase in
)!"! interest rates! I( the *ritish economy is relati#elyunchange&' the increase in )!"! in(lation will place
upwar& pressure on the poun&7s #alue while the
increase in )!"! interest rates places &ownwar&
pressure on the poun&7s #alue!
7/24/2019 IFM Chapter 04.ppt
31/44
.he sensiti#ity o( the exchangerate to these (actors is&epen&ent on the #olume o(
international transactions
,etween the two countries!
Interaction Factors
7/24/2019 IFM Chapter 04.ppt
32/44
Factors that In(luence
Exchange Rates: Interactions
7/24/2019 IFM Chapter 04.ppt
33/44
"peculating on %nticipate& ExchangeRates: % step@,y@step example
Chicago *an5 expects the exchange rateo( the ?ew Aealan& &ollar ?AB6 to
appreciate (rom its present le#el o( B!0to B!; in 30 &ays!
Chicago *an5 is a,le to ,orrow B;0million on a short@term ,asis (rom other,an5s!
7/24/2019 IFM Chapter 04.ppt
34/44
"peculating on %nticipate& ExchangeRates: % step@,y@step example
Present short@term interest ratesannuali$e&6 in the inter,an5 mar5et are
as (ollows:
7/24/2019 IFM Chapter 04.ppt
35/44
"peculating on %nticipate& ExchangeRates: % step@,y@step example
"teps that the Chicago *an5 woul& (ollow:
! *orrow B;0 million!
;! Con#ert the B;0 million to ?AB40 millioncompute& as B;0'000'000B!06!
7/24/2019 IFM Chapter 04.ppt
36/44
"peculating on %nticipate& ExchangeRates: % step@,y@step example
3! Len& the ?ew Aealan& &ollars at !4percent annuali$e&' which represents a !
4 percent return o#er the 30@&ay perio&Gcompute& as !41 H 30306! %(ter 30
&ays' the ,an5 will recei#e ?AB40';'000
Gcompute& as ?AB40'000'000 H J !0046!
7/24/2019 IFM Chapter 04.ppt
37/44
"peculating on %nticipate& ExchangeRates: % step@,y@step example
4! )se the procee&s (rom the ?ew Aealan& &ollarloan repayment on &ay 306 to repay the )!"!
&ollars ,orrowe&! .he annual interest on the )!"!
&ollars ,orrowe& is
7/24/2019 IFM Chapter 04.ppt
38/44
"peculating on %nticipate& ExchangeRates: % step@,y@step example
%ssuming that the exchange rate on &ay30 is B!; per ?ew Aealan& &ollar as
anticipate&' the num,er o( ?ew Aealan&
&ollars necessary to repay the )!"! &ollar
loan is ?AB3'K;'30 compute& as
B;0';0'000B!; per ?ew Aealan& &ollar6!
7/24/2019 IFM Chapter 04.ppt
39/44
"peculating on %nticipate& ExchangeRates: % step@,y@step example
=i#en that the ,an5 accumulate&?AB40';'000 (rom len&ing ?ew Aealan&
&ollars' it woul& earn a speculati#e pro(it
o( ?AB';3'K; Gcompute& as
?AB40';'000 @ ?AB3'K;'30
7/24/2019 IFM Chapter 04.ppt
40/44
"peculating on %nticipate& ExchangeRates: % step@,y@step example
Points to ,e note&:
.he ,an5 woul& earn this speculati#e
pro(it without using any (un&s (rom&eposit accounts ,ecause the (un&s
woul& ha#e ,een ,orrowe& through the
inter,an5 mar5et!
7/24/2019 IFM Chapter 04.ppt
41/44
Exchange at
B0!;?AB
4! 8ol&sB;0'K;'3;0
;! 8ol&s?AB40 million
Exchange at
B0!0?AB
"peculating on %nticipate& Exchange Rates
Chicago *an5 expects the exchange rate o( the ?ew
Aealan& &ollar to appreciate (rom its present le#el o(B0!0 to B0!; in 30 &ays!
! *orrowsB;0 million
*orrows at
(or 30 &ays
Len&s at !41(or 30 &ays 3! Recei#es
?AB40';'000
Returns B;0';0'000Pro(it o( B
7/24/2019 IFM Chapter 04.ppt
42/44
"peculating on %nticipate& ExchangeRates: 9hat i( the Chicago *an5
expects that the ?ew Aealan& &ollarwill &epreciate
?ow' the situation woul& ,e other way
roun&!Repeat' present short@term interest rates
annuali$e&6 in the inter,an5 mar5et are
as (ollows:
7/24/2019 IFM Chapter 04.ppt
43/44
"peculating on %nticipate& Exchange Rates
Chicago *an5 expects the exchange rate o( the ?ew
Aealan& &ollar to &epreciate (rom its present le#el o(B0!0 to B0!4 in 30 &ays!
Exchange at
B0!4?AB
4! 8ol&s?AB4'K00'000
;! 8ol&sB;0 million
Exchange at
B0!0?AB
! *orrows?AB40 million
*orrows at !K1
(or 30 &ays
Len&s at !
7/24/2019 IFM Chapter 04.ppt
44/44
Impact o( Exchange Rates on an ?C7s 2alue
( ) ( )[ ]( )
+
=n
tt
m
j
tjtj
k%&
%''
%
E(ECFE&)alue
E CFj,t 6 M expecte& cash (lows in
currencyjto ,e recei#e& ,y the )!"! parent at theen& o( perio& tE ERj,t 6 M expecte& exchange rate at
In(lation Rates' Interest Rates'Income Le#els' =o#ernment Controls'Expectations