The Foreign Exchange Market Forex An exchange rate
- Slides: 16
The Foreign Exchange Market (Forex) • An exchange rate is the conversion factor between currencies of different countries. i. e. , how much one currency is worth in terms of another • Can be represented in two ways • Eg. $/£ or £/$ • Write as E$/£ or E£/$
The Foreign Exchange Market (Forex) • Review some ERs on x-rate website • Define Appreciation and Depreciation rates • Define currency value • E$/£ is the value of the pound • E£/$ is the value of the pound • Review the Economist Exchange rate data (next page)
from May 7, 2020
Floating vs Fixed Exchange Rates • With floating exchange rates a country allows the private market (banks) determine the rate for each trade • With fixed exchange rates a government decrees the exchange rate that will prevail and takes steps to assure that rate is maintained • Show the IMP defacto exchange rate table to highlight countries with different exchange rate systems
The Foreign Exchange Market (Forex) Value of the pound in terms of $ • Quantity (value of pounds) • Price (exchange rate - $/£ ) • Market is at private banks • Demand is by holders of $ who wish to buy pounds • Supply is by holders of pounds who wish to buy $ Value of pounds traded
The Foreign Exchange Market (Forex) Value of the pound in terms of $ • Banks charge transaction fee • Show to Max profit they adjust their ER to maximize the quantity traded Value of pounds traded
The Foreign Exchange Market (Forex) Value of the pound in terms of $ • Market Participants • Traders • Exporters and importers of G&S • Recorded on current acct of Bo. P • Purchasing Power Parity (PPP) theory of exchange rate determination • Motivated by price differences Value of pounds traded
The Foreign Exchange Market (Forex) Value of the pound in terms of $ Value of pounds traded • Market Participants • Investors/Savers • Buyers and sellers of assets • Eg. Financial institutions • Recorded on financial acct. of Bo. P • Interest rate parity (IRP) theory of exchange rate determination • Motivated by financial differentials
Interest Rate Parity Theory • Focuses on the participation of investors in the Forex • Investors are stewards of others’ money • Banks, pension funds, mutual funds, IRAs, etc. • Identify investor motivation to exchange currencies • Same goals as in domestic investment
Investor Objectives • High Rate of Return on investment • Ro. R = % change in the value of an asset over time • Ro. R is sometimes the interest rate • Sometimes it’s a capital gain rate • Sometimes it’s more complicated (foreign investments) • Reduce risk / Ensure safety • Manage Liquidity
Interest Rate Parity Theory • Focuses exclusively on Ro. R • Assumes no risk and liquidity differences for domestic vs foreign assets • Derive theory by imagining a US $ holder comparing a simple investment in the US vs another in a foreign country. • Derive the Ro. R for the two investments
Interest Rate Parity Theory • Focuses exclusively on Ro. R • Assumes no risk and liquidity differences for domestic vs foreign assets • Derive theory by imagining a US $ holder comparing a simple investment in the US vs another in a foreign country. • Derive the Ro. R for the two investments
Rate of Return Calculations
2020 Data for Ro. R Calculations 2019 Interest Rate 2020 ER 2019 ER Turkey 20% 7 TL/$ 6 TL/$ UK 1. 2% 1. 22 $/£ 1. 28 $/£ Switzerland - 0. 5% 0. 97 SF/$ 1. 01 SF/$ Mexico 8. 0% 24 p/$ 19 p/$
2020 Data for Ro. R Calculations 2019 Interest Rate % change in country currency wrt. US$ between 2019 -2020 Russia 8. 2% - 12. 4% Taiwan 0. 75% + 3. 5% Euro Area 0. 0% - 4. 3%
Rate of Return Calculations • On Whiteboard work out several ex post Ro. R calculations using the data on previous page • Ro. RTL = [[(1/7)/(1/6)](1 + 0. 20) – 1]x 100 = 2. 86% • Show same using expanded formula • Ro. R€ = 0 + (1 + 0)(- 0. 043) = -0. 043 or - 4. 3%
- Spot market in foreign exchange market
- Real exchange rate formula
- Functions of foreign exchange market
- Objectives of foreign exchange
- Market structure in forex
- Structure of foreign exchange market
- Foreign exchange market features
- Stability of foreign exchange market
- Foreign exchange market example
- Foreign exchange market graph
- Foreign exchange market slideshare
- Foreign exchange market graph
- Exchange market graph
- Foreign exchange market
- Exchange rate shifters
- Interbank wholesale
- Too foreign for home