Devaluation
Intentionally lowering the value of a nation's currency.
Revaluation
Intentionally raising the value of a nation's currency.
Efficient market view
View that prices of financial instruments reflect all publicly available information at any given time.
Inefficient market view
View that prices of financial instruments do not reflect all publicly available information.
Fundamental analysis
Technique that uses statistical models based on fundamental economic indicators to forecast exchange rates.
Technical analysis
Technique that use charts of past trends in currency prices and other factors to forecast exchange rates.
Law of one price
Principle that an identical item must have an identical price in all countries when the price is expressed in a common currency.
Fisher Effect
Principle that the nominal interest rate is the sum of the real interest rate and the expected rate of inflation over a specific period.
International Fisher effect
Principle that a difference in nominal interest rates supported by two countries' currencies will cause an equal but opposite change in their spot exchange rates.
International monetary system
Collection of agreements and institutions that govern exchange rates.
Gold standard
Intentional monetary system in which nations link the value of their paper currencies to specific of gold.
Fixed exchange-rate system
System in which the exchange rate for converting one currency into another is fixed by international agreement.
Bretton Woods Agreement
Agreement (1944) among nations to create a new international monetary system based on the value of the U.S dollar.
Fundamental disequilibrium
Economic condition in which a trade deficit causes a permanent negative shift in a country's balance of payments.
Special drawing right (SDR)
IMF asset whose value is based on a "weighted basket" of four currencies.
Smithsonian Agreement
Agreement (1971) among IMF members to restructure and strengthen the international monetary system created at Bretton Woods.
Jamaica Agreement
Agreement (1976) among IMF members to formalize the existing system of floating exchange rates as the new international monetary system.
Managed float system
Exchange-rate system in which currencies float against once another, with governments intervening to stabilize their currencies at particular target exchange rates.
Free float system
Exchange-rate system in which currencies float freely against one another, without governments intervening in currency markets.
Currency bond
Monetary regime based on an explicit commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate.
Describe the importance of the exchange rate in business activities.
Exchange rates affect demand for products. When a country's currency is weak, the price of its exports declines, making the exports more appealing on world markets.
The intentional lowering of the value of a currency by the nation's government is called d
Outline the factors that help determine exchange rates.
Law of one price says an identical product must have an identical price in all countries when expressed in the same currency. PPP can be interpreted as the exchange rate between two nations' currencies that is equal to the ratio of their price levels.
Inf
Explain attempts to construct a system of fixed exchange rates.
Gold standard was an international monetary system in which nations linked the value of their paper currencies to a specific value of gold. The gold standard operated from the early 1700s until 1939.
Bretton Woods Agreement - 1944 accord among nations to
Describe efforts to create a system of floating exchange rates.
Jamaica Agreement - 1976 accord among IMF members to formalize the existing system of floating exchange rates.
The Plaza Accord (1985) was an agreement among the largest industrialized economies known as the G5 (Britain, France, Germany, Japan, and the Un
Importance of Exchange Rates
Exchange rates influence demand for a company's products in the global marketplace.
� Devaluation
- Intentionally lowering the value of a
nation's currency
� Revaluation
- Intentionally raising the value of a nation's currency
Desire for Predictability and stability
� Stable exchange rates
� Predictable exchange rates
� Stable exchange rates
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� Predictable exchange rates
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Efficient versus Inefficient Market View
Efficient Market View
� View that prices of financial instruments reflect all publicly available information at any given time
Inefficient Market View
� View that prices of financial instruments do not reflect all publicly
available information
Forecasting Techniques
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Fundamental Analysis
� Technique that uses statistical models based on fundamental economic indicators to forecast exchange rates
Technical Analysis
� Technique that uses charts of past trends in currency prices and other factors to forecast exchange rates
Forecasting Difficulties
� Unexpected events
� Human error
� Regulatory changes
What Factors Determine Exchange
Rates?
-Law of One Price
-Law of One Price:
Law of One Price
� Principle that an identical item must have an identical price in all countries when the price is expressed in a
common currency
Law of One Price: McCurrency
McCurrency
� "Big Mac Index
Purchasing Power Parity (PPP)
� PPP can be interpreted as the exchange rate between two
nations' currencies that is equal to the ratio of their price levels.
Purchasing Power Parity
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Role of Inflation
Inflation erodes people's purchasing power.
Money Supply
� Monetary policy directly affects interest rates and money supply
� Fiscal policy indirectly affects taxes and spending
Employment
� High employment raises wages, which are embodied in consumer prices
Interest Rates
� High interest rates lower borrowing and spending, which lowers
inflation
(PPE) How Exchange Rates Adjust to Inflation
� Exchange rates adjust to different rates of inflation in different countries.
-Necessary to maintain PPP between nations
(PPE) Role of Interest rates
How do interest rates affect exchange rates between two currencies?
Two Types
Two Types
� Real interest rates
� Nominal interest rates
Fisher Effect
� Nominal interest rate = real interest rate + inflation rate
International Fisher Effect
� Principle that a difference in nominal interest rates supported by two countries' currencies will cause an equal but opposite change in their spot exchange rates
Evaluating PPP
� Impact of Added Costs
� Impact of Trade Barriers
� Impact of Business Confidence and Psychology
� Impact of Added Costs
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� Impact of Trade Barriers
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� Impact of Business Confidence and Psychology
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Fixed Exchange-Rate Systems (2)
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International Monetary System
� Collection of agreements and institutions that govern exchange rates
Fixed Exchange-Rate System
� System in which the exchange rate for converting one
currency into another is fixed by international agreement
The Gold Standard-Advantages of the Gold Standard
� Reduced the risk in exchange rates
� Imposed strict monetary policies
� Help correct a nation's trade imbalance
The Gold Standard-Collapse of the Gold Standard
� Aggressive printing of paper currency caused high inflation
� Decision of the United States to devalue its currency and Britain's decision not to do so:
- Lowered the price of U.S. exports on world markets
- Increased the price of imports from Britain (
� Bretton Woods Agreement:
Agreement (1944) among nations to create a new international monetary system based on the value of the U.S. dollar
- Incorporated fixed exchange rates
- Incorporated a degree of built-in flexibility
- Created the World Bank
- Established the International
� Collapse of the Bretton Woods Agreement
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System of Floating Exchange Rates
-Jamaica Agreement
-Managed Float System
-Free Float System
-Later Accords
-
Jamaica Agreement
� Agreement (1976) among IMF members to formalize the existing system of floating exchange rates as the new international monetary system
Managed Float System
� Exchange rate system in which currencies float against one another, with governments intervening to stabilize their currencies at particular target exchange rates
Free Float System
� Exchange-rate system in which currencies float freely against one another, without governments intervening in currency markets
Later Accords
� The Plaza Accord: caused traders to sell the dollar, and its value fell
� The Louvre Accord: affirmed that the U.S. dollar was appropriately valued
Today's Exchange-Rate Arrangements
� Managed Float System
� "Pegged" Exchange-Rate Arrangement
� Currency Board
� "Pegged" Exchange-Rate Arrangement
- "Peg" a country's currency to a more stable and widely used currency in international trade.
� Currency Board
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European Monetary System (EMS)
� Established in 1979 by EU nations
- Exchange Rate Mechanism (ERM): Limited the fluctuations of EU members' currencies within a specified trading range (2.25 percent of the highest- and lowest-valued members' currencies)
� The EMS was quite successful in
� The EMS was established to:
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Recent Financial Crises
� Most prominent financial crises
- Developing Nations' Debt Crisis
- Mexico's Peso Crisis
- Southeast Asia's Currency Crisis
- Russia's Ruble Crisis
- Argentina's Peso Crisis
� Future of the international monetary system
- Calls for a new system