Multinational Financial
Management
Alan Shapiro
7
Edition
Power Points by
th
J.Wiley
& Sons
Joseph
F. Greco,
Ph.D.
California State University, Fullerton
1
CHAPTER 2
THE
DETERMINATION OF
EXCHANGE RATES
2
CHAPTER 2 OVERVIEW:
I.
EQUILIBRIUM EXCHANGE
RATES
II. ROLE OF CENTRAL BANKS
III.
EXPECTATIONS AND THE
ASSET MARKET MODEL
3
Part I.
Exchange Rates
I. Equilibrium
SETTING THE EQUILIBRIUM
A. Exchange Rates
market-clearing prices that
equilibrate the quantities
supplied and
demanded of
foreign currency.
4
Equilibrium Exchange Rates
B. How Americans Purchase
Goods
German
1. Foreign Currency Demand
-derived from the demand for
foreign country’s goods,
and financial
assets.
services,
e.g. The demand for German
goods by Americans
5
Equilibrium Exchange Rates
2. Foreign Currency Supply:
a. derived from the foreign
country’s demand for
goods.
local
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.
6
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.
7
Equilibrium Exchange Rates
C. How Exchange Rates Change
1. Increased demand
as more foreign goods are
demanded, the price of the
foreign currency in local
currency increases and vice
versa.
8
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.
9
Equilibrium Exchange Rates
3. Calculating a Depreciation:
Currency Depreciation
=
e0 − e1
=
e1
where e0 = old currency value
e1 = new currency value
Note: Resulting sign is always negative
10
Equilibrium Exchange Rates
Currency Appreciation
e1 − e0
=
e0
11
Equilibrium Exchange Rates
EXAMPLE: euro appreciation
If the dollar value of the euro goes from $0.64
(e0) to $0.68 (e1), then the euro
has appreciated by
e1 − e0
=
e0
= (.68 - .64)/ .64
= 6.25%
12
Equilibrium Exchange Rates
EXAMPLE: US$ Depreciation
We use the first formula,
(e0 - e1)/ e1
substituting
(.64 - .68)/ .68 = - 5.88%
which is the value of the US$
depreciation.
13
Equilibrium Exchange Rates
D. FACTORS AFFECTING
EXCHANGE RATES:
1.
Inflation rates
2.
Interest rates
3.
GNP growth rates
14
PART II.
THE ROLE OF CENTRAL
BANKS
I. FUNDAMENTALS OF CENTRAL BANK INTERVENTION
A.
Role of Exchange Rates:
LINKS BETWEEN THE DOMESTIC
AND THE WORLD ECONOMY
15
THE ROLE OF CENTRAL BANKS
B. THE IMPACT OF EXCHANGE RATE CHANGES
1.
Currency Appreciation:
-domestic prices increase relative to
foreign prices.
- Exports: less price competitive
- Imports: more attractive
16
THE ROLE OF CENTRAL BANKS
2. Currency Depreciation
- domestic prices fall relative
to foreign prices.
- Exports: more price competitive.
- Imports: less attractive
17
THE ROLE OF CENTRAL BANKS
C. Foreign Exchange Market
Intervention
1.
Definition: the official
purchases and sales of
currencies
through the
central bank to
influence
the home exchange rate.
18
THE ROLE OF CENTRAL BANKS
2. Goal of Intervention:
to alter the demand for
one currency by
changing the supply of
another.
19
THE ROLE OF CENTRAL BANKS
D.
The Effects of Foreign Exchange
Intervention
1.
Effects of Intervention:
- either ineffective or
irresponsible
2.
Lasting Effect:
- If permanent, change
results
20
Part III. EXPECTATIONS
I.
WHAT AFFECTS A CURRENCY’S VALUE?
A.
Current events
B. Current supply
C. Demand flows
D. Expectation of future
exchange rate
21
EXPECTATIONS
II. Role of Expectations :
A. Currency = financial
asset
B. Exchange rate =
simple relation of two
financial assets
22
EXPECTATIONS
III.Demand for Money and
Currency
Values: Asset
Market Model
Exchange rates reflect the
supply of and demand for
foreign-currency denominated
A.
assets.
23
EXPECTATIONS
B.
Soundness of a Nation’s
Economic Policies
- a nation’s currency tends
strengthen with sound
economic
policies.
to
24
EXPECTATIONS
IV. EXPECTATIONS AND
CENTRAL
BANK BEHAVIOR
- exchange rates also
influenced by
expectations of central
bank behavior.
25