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Lecture Financial institutions, instruments and markets (4/e): Chapter 16 - Christopher Viney

Chapter 16 - Determinants of the foreign exchange value of a currency. After completing this unit, you should be able to: Explain how exchange rates are determined, explain how exchange rates are determined. | Chapter 16 Determinants of the Foreign Exchange Value of a Currency Learning Objectives Explain how exchange rates are determined Describe the factors responsible for movements in the exchange rate Chapter Organisation 16.1 Introduction 16.2 FX Market and the Equilibrium Exchange Rate 16.3 Factors Influencing Exchange Rate Movements 16.4 Sensitivity of the Exchange Rate to Changes in Economic Variables 16.5 Purchasing Power Parity 16.6 Summary 16.1 Introduction The structure and operations of the FX markets are considered in Chapter 15 Attention is now focused on the factors that influence the value of a currency (in a floating exchange rate regime) in order to attempt to forecast future exchange rates with some reliability and accuracy 16.1 Introduction (cont.) A floating exchange rate regime is one in which the value of the currency is determined by demand and supply conditions A pegged exchange rate regime is where a domestic currency is locked into a multiple of another currency . | Chapter 16 Determinants of the Foreign Exchange Value of a Currency Learning Objectives Explain how exchange rates are determined Describe the factors responsible for movements in the exchange rate Chapter Organisation 16.1 Introduction 16.2 FX Market and the Equilibrium Exchange Rate 16.3 Factors Influencing Exchange Rate Movements 16.4 Sensitivity of the Exchange Rate to Changes in Economic Variables 16.5 Purchasing Power Parity 16.6 Summary 16.1 Introduction The structure and operations of the FX markets are considered in Chapter 15 Attention is now focused on the factors that influence the value of a currency (in a floating exchange rate regime) in order to attempt to forecast future exchange rates with some reliability and accuracy 16.1 Introduction (cont.) A floating exchange rate regime is one in which the value of the currency is determined by demand and supply conditions A pegged exchange rate regime is where a domestic currency is locked into a multiple of another currency such as the USD e.g. Hong Kong dollar Chapter Organisation 16.1 Introduction 16.2 FX Market and the Equilibrium Exchange Rate 16.3 Factors Influencing Exchange Rate Movements 16.4 Sensitivity of the Exchange Rate to Changes in Economic Variables 16.5 Purchasing Power Parity 16.6 Summary 16.2 FX Market and the Equilibrium Exchange Rate Demand for a currency To purchase Australian goods and services, foreigners must buy AUD Downward sloping demand curve occurs as the devaluation of AUD results in a greater demand by foreigners For foreigners, a fall in the price of the AUD is equivalent to a reduction in the price of everything in Australia 16.2 FX Market and the Equilibrium Exchange Rate (cont.) Supply of a currency Upward sloping supply curve occurs as the quantity of AUDs supplied to the FX market increases as the price of the AUD increases As the AUD appreciates, the price of foreign currency falls, making foreign goods cheaper for Australian residents The demand for foreign currency