Krugman PPT C13 Rev
Chapter 13Exchange Ratesand the ForeignExchange Market:An AssetApproachSlides prepared by Thomas Bishop
Preview The basics of exchange rates Exchange rates and the prices of goods The foreign exchange markets The demand for currency and other assets A model of foreign exchange markets role of interest rates on currency deposits role of expectations about exchange ratesCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-2
Definitions of Exchange Rates Exchange rates are quoted as foreign currency perunit of domestic currency or domestic currency perunit of foreign currency. How much can be exchanged for one dollar? 102/ 1 How much can be exchanged for one yen? 0.0098/ 1 Exchange rate allow us to express the cost or price ofa good or service in a common currency. How much does a Honda cost? 3,000,000 Or, 3,000,000 x 0.0098/ 1 29,400Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-3
Depreciation and Appreciation Depreciation is a decrease in the value of acurrency relative to another currency. A depreciated currency is less valuable (lessexpensive) and therefore can be exchanged for(can buy) a smaller amount of foreign currency. 1/ 1 1.20/ 1 means that the dollar hasdepreciated against the euro. It now takes 1.20 tobuy one euro, so that the dollar is less valuable. At the same time, the euro has appreciated againstthe dollar: it is now more valuable.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-4
Depreciation and Appreciation (cont.) Appreciation is an increase in the value of acurrency relative to another currency. An appreciated currency is more valuable (moreexpensive) and therefore can be exchanged for(can buy) a larger amount of foreign currency. 1/ 1 0.90/ 1 means that the dollar hasappreciated against the euro. It now takesonly 0.90 to buy one euro, so that the dollar isrelatively more valuable. The euro has depreciated against the dollar:it is now relatively less valuable.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-5
Depreciation and Appreciation (cont.) A depreciated currency is less valuable, and thereforeit can buy fewer foreign-produced goods with pricesthat are quoted in foreign currency terms.How many yen does a Japanese Honda cost? 3,000,000 3,000,000 x 0.0098/ 1 29,400 3,000,000 x 0.0100/ 1 30,000 A depreciated currency means that imports are moreexpensive and domestically produced goods andexports are less expensive. A depreciated currency lowers the price of exportsrelative to the price of imports.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-6
Depreciation and Appreciation (cont.) An appreciated currency is more valuable, andtherefore it can buy more foreign produced goods thatare denominated in foreign currency.How much does a Honda cost? 3,000,000 3,000,000 x 0.0098/ 1 29,400 3,000,000 x 0.0090/ 1 27,000 An appreciated currency means that imports are lessexpensive and domestically produced goods andexports are more expensive. An appreciated currency raises the price of exportsrelative to the price of imports.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-7
Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-8
The Foreign Exchange MarketThe main players: Commercial banks and other depository institutions:transactions involve buying/selling of bank depositsin different currencies for investment. Non-bank financial institutions (pension funds,insurance funds) may buy/sell foreign assets. Private firms: conduct foreign currency transactionsto buy/sell goods, assets, or services. Central banks: conduct official internationalreserve transactions; foreign exchange intervention.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-9
The Foreign Exchange Market (cont.) Buying and selling in the foreign exchangemarket are dominated by commercial banks. Inter-bank transactions of deposits in foreigncurrencies occur in amounts 1 million or moreper transaction. Central banks sometimes intervene, but the directeffects of their transactions are usually smalland transitory (unless they can have a major effecton expectations of future policies and exchangerates; see below).Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-10
The Foreign Exchange Market (cont.)Characteristics of the market: Trading occurs mostly in major financialcities: London, New York, Tokyo, Frankfurt,Singapore. The volume of foreign exchange has grown: in 1989 the daily volume of trading was 600 billion,in 2004 the daily volume of trading was 1.9 trillion. Nearly 90% of transactions in 2004 involvedUS dollars. Why? US dollar is the mainvehicle currency.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-11
The Foreign Exchange Market (cont.) Electronic information transmission (mostrecently internet) has helped to integrateregional FX markets since the 1860s. The integration of markets implies that there isno significant arbitrage between markets. if dollars are cheaper in New York than in London,people will buy them in New York and stop buyingthem in London. The price of dollars in New Yorkrises and the price of dollars in London falls, untilthe prices in the two markets are equal.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-12
Spot Rates and Forward Rates Spot rates are exchange rates for currencyexchanges “on the spot”, or when trading isexecuted in the present. Forward rates are exchange rates forcurrency exchanges that will occur at a future(“forward”) date. forward dates are typically 30, 90, 180 or 360 daysin the future. rates are negotiated between individual institutionsin the present, but the exchange occurs in thefuture.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-13
Spot and Forward RatesCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-14
The Demand for Currency Deposits What influences the demand for (willingnessto buy) deposits denominated in domestic orforeign currency? Factors that influence the return on assetsdetermine the demand for those assets.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-15
The Demand for Currency Deposits (cont.) Rate of return: the percentage change in value thatan asset offers during a time period. The annual total return for 100 savings account with anannual interest rate of 2% is 100 x 1.02 102, so that therate of return ( 102 - 100)/ 100 2% per year. Real rate of return: inflation-adjusted rate of return. stated in terms of real purchasing power: the amount of realgoods & services that can be purchased with the asset. the real rate of return for the savings account when annualinflation is 1.5%: 2% – 1.5% 0.5%. The asset canpurchase only 0.5% more goods and services after 1 year.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-16
The Demand for Currency Deposits (cont.) If prices are given (fixed) at some level,inflation is 0% and then (nominal) rates ofreturn real rates of return. But this is notusually true over longer periods of time. For bank deposits in different currencies, weoften assume that prices are given at somelevel. (A reasonable short-run assumption.)Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-17
The Demand for Currency Deposits (cont.) Risk of holding assets also influences decisionsabout whether to buy them. Liquidity of an asset, or ease of using the asset tobuy goods and services, also influences thewillingness to buy assets. But we assume for now that risk and liquidity of bankdeposits in the foreign exchange market are the same,regardless of their currency denomination. we will discuss FX risk more carefully in Chapter 17 it is related, in general, to the covariance of exchange rateswith the uncertain returns on other forms of wealthCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-18
The Demand for Currency Deposits (cont.) We assume that investors are primarilyconcerned about the rates of return on bankdeposits. Rates of return are determined by interest rates that the assets earn expectations about appreciation or depreciation ofthe currency in which the deposit is denominated our assumptions mean that investors always preferthe asset offering the highest expected return,regardless of risk or liquidity characteristics:assumption of perfect asset substitutability ofinterest-bearing assets denominated in differentcurrenciesCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-19
Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-20
The Demand for Currency Deposits (cont.) A currency’s interest rate is the amount of a currencyan individual can earn by lending a unit of thecurrency for a year. The rate of return for a deposit in domestic currencyis the interest rate that the bank deposit earns. To compare the rate of return on a deposit indomestic currency with one in foreign currency, weneed to consider 2 factors:(i) the interest rate for the foreign currency deposit (ii) the expected rate of appreciation or depreciation of theforeign currency against the domestic currency. Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-21
The Demand for Currency Deposits (cont.) Suppose the interest rate on a dollar deposit is 2%. Suppose the interest rate on a euro deposit is 4%. Does a euro deposit yield a higher expected rateof return? It depends Suppose today the exchange rate is 1/ 1, and the expectedrate 1 year in the future is 0.97/ 1. 100 can be exchanged today for 100. These 100 will yield 104 after 1 year. These 104 are expected to be worth 0.97/ 1 x 104 100.88.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-22
The Demand for Currency Deposits (cont.) The rate of return in terms of dollars from investing ineuro deposits is ( 100.88- 100)/ 100 0.88%. Let’s compare this rate of return with the rate of returnfrom a dollar deposit. rate of return is simply the interest rate After 1 year the 100 is expected to yield 102:( 102- 100)/ 100 2% The euro deposit has a lower expected rate of return:all investors will prefer dollar deposits and none arewilling to hold euro deposits.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-23
The Demand for Currency Deposits (cont.) Note that the expected rate of appreciation ofthe euro is ( 0.97- 1)/ 1 -0.03 -3%. We simplify the analysis by saying that thedollar rate of return on euro depositsapproximately equals the interest rate on euro depositsplus the expected rate of appreciation oneuro deposits4% -3% 1% 0.88% R (Ee / - E / )/E / dollar return on eurosCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-24
The Demand for Currency Deposits (cont.) The difference in the rate of return on dollardeposits and euro deposits is R - (R (Ee / - E / )/E / ) R expected rateof return interest rateon dollardeposits- R interest rateon eurodeposits- (Ee / - E / )/E / expectedexchange ratecurrentexchange rateexpected rate of appreciationof the euroexpected rate of return on euro depositsCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-25
The Demand for Currency AssetsCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-26
The Market for Foreign Exchange We use the demand for (rate of return on) dollar denominateddepositsand the demand for (rate of return on) foreigncurrency denominated deposits to construct amodel of the foreign exchange market. The foreign exchange market is in equilibriumwhen deposits of all currencies offer the sameexpected rate of return: interest parity. interest parity implies that deposits in all currenciesare deemed equally desirable assets if they offerthe same expected rate of return.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-27
The Market for Foreign Exchange (cont.) Interest parity says:R R (Ee / - E / )/E / Why should this condition hold? Suppose it didn’t.Suppose R R (Ee / - E / )/E / . Then no investor would want to hold euro deposits, drivingdown the demand for and relative price of euros. Then all investors would want to hold dollar deposits, drivingup the demand for and relative price of dollars. The dollar would appreciate and the euro would depreciatetoday, increasing the right side (given the expected futureexchange rate Ee / ) until equality was achieved. Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-28
The Market for Foreign Exchange (cont.) How do changes in the current exchange rateaffect expected returns in foreign currency? Very important: In asking this question now,we are hypothetically holding the expectedfuture exchange rate Ee / constant. (We will talk later on about how expectationsare determined.)Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-29
The Market for Foreign Exchange (cont.) Depreciation of the domestic currency today lowersthe expected return on deposits in foreign currency. A current depreciation of domestic currency will raise theinitial cost of investing in foreign currency, thereby loweringthe expected return in foreign currency. (Alt: it lowers theexpected future depreciation rate of domestic currency.) Appreciation of the domestic currency today raisesthe expected return of deposits in foreign currency. A current appreciation of the domestic currency will lower theinitial cost of investing in foreign currency, thereby raising theexpected return in foreign currency. (Alt: it raises theexpected future depreciation rate of domestic currency.)Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-30
Expected Returns on Euro Deposits whenExpectation of Ee / 1.05 per Euro is GivenExpected rate ofCurrentInterest rate ondollarexchange rate euro depositsdepreciationE / R (1.05 - E / )/E / Expected dollar returnon euro depositsR (1.05 - E / )/E / 0.0691.020.050.0290.0791.000.050.0500.100Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-31
The CurrentExchangeRate andthe ExpectedDollar Returnon EuroDepositsCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-32
The Current Exchange Rate and theExpected Dollar Return on Euro DepositsCurrent exchangerate, E / 1.071.051.031.021.000.0310.050R Copyright 2006 Pearson Addison-Wesley. All rights reserved.0.0690.079 0.100Expected dollar returnon dollar deposits, R 13-33
Determination of the EquilibriumExchange RateNo one is willing tohold euro depositsNo one is willing tohold dollar depositsCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-34
The Market for Foreign Exchange The effects of changing interest rates: an increase in the interest rate paid on depositsdenominated in a particular currency will increasethe rate of return on those deposits. This leads to an appreciation of the currency. A rise in dollar interest rates causes the dollarto appreciate. A rise in euro interest rates causes the dollarto depreciate.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-35
The Effect of a Rise in theDollar Interest RateAn appreciationof the dollar is adepreciationof the euro.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-36
The Effect of a Rise in theEuro Interest RateCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-37
The Effect of a Rise in the ExpectedFuture /Euro Exchange RatePeople nowexpect theeuro toappreciateCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-38
The Effect of a Rise in the ExpectedFuture /Euro Exchange Rate (cont.) If people expect a higher value for the /eurorate in the future than they did previously,then euro investments will pay off later in amore valuable (“stronger”) euro, so that thesefuture euros will be able to buy more dollarsand more dollar-denominated goods. the expected return on euro deposits thereforeincreases.an expected future appreciation of a currencyleads to a current appreciation; an expected futuredepreciation of a currency leads to a currentdepreciationCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-39
Covered Interest Parity Covered interest parity relates interest rates acrosscountries and the rate of change between forwardexchange rates and the spot exchange rate:R R (F / - E / )/E / where F / is the forward exchange rate. It says that rates of return on dollar deposits and“covered” foreign currency deposits are the same. How could you make easy, risk-free money in the foreignexchange markets if covered interest parity did not hold? Covered positions using the forward rate involve little risk.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-40
Summary Exchange rates are prices of foreigncurrencies in terms of domestic currencies,or vice versa. Depreciation of a country’s currency meansthat it is less expensive (valuable) andgoods denominated in it are less expensive:exports are cheaper and imports moreexpensive. A depreciation will hurt consumers of imports buthelp producers of exports.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-41
Summary (cont.) Appreciation of a country’s currency means that it ismore expensive (valuable) and goods denominatedin it are more expensive: exports are moreexpensive and imports cheaper. An appreciation will help consumers of imports but hurtproducers of exports.Commercial banks that invest in deposits of differentcurrencies dominate the foreign exchange market. Expected rates of return are most important in determiningthe market demands for these deposits.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-42
Summary (cont.) Returns on bank deposits in the foreignexchange market are influenced by interestrates and expected exchange rates. Equilibrium in the foreign exchange marketoccurs when expected returns on deposits indomestic currency and in foreign currencyare equal: interest rate parity. An increase in the interest rate on acurrency’s deposit leads to an increase inthe rate of return and to an appreciation ofthe currency.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-43
Summary (cont.) A higher expected appreciation of acurrency (for example) leads to an increasein the expected rate of return for thatcurrency, and leads to an actualappreciation. Covered interest parity says that rates ofreturn on domestic currency deposits and“covered” foreign currency deposits usingthe forward exchange rate are the same.(This is true regardless of uncertainty, etc.-it is a pure arbitrage relation.)Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-44
Spot Rates and Forward Rates Spot rates are exchange rates for currency exchanges “on the spot”, or when trading is executed in the present. Forward rates are exchange rates for currency exchanges that will occur at a future (“forward”) date. forward d
Robin Wells. In this book, Krugman and Wells take a story-driven approach that focuses on real world economics at work. The book o ers the trademark clarity and engaging writing style that distinguish Krugman's work. In The Conscience of a Liberal (2007), which later gave name to Krugman's blog in The New York Times , Krugman studies the
The Rt. Rev. George N. Hunt The Rev. Frederick K. Jellison The Rev. Dn. Ida R. Johnson The Rev. Michaela Johnson The Rev. Paul S. Koumrian The Rev. Canon Harry E. Krauss * The Rev. H. August Kuehl The Rev. Richard T. Laremore * The Rev. Donald A. Lavallee The Rev. Canon John E. Lawrence The Rev. Dr. Gary C. Lemery * The Rev. Dn. Betsy Lesieur *
PPT 5 3 Contact Hours DHCP and Auto-configuration, Firewalls and NAT, ICMPv4 PPT 6 2 Contact Hours IP Fragmentation, DNS, Broadcasting and Local Multicasting - IGMP PPT 7 2 Contact Hours Routing Protocols PPT 8 2 Contact Hours IPv6 Transition issues, Protocol basics PPT 9 2 Contact Hours Addressing, Options and Extension headers, ICMPv6 PPT 10
NACE Rev. 1.1 (ISIC Rev. 3) codes are often linked with more than one NACE Rev. 2 (ISIC Rev. 4) code. For example, 323 NACE Rev. 1.1 is linked with 261, 263 and 264 NACE Rev. 2 codes; 261 NACE Rev. 2 is linked with only one part of 311, 312, 313, 321 and 323 NACE Rev. 1.1 codes. Thus, it is not possible to obtain full codes of NACE
Show PPT 1-1 as you refer participants to Page 1 in Module 1 of their Participant Guides. Introduce the module by saying that before they learn the specifics of electrical safety, you want to make sure everyone has a common understanding of electrical basics. This module will cover the basics. PPT 1-2 through PPT 1-4 Show PPT 1-2 through PPT 1 .
and PFOS concentration of 8.1 ppt, ranging from 5.3 to 12.2 ppt. Results from the Schuylkill River water treatment plant intakes exhibited an average combined PFOA and PFOS concentration of 12.1 ppt and 9.7 ppt, respectively, ranging from 6.8 to 16.2 ppt.
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guided inquiry teaching method on the total critical thinking score and conclusion and inference of subscales. The same result was found by Fuad, Zubaidah, Mahanal, and Suarsini (2017); there was a difference in critical thinking skills among the students who were taught using the Differentiated Science Inquiry model combined with the mind
