1 Foundations of Multinational Financial Management - PowerPoint Presentation

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Foundations of Multinational Financial Management Alan Shapiro10th Edition John Wiley & Sons, Inc.

PowerPoints

by

Joseph F. Greco, Ph.D.

California State University, FullertonSlide2

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The Determination of Exchange RatesChapter 2Slide3

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CHAPTER 2THE DETERMINATION OF EXCHANGE RATESCHAPTER OVERVIEW:2.1 SETTING THE EQUILIBRIUM SPOT EXCHANGE RATES2.2 EXPECTATIONS AND THE ASSET MARKET MODEL2.3 THE FUNDAMENTALS OF CENTRAL BANK INTERVENTION2.4 THE EQUILILBRIUM APPROACHSlide4

Equilibrium Exchange Rates2.1 SETTING THE EQUILIBRIUM A. The exchange rate is the price of one unit of foreign currency expressed as a certain price in local currency. For example, $1.30/€ means the euro in the U.S. is worth $1.30.

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Equilibrium Exchange Rates B. When Americans Purchase German Goods: 1. Foreign Currency Demanded derived from the demand for foreign country’s goods, services, and financial assets. e.g. The demand for German

car

s by AmericansSlide6

The Demand for € in the U.S.

Qty

$1.10/

€

$/

€

D

At higher exchange rates, Americans demand

less euros and vice versa.

$1.20/ €

$1.00/ €

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Equilibrium Exchange Rates 2. Foreign Currency Supply: a. derived from the foreign country’s demand for local goods. b. Foreigners must convert their currency to purchase. e.g. German demand for US goods means Germans

convert € to US $

in order to buySlide8

The Supply of € in the U.S.

Qty

$1.10/

€

S

$1.20/€

$1.00/€

At higher exchange rates, Germans supply

more euros and vice versa.

$/

€

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Equilibrium Exchange Rates 3. Equilibrium Exchange Rate occurs where the quantity supplied equals the quantity demanded of a foreign currency at a specific local exchange rateSlide10

The $/€ Equilibrium Rate

Qty

$1.10

S

$/

€

D

Equilibrium

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Equilibrium Exchange Rates C. How Exchange Rates Change 1. Increased demand as more foreign goods are demanded, more of the foreign currency is demanded at each possible exchange rate 2. The exchange rate of the foreign currency in local currency increases.

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Equilibrium Exchange Rates 3. Home Currency Depreciation a. Foreign currency more valuable than the home currency b. Conversely, the foreign currency’s value has appreciated against the home currency

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The US$ Depreciates When

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$1.10/

€

S

$/

€

D

D’

$1.20/

€

Q1

Q2

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Equilibrium Exchange Rates Computing a Currency Appreciation = (e1 - e0)/ e0 where e0 = old currency value e

1 = new currency value

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Equilibrium Exchange Rates Computing a Currency Depreciation: = (e0 - e1)/ e1 where e0 = old currency value e1 = new currency value

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Equilibrium Exchange Rates D. FACTORS AFFECTING EXCHANGE RATES: 1. Inflation rates 2. Interest rates 3. GNP growth rates Slide17

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Expectations and the Asset Market Model of Exchange Rates2.2 The Role of Expectations: A. Currency = financial asset B. Exchange rate = simple relation of two financial assetsSlide18

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ExpectationsC. The Nature of Money and Currency Values: 1. Asset Market Model Exchange rates reflect the supply of and demand for foreign-currency denominated assets.Slide19

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Expectations 2. Soundness of a Nation’s Economic Policies a nation’s currency tends to strengthen with sound economic policiesSlide20

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Expectations 3. Expectations and Central Bank Behavior exchange rates are also influenced by expectations of central bank behavior Slide21

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Expectations D. Central Bank Reputations and Currency Values 1. Central bank: the nation’s official monetary authority Slide22

Expectations2. Price Stability and Central Bank Independence: when the Bank limits its focus to price stability, it is more likely to succeed in its goal.Slide23

Expectations3. Currency Boards - exist where there is no central bank - instead the board issues notes - has not discretionary monetary policySlide24

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Central Bank Interventions2.3 How Real Exchange Rates Affect Relative Competitiveness A. Appreciation: -domestic prices increase relative to foreign prices. -Exports: less competitive Imports: more attractive Slide25

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Central Bank Interventions B. Currency Depreciation domestic prices fall relative to foreign prices. - Exports: more price competitive - Imports: less attractive Slide26

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Central Bank Interventions C. Foreign Exchange Market Intervention Mechanics of Intervention Sterilized vs Unsterilized Intervention Slide27

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Central Bank Interventions D. The Effects of Foreign Exchange Market Intervention 1. Definition: the official purchases and sales of currencies through the central bank to influence the home exchange rateSlide28

The Equilibrium Approach2.4 The Equilibrium Approach to Exchange Rates A. Disequilibrium Theory and Exchange Rate Overshooting 1. various economic frictions cause prices to adjust slowly over time 2. leads to “overshooting”Slide29

The Equilibrium Approach B. The Equilibrium Theory of Exchange Rates and Its Implications 1. markets clear through price adjustments 2. Repeated shocks in supply and demand create a correlation between changes in nominal and real exchange rates.Slide30

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