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CHAPTER 4 - Coggle Diagram
CHAPTER 4
Factors That Influence Exchange Rates
Inflation Rates
Increase in U.S. inflation leads to increase in U.S. demand for foreign goods, an increase in U.S. demand for foreign currency, and an increase in the exchange rate for the foreign currency.
Interest Rates
Increase in U.S. rates leads to increase in demand for U.S. deposits and a decrease in demand for foreign deposits, leading to an increase in demand for dollars and an increased exchange rate for the dollar
Relative Income Levels
increase income --> increase demand foreign currency --> increase exchange rate
Government Controls
foreign exchange barriers
foreign trade barriers
intervening foreign exchange markets
Affecting inflation, interest rate, income levels
Capitalizing on Expected Exchange Rate Movements
Institutional speculation based on expected depreciation
If financial institutions believe that a currency is valued higher than it should be in the foreign exchange market, they may borrow funds in that currency and convert it to their local currency now before the currency’s value declines to its proper level
Speculation by individuals
Individuals can speculate in foreign currencies
Institutional speculation based on expected appreciation
When financial institutions believe that a currency is valued lower than it should be in the foreign exchange market, they may invest in that currency before it appreciates
The “Carry Trade”
Where investors attempt to capitalize on the differential in interest rates between two countries
Impact of appreciation in the investment currency: Increased trade volume can have a major influence on exchange rate movements over a short period
Risk of the Carry Trade: Exchange rates may move opposite to what the investors expected
Movements in Cross Exchange Rates
Explaining Movements in Cross Exchange Rate.
Changes are affected in the same way as types of forces explained earlier for those that affect demand and supply conditions between two currencies
A appreciates against the dollar by a greater (smaller) degree than currency B
A appreciates (depreciates) against B
A appreciates (depreciates) against the dollar,
while currency B is unchanged against the dollar
A appreciates (depreciates) against currency B by the same degree
as it appreciates (depreciates) against the dollar
A and B move in same direction
No change in the cross exchange rate
Exchange Rate Equilibrium
when demand increases
Banks will increase the exchange
When demand decreases
Banks will reduce the exchange
When supply increases
Banks will reduce the exchange
When supply decreases
Banks will increase the exchange
Measuring Exchange Rate Movements
Depreciation
decrease in monetary value
Appreciation
increase the value of the coin
Compare spot foreign currency rates on two points in
time, S and St-1
A positive percentage change indicates that the currency has
appreciate. A negative percentage change indicates that it has declined in price.
