Exchange Rate Determination

In: Business and Management

Submitted By kittyvuu
Words 3260
Pages 14
exchange rate determination

“Having endeavored to forecast exchange rates for more than half a century, I have understandably developed significant humility about my ability in this area…”[1] - Alan Greenspan

Figure 1: Exchange Rate Determination
Source: Exchange Rate Determination

I. Short-Run Forecasting Tools

Short-term changes in exchange rates are the most difficult to predict and are often determined based on bandwagon effects, overreaction to news, speculation, and technical analysis.[2]

Trend-Following Behavior is the tendency for the market to follow a trend. In other words an increase in the exchange rate is more likely to be followed by another increase.

Investor Sentiment is based on the consensus of the market. For example if the market is bullish on the dollar, then the dollar is likely to strengthen versus other currencies.

The FX market is quite different from the world equity markets in one important aspect: transparency. In equity markets, rules ensure that volume and price data are readily available to all parties… this is NOT the case in FX markets. In fact large FX dealers are able to observe factors such as: shifts in risk appetite, liquidity needs, hedging demands, and institutional rebalancing.[3]

Order Flow - there is evidence of a positive correlation between spot exchange rate movements and order flows in the inter-dealer market[4] and with movements in customer order flows.[5]

Three explanations for the cause of these correlations have been put forth: 1) Private information - related to the payoff from holding the currency may be contained in the order flow data. For example, future interest rates or the discount rate may be known to traders. 2) Liquidity effects – dealers charge a temporary risk premium to absorb unwanted inventory. 3) Feedback trading – the positive correlation could be…...

Similar Documents

Exchange Rates

...negative, the economy is experiencing a capital inflow: investment exceeds saving, and the economy is financing this extra investment by borrowing from abroad FISCAL POLICY UNDER FIXED RATE REGIME LM1 R1 LM2 R=r* IS2 IS1 Y1 Y2 Y3 A fiscal expansion pushes out IS. Investors demand Home currency to purchase high yielding Home assets. CB accommodates currency demand at target exchange rate. This boosts the money supply and shifts out the LM curve. This continues until interest rate at world level. Fiscal policy is now super‐expansionary. MONETARY POLICY UNDER FIXED RATE REGIME A monetary expansion pushes out LM. Investors short Home currency to purchase high yielding foreign assets. CB purchases extra currency supplied at target exchange rate. This cuts the money supply and returns LM to initial position. This Continues until interest rate at world level interest rate LM1 r=r* LM2 r IS1 Y0 output MONETARY POLICY UNDER A FLEXIBLE EXCHANGE RATE interest rate LM1 r LM2 r=r* IS2 IS1 Y1 ......

Words: 661 - Pages: 3

Exchange Rates

...1 Explain how foreign exchange rates are determined. How do changes in interest rates, inflation, productivity, and income affect exchange rates? What are the advantages and disadvantages of a weak versus a strong dollar for imports, exports, international and domestic markets? Explain how foreign exchange rates are determined? Foreign exchange rates exist because banks buy and sell foreign currencies from other countries in large quantities. Exchange rates exist in the U.S. dollar, Europe euros, Japanese yen, British pounds, Canadian dollars, Australian dollars, and much more. There are currently two main systems that are used to determine a currencies exchange rate. The floating currency sort of works like the supply demand method. This system is normally used for countries that are in a stable economy. These exchanges are considered more efficient because the market will correct the rate to reflect inflation and other economic forces automatically. The downfall of this system is that it can discourage investment. The other system is a pegged or also known as a fixed system. This is the system that is used when an exchange rate is set and artificially maintained by the government. The rate will be pegged to other countries dollar and does not fluctuate from day to day.  How do changes in interest rates, inflation, productivity, and income affect exchange rates? Exchange rates affect different areas in the economy such as interest rates, inflation, productivity...

Words: 377 - Pages: 2

Exchange Rates

...Friday, May 3, 13 Principles of Macroeconomics Exchange Rates People, firms and nation exchange products for money and use the money to buy other products to pay for the use of resources. Within an economy, prices are stated in the domestic currency, such as US dollars to European euros. Buyers use their currency to purchase goods. International markets are different. Producers in other countries who export goods want to be paid in their own currencies so they can carry out transactions. As a result, a foreign exchange market develops where national currencies can be exchanged. Such markets serve the need of all international buyers and sellers. The equilibrium prices in these markets are called exchange rates. An exchange rate is the rate at which the currency of one nation is exchanged for the currency of another. The foreign exchange market is the financial relationship between countries that makes it possible for international trade to be accomplished more efficiently than barter. Because each nation uses its own monetary unit, people in one country who want to purchase something in another country must exchange their own currency for the other to accommodate the transaction. Many travelers will research foreign exchange rates before purchasing cheap airline tickets or other means of travel to other countries. Depending on the destination, some travelers can benefit greatly from exchanging currencies .The foreign exchange market is where one nation's currency is......

Words: 1094 - Pages: 5

Exchange Rate

...|Exchange rate |Monetary Policy Framework | |arrangement (Number | | |of countries) | | | |Exchange rate anchor |Monetary aggregate|Inflation targeting framework |Other1 | | | |target | | | | |U.S. dollar (66) |Euro (27) |Composite (15) |Other(7) |(22) |(44) |(11) | |Exchange arrangement |Ecuador |Palau |Montenegro |  |Kiribati |  |  |  |  | |with no separate |El Salvador |Panama |San Marino | | | | | | | |legal tender (10) |Marshall Islands |Timor-Leste ...

Words: 454 - Pages: 2

Exchange Rate

...MP A R Munich Personal RePEc Archive Optimal choice of an exchange rate regime: a critical literature review Mariam Ouchen Cadi Ayyad University, Faculty of Economics Marrakesh Morocco, University of Basel 17. January 2013 Online at MPRA Paper No. 43907, posted 21. January 2013 12:56 UTC Optimal Choice of an Exchange Rate Regime: A Critical Literature Review 1 Mariam OUCHEN Laboratory of innovation, responsibility and sustainable development Cadi Ayyad University, Faculty of Economics Marrakesh Morocco Center of Macroeconomics and economic theory University of Basel Abstract :This paper set out to review the main theories and empirical methods employed in selecting an appropriate exchange rate regime.In order to achieve this, the paper is organized as follows : Section 2 introduces the distinct classifications of exchange regimes(de jure exchange rate regimes versus the facto exchange rate regimes), and the different theoretical approaches which illustrate how an optimal exchange rate regime is determined . Despite their initial popularity, the theoretical considerations have not escaped criticism.Section 3 reviews the criticism of these theories.A conclusion is provided in Section 4. Keywords :  Exchange rate regime, the structural approach, credibility, flexibility, the bipolar view. 1 - Introduction The literature on the selection of exchange rate regimes can be divided into three main groups : the structural approach, the......

Words: 10108 - Pages: 41

Exchange Rate..

...EXCHANGE RATES & SURCHARGES YR. 2013 IN PHP FUEL SURCHARGE TNT IATA EXCHANGE RATE JANUARY 20% Dec 30, 2012 - Jan 05, 2013 Jan 06-12 Jan 13-19 Jan 20-26 Jan 27 - Feb 02 FEBRUARY 19.50% Feb 03-09 (Feb 3 - Mar 2) Feb 10-16 Feb 17-23 Feb 24 Mar 02 MARCH 20% Mar 03-09 Mar 10-16 Mar 17-23 Mar 24-30 APRIL 20.50% Mar 31 - Apr 06 April 07-13 April 14-20 April 21-27 April 28 - May 04 MAY 19.50% May 05-11 May 12-18 May 19-25 May 26 - June 01 JUNE 19.50% June 02-08 June 09-15 June 16-22 June 23-29 JULY 19% June 30 - July 06 July 07-13 July 14-20 July 21-27 July 28 - Aug 03 AUGUST 19% Aug 04-10 Aug 11-17 Aug 18-24 Aug 25 -31 SEPTEMBER 19.50% Sept 01-07 Sept 09-14 Sept 16-21 Sept 22-28 20% Sept 29 - Oct 05 OCTOBER Oct 06-12 Oct 13-19 Oct 20-26 Oct 27 - Nov 02 NOVEMBER 20% Nov 03-09 Nov 10-16 Nov 17-23 Nov 24-30 DECEMBER Dec 01-07 Dec 08-14 Dec 15-21 Dec 22-28 Dec 29, 2013 - Jan 04, 2014 VLI EXCHANGE RATE Dec 30, 2012 - Jan 05, 2013 Jan 06-12 Jan 13-19 Jan 20-26 Jan 27 - Feb 02 Feb 03-09 Feb 10-16 Feb 17-23 Feb 24 Mar 02 Mar 03-09 Mar 10-16 Mar 17-23 Mar 24-30 Mar 31 - Apr 06 April 07-13 April 14-20 April 21-27 April 28 - May 04 May 05-11 May 12-18 May 19-25 May 26 - June 01 June 02-08 June 09-15 June 16-22 June 23-29 June 30 - July 06 July 07-13 July 14-20 July 21-27 July 28 - Aug 03 Aug 04-10 Aug 11-17 Aug 18-24 Aug 25 -31 Sept 01-07 Sept 09-14 Sept 16-21 Sept 22-28 Sept 29 - Oct 05 Oct 06-12 Oct 13-19 Oct 20-26 Oct 27 - Nov 02 Nov 03-09 Nov 10-16 Nov 17-23 Nov 24-30 Dec 01-07 Dec 08-14......

Words: 589 - Pages: 3

Exchange Rate

...Volatility of exchange rate The main objective of this research is to present a rationalized concept of the theory and composition of exchange rate that are compulsory to solve the important economic problems facing the economy in the country, like volatile exchange rate, unbalanced financial circumstances and frustration of government to have control over domestic money market. “Exchange rate” shows that how much unit of onenation’s currency can be purchased with one unit of domestic currency. More precisely, exchange rate is a conversion factor that determines rate of change of currencies. While exchange rates volatility shows that exchange rate is settled on demand and supply of one nation’s currency, it may turn out fastest moving price of currency and bring all the foreign capital in the economy. Exchange rate volatility can influence the decisions of policy makers and affect the volume of exports and imports. It can also affect the allocation of manufacturing of goods, reserve money, exports, imports and balance of payments. Exchange rate volatility provides chances to domestic investors to invest in foreign currency to obtain higher profits and thus domestic currency undervalue and foreign currency gain values. Moreover, this volatility of exchange rate directly influences the prices of exports, imports, reserve money, manufacturing productions and their growth rates. Traders and investors always support the system where the discrepancy of the difference between......

Words: 4807 - Pages: 20

Spot Rate Exchange Rate

...Critical Thinking, (Spot Exchange Rate) The interest rate on South Korean government securities with one-year maturity is 4%, and the expected inflation rate for the coming year is 2 %. The interest rate on U.S. government securities with one-year maturity is 7%, and the expected rate of inflation is 5%.The current spot exchange rate for Korean Won (W) is $1 = W1,200. Forecast the spot exchange rate one year from today (Hall, p. 318). The forecast spot exchange rate one year from now will be W1,166.35. Explain the logic of this answer? The logic for the above answer begins by understanding the meaning and relationship between Spot, Exchange Rate, Interest Rate Parity, and Fisher Effect. 1. Spot Exchange Rates The interaction between supply and demand influences the exchange spot rate. The spot exchange rate is the daily rate which one currency is converted into another. 2. The Fisher Effect In foreign currency transactions between two countries, the spot exchange rate changes in equal amounts as it moves the opposite direction to the difference in nominal interest rates between two countries. According to the Fisher effect, only the interest rate and not the inflation rate are used for calculating the spot interest rate. 3. Interest Rate Parity The differences in currency values pertain to short-term interest rate differences between two countries. The real int. rate in the United States is 2% (7-% maturity – 5% expected inflation). The real interest......

Words: 486 - Pages: 2

Exchange Rate

...Abstract INTRODUCTION When first looking at an exchange rates, and foreign exchange, there are a few questions which must be considered. What factors affect the demand and supply of Australian dollars in the foreign exchange markets? Distinguish between the possible causes and effects of currency depreciation and a currency appreciation on the Australian economy. What forces have come into play, if any, in the past few years that have affected the value of the Australian dollar? In addition to looking further into those questions, it is helpful to know what the word Exchange Rate means; it is defined as, “The rate at which one unit of domestic currency is exchanged for a given amount of foreign currency.”  A BRIEF HISTORY OF THE AUSTRALIAN DOLLAR Until 1971, the Australian dollar (AUD) was “pegged” to the British pound. This meant that the AUD rose or fell in line with the pound. In 1971, the AUD became pegged to the US dollar instead. These currencies were fixed currencies, which meant that the Australian currency would only change value when a major world currency also changed. This system lasted only until 1974 when the AUD became pegged to a trade-weighted selection of other currencies. This was still a fixed currency. In 1976 this selection of currencies became moveable. Small shifts were able to take place when needed. In 1983 the AUD became a floating currency. This means that the value of the dollar is determined by supply and demand. Initially, the......

Words: 3252 - Pages: 14

Bus138: International Finance Exchange Rate Determination

...INTERNATIONAL FINANCE EXCHANGE RATE DETERMINATION Factors that affect exchange rates! How are each of the factors (events) below expected to affect exchange rates? Why? 1. Increase in foreign imports and an increase in trade deficits The exchange rates will increase. Because the trade deficits made a great demand of dollar, dollar became going up and the exchange rate will increase. 2. Increase in government budget deficits The exchange rates will increase. Because the government budget deficits will lead to the BOP deficits, as a result, the purchasing power of dollar will decrease and the demand of foreign currencies will increase, then the exchange rate will go up. 3. Inflation The exchange rates will increase. Because of the decline of the purchasing power of dollar, the demand of foreign currencies will go up. 4. Government provides tax breaks and other incentives for capital spending The exchange rate will decrease. Because these fiscal tools lead to a increasing purchasing power of dollar. 5. Good stock market performance (Dow Jones Index goes up) The exchange rates will decrease. Because the good stock market performance attract more foreign investors to buy dollars. 6. Government announcements an intention to intervene in foreign exchange markets to weaken a currency. The exchange rate will decrease. Because the currency which is weakened, the foreign exchange rate will decrease......

Words: 672 - Pages: 3

The Exchange Rate

...The exchange rate An exchange rate is the rate at which one currency is exchanged on another one. This rate differs from country to country and depends on many economical variables, the main of which are the general balance and disbalance of economy, monetary and fiscal policy, the state of the budget, international policy, the condition and development of the country’s economy compared to the world situation and dominating countries, purchasing power of the currency, and other internal and external factors. The history of world exchange rate systems shows us that the world community (in its majority) has in fact shifted from the system of fixed exchange rates to floating exchange rate system. Currently there exist different combinations of floating and fixed exchange rate systems, together with specific economical instruments, created for exchange rate regulating. Since the development of production and a number of divisions of labor there existed such a phenomenon as commodity money. There was no other monetary system until 17th century when there appeared coins having an intrinsic value, not linked with commodity. Usually the value of the coin was associated with the content of gold in the coin. The exchange rate between different coins and different currencies depended on the content of gold in the coin as well, and equaled to the relative content of gold in the coins. In 17th century banks started issuing own banknotes which had the same purchasing power as...

Words: 2755 - Pages: 12

Exchange Rate Determination Model

...Exchange rate determination model as discussed by Alan C. Stockman A. Stockman did propose an alternative equilibrium explanation of ex- change rate behavior. The explanation is based on a model of the simultaneous determination of exchange rates and relative prices of different goods in international trade in an intertemporal framework with uncertainty and rational expectations. The model emphasizes the role of relative price changes, caused by real disturbances, in determining the behavior of exchange rates and integrates the important issues discussed by the traditional "elasticity theorists" into a general equilibrium framework. 2. In the model developed in his paper, explains exchange rates may be volatile and can exhibit auto correlated deviations from purchasing power parity, even though prices freely adjust to clear markets. Ex- change rate changes may appear to cause relative price changes and generate additional uncertainty even when all markets are in equilibrium. Nevertheless ,the relationship between the exchange rate and the terms of trade cannot be exploited by government exchange rate policies.-' 3. The model shows how a change in the terms of trade caused by relative supply or demand shifts is divided between nominal price changes in each country and an exchange rate change, creating a correlation between the exchange rate and the terms of trade. The greater the changes in the terms of the trade and the larger the role of changes in the exchange rate......

Words: 360 - Pages: 2

Exchange Rate

...The current rate of Singapore’s dollar against the United States’ dollar is 1USD=1.39SGD The Singapore dollar has depreciate slightly since recent months, with rates going to as high as 1USD=1.43SGD on 5th October. The exchange rate between the Sing dollar and the US dollar has been relatively stable since last year, May 2014 to Aug 2014. However, the exchange rate has been rising consistently since Aug 2014. The appreciation of the USD, or the depreciation of the Singdollar was due to a weaker Singdollar. The Monetary Authority of Singapore (MAS), which uses the exchange rate as its main monetary policy tool made a statement in January 28, mentioning that the Singdollar will be seeking a slower pace of appreciation against a basket of currencies. Given that US is likely to be a large trade partner of Singapore, the exchange rate between Singapore and US is thus likely to be affected. The strengthening of the USD due to signs of economy recovery, and a slower rate of appreciation of the Singdollar, has translated to a depreciation of the Singdollar since August last year. However, there was a reversal in trend in April this year, where the Singdollar strengthened and appreciated against the dollar. This reversal in trend could be due to the MAS decision in April to refrain from easing monetary policy further, which is likely to have increase investors’ confidence, and putting a stop on investors’ expectation of a weakening Singdollar. It is highly likely that the......

Words: 1238 - Pages: 5

Exchange Rates

...6 Factors That Influence Exchange Rates: Aside from factors such as interest rates and inflation, the exchange rate is one of the most important determinants of a country's relative level of economic health. Exchange rates play a vital role in a country's level of trade, which is critical to most every free market economy in the world. For this reason, exchange rates are among the most watched, analyzed and governmentally manipulated economic measures. But exchange rates matter on a smaller scale as well: they impact the real return of an investor's portfolio. Here we look at some of the major forces behind exchange rate movements. Overview Before we look at these forces, we should sketch out how exchange rate movements affect a nation's trading relationships with other nations. A higher currency makes a country's exports more expensive and imports cheaper in foreign markets; a lower currency makes a country's exports cheaper and its imports more expensive in foreign markets. A higher exchange rate can be expected to lower the country's balance of trade, while a lower exchange rate would increase it. Determinants of Exchange Rates Numerous factors determine exchange rates, and all are related to the trading relationship between two countries. Remember, exchange rates are relative, and are expressed as a comparison of the currencies of two countries. The following are some of the principal determinants of the exchange rate between two countries. Note that these factors......

Words: 1096 - Pages: 5

Exchange Rate

...-21 (revised) OFFICE OF INDUSTRIES WORKING PAPER U.S. INTERNATIONAL TRADE COMMISSION How Do Exchange Rates Affect Import Prices? Recent Economic Literature and Data Analysis Cathy L. Jabara Office of Industries U.S. International Trade Commission Revised, October 2009 Cathy Jabara is a Senior Economist with the Office of Industries of the U.S. International Trade Commission. Office of Industries working papers are the result of the ongoing professional research of USITC Staff and are solely meant to represent the opinions and professional research of individual authors. These papers are not meant to represent in any way the views of the U.S. International Trade Commission or any of its individual Commissioners. Working papers are circulated to promote the active exchange of ideas between USITC Staff and recognized experts outside the USITC, and to promote professional development of Office staff by encouraging outside professional critique of staff research. This paper is a revised version of Working Paper No. 21 dated May 2009. The paper has been updated to include 4 lags in the exchange rate estimation, instead of 3, and a new equation for Latin America is included. JEL codes: F10, F12 Key words: Exchange rates, pass-through, U.S. imports Address correspondence to: Office of Industries U.S. International Trade Commission Washington, DC 20436 How Do Exchange Rates Affect Import Prices? Recent Economic Literature and Data Analysis Cathy L. Jabara U.S.......

Words: 6701 - Pages: 27

RUIMIO Espejo de Maquillaje LED Luz Cosmético 7X Aumento Ajustable con Ventosa | El Objetivo | Gautama Buddha