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Foreign Exchange Basics Explained

The document covers the basics of foreign exchange, including nominal and real exchange rates, and their importance in international trade. It discusses foreign exchange markets, the law of one price, and the theory of purchasing power parity (PPP), highlighting factors that affect exchange rates in the long run. Additionally, it explains how changes in relative price levels, tariffs, and consumer preferences influence currency appreciation and depreciation.

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boscowan112
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6 views3 pages

Foreign Exchange Basics Explained

The document covers the basics of foreign exchange, including nominal and real exchange rates, and their importance in international trade. It discusses foreign exchange markets, the law of one price, and the theory of purchasing power parity (PPP), highlighting factors that affect exchange rates in the long run. Additionally, it explains how changes in relative price levels, tariffs, and consumer preferences influence currency appreciation and depreciation.

Uploaded by

boscowan112
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

topic 8

. foreign exchange basics


- exchange rate: the price of one currency in terms of another

1. the nominal exchange rate


- the price you pay for this currency
- exchange the currency of one country for the currency
- depreciation 貨幣貶值 of the currency that is falling in value
- appreciation 貨幣增值 of the currency that is rising in value

2. the real exchange rate


- exchange the goods and services from one country for the goods
3
and services from another country

- the ratio more than one, foreign products cheap


2
3. why are exchange rates important
- appreciates: country’s goods abroad become expensive, foreign goods
become cheaper
- depreciates: goods abroad become cheaper, foreign goods more
expensive

. foreign exchange markets


- over-the-counter 場外交易市場
- 2 transactions make up
1. spot transactions 即期交易: immediate exchange of bank deposits,
completed at the spot rate
2. forward transactions: exchanges at future date, completed at the
forward rate

. exchange rates in the long run


1. the law of one price
- arbitrage 調解: identical 完全相同的 products should sell for the same
price of where they are sold
- American steel costs $100 per ton; Japanese steel costs 10,000 yen
per ton
- the yen and the dollar must be 100 yen per dollar

2. change in exchange rate


- the exchange rate were 200 yen to the dollar
- Japanese steel sell $50 per ton (10,000/2)
1
- american sell 20,000 yen per ton (100x200)
- american steel more expensive than japanese steel in both countries
- given a fixed dollar price, excess supply of american steel

3. change in price
- yen of japanese steel has increased by 10%
- the exchange rate 110 yen per dollar, a 10% appreciation of the dollar
- unchanged (11,000 yen/110 yen per dollar)

4. the law of one price fails


- Transportation costs
- tariffs 關稅
3
- technical specifications 技術規格
- tastes
- cannot be traded

. theory of purchasing power parity 比價 (PPP)


- one unit of U.S. domestic currency will buy same basket of good and
services anywhere in the world.
- exchange rates reflect changes in the price levels of the two
countries.
- if one country’s price level 物價⽔平 rises relative to another’s, its
currency should depreciate, other one should appreciate

. why PPP cannot fully explain exchange rates


- the exchange rates are determined by changes in relative price levels
相對價格, assumption all goods are identical in both countries
- does not take many goods and services, not traded across borders

. factors affecting exchange rates in long-run


1. Relative price levels: a rise in relative price levels cause a country’s
.

currency to depreciate (inflation)


2. tariffs and quotas: trade barriers causes a country’s currency to
appreciate
3. preferences for domestic v. foreign goods
- increased demand for a country’s good, appreciate
- increased demand for imports, depreciate
4. productivity: more productive relative, appreaciates

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