18-09-2012, 12:17 PM
Background On Foreign Exchange Markets
Background On Foreign.ppt (Size: 294 KB / Downloads: 34)
Exchanging currencies is needed when:
Trade (real) prompts need for forex
Capital flows (financial) prompts need for forex
Foreign exchange trading
Via global telecommunications network between mostly large banks
Bid/ask spread
Foreign Exchange Rates
Quoted two ways:
Foreign currency per U.S. dollar
Dollar cost of unit of foreign exchange
Appreciation/depreciation of currency
Appreciation = more forex to buy $
Purchase more forex with $
Depreciation = foreign goods cost more $
Total return to foreign investor decreases
Background on Foreign Exchange Markets
Exchange rate quotations are available in the financial press and on the Internet with spot exchange rate quotes for immediate delivery
Forward exchange rate is for delivery at some specified future point in time
Forward premium is the percent annualized appreciation of a currency
Forward discount is the percent annualized depreciation of a currency
Smithsonian Agreement (1971) among major countries allowed dollar devaluation and widened boundaries around set values for each currency
No formal agreements since 1973 to fix exchange rates for major currencies
Freely floating exchange rates involve values set by the market without government intervention
Dirty float involves some government intervention
Classification of Exchange Rate Arrangement
There is a wide variation in how countries approach managing or influencing their currency’s value
Float with periodic intervention
Pegged to the dollar or some kind of composite
Some countries have both controlled and floating rates
Some arrangements are temporary and others more permanent
Factors Affecting Exchange Rates: Real Sector
Differential country inflation rates affect the exchange rate for euros and dollars if inflation is suddenly higher in Europe
Theory of Purchasing Power Parity suggests the exchange rate will change to reflect the inflation differential—influence from real sector of economy
Currency of the higher inflation country (euro) depreciates compared to the lower inflation country ($)
Factors Affecting Exchange Rates
Direct intervention occurs when a country’s central bank buys/sells currency reserves
For example, the U.S. central bank, the Federal Reserve sells one currency and buys another
Sale by central bank creates excess supply and that currency’s value drops relative to the one purchased
Market forces of supply and demand can overwhelm the intervention