International Finance Multiple choice questions, finish within 30 mins
Student Lee 
ch021.ppt*
Multinational Financial Management
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CHAPTER 2
THE DETERMINATION OF EXCHANGE RATES
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CHAPTER 2 OVERVIEW:
I. EQUILIBRIUM EXCHANGE RATES
II. ROLE OF CENTRAL BANKS
III. EXPECTATIONS AND THE ASSET MARKET MODEL
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Part I.
Equilibrium Exchange Rates
I. SETTING THE EQUILIBRIUM
A. Exchange Rates
market-clearing prices that equilibrate the quantities supplied and demanded of foreign currency.
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Equilibrium Exchange Rates
B. How Americans Purchase German Goods
1. Foreign Currency Demand
-derived from the demand for foreign country’s goods, services, and financial assets.
e.g. The demand for German goods by Americans
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Equilibrium Exchange Rates
2. Foreign Currency Supply:
a. derived from the foreign country’s demand for local goods.
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.
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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.
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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.
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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.
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Equilibrium Exchange Rates
3. Calculating a Depreciation:
Currency Depreciation
where e0 = old currency value
e1 = new currency value
Note: Resulting sign is always negative
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Equilibrium Exchange Rates
Currency Appreciation
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Equilibrium Exchange Rates
EXAMPLE: euro appreciation
If the dollar value of the euro goes from $0.64 (e0) to $0.68 (e1), then the euro
has appreciated by
= (.68 - .64)/ .64
= 6.25%
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Equilibrium Exchange Rates
EXAMPLE: US$ Depreciation
We use the first formula,
(e0 - e1)/ e1
substituting
(.64 - .68)/ .68 = - 5.88%
which is the value of the US$ depreciation.
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Equilibrium Exchange Rates
D. FACTORS AFFECTING EXCHANGE RATES:
1. Inflation rates
2. Interest rates
3. GNP growth rates
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I. FUNDAMENTALS OF CENTRAL BANK INTERVENTION
A. Role of Exchange Rates:
LINKS BETWEEN THE DOMESTIC AND THE WORLD ECONOMY
PART II. THE ROLE OF CENTRAL
BANKS
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B. THE IMPACT OF EXCHANGE RATE CHANGES
1. Currency Appreciation:
-domestic prices increase relative to foreign prices.
- Exports: less price competitive
- Imports: more attractive
THE ROLE OF CENTRAL BANKS
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THE ROLE OF CENTRAL BANKS
2. Currency Depreciation
- domestic prices fall relative to foreign prices.
- Exports: more price competitive.
- Imports: less attractive
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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.
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THE ROLE OF CENTRAL BANKS
2. Goal of Intervention:
- to alter the demand for one currency by changing the supply of another.
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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
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Part III. EXPECTATIONS
WHAT AFFECTS A CURRENCY’S VALUE?
A. Current events
B. Current supply
C. Demand flows
D. Expectation of future exchange rate
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EXPECTATIONS
II. Role of Expectations :
A. Currency = financial asset
B. Exchange rate = simple relation of two financial assets
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EXPECTATIONS
III. Demand for Money and Currency Values: Asset Market Model
A. Exchange rates reflect the supply of and demand for foreign-currency denominated assets.
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EXPECTATIONS
B. Soundness of a Nation’s Economic Policies
- a nation’s currency tends to strengthen with sound economic policies.
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EXPECTATIONS
IV. EXPECTATIONS AND CENTRAL BANK BEHAVIOR
- exchange rates also influenced by
expectations of central bank behavior.
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EXPECTATIONS
A. Central Bank Reputations
B. Central Bank Independence
C. Currency Boards
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