CHAPTER 2:
EXCHANGE RATE AND THE
INTERNATIONAL BALANCE OF
PAYMENT
CONTENT
Exchange rate
The international balance of payment
2.1. FOREIGN EXCHANGE RATE
Concept
Determination method of exchange
rate
Factors that affect to exchange rate
Regimes of exchange rate
2.1.1. FOREIGN EXCHANGE RATE: DEFINITIONS
There are some definitions about Exchange
rate:
Exchange rate is the price of one country's
currency expressed in another country's
currency. In other words, it is the rate at
which one currency can be exchanged for
another.
OR: Exchange rate is the number of units of a
foreign currency that can be bought with one
unit of the domestic currency, or vice versa.
OR: Exchange rate is the comparison of the
purchasing power among currencies.
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2.1.1. FOREIGN EXCHANGE RATE:DEFINITIONS
=> In conclusion, exchange rate is
the rate at which, one currency can
be exchanged for another, and
expresses the comparison of the
purchasing power among
currencies
5
2.1.1. FOREIGN EXCHANGE RATE:
DEFINITIONS
Exchange rate between USD and VND
on 24th Octorber 2012 in Hanoi :
USD/VND = 20200
Note: …
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2.1.1. FOREIGN EXCHANGE RATE: DEFINITIONS
Exchange rate between EUR and USD
on 26th September 2010 in New York :
10h30 am : EUR/USD = 1.3466 -
1.3471
12h02 am : EUR/USD = 1.3463 -
1.3468
[Link]
Note: Time and Place of quotations?
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UNIT CURRENCY AND TERM CURRENCY
Exchange rate between USD and VND
on 24th October 2012 in Hanoi :
USD/VND = 20200
- What is unit/base/commodity currency?
- What is term currency?
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QUOTATIONS
- What is direct quotation?
Quotes using a country's home currency as the term (price)
currency are known as direct quotation or price quotation
(from that country's perspective) and are used by most
countries.
Ex: In Hanoi, USD 1.00 = VND 21,200
=> Direct quotation: 1 foreign currency unit = x home
currency units
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QUOTATIONS
What is indirect quotation?
Quotes using a country's home currency as the unit currency
are known as indirect quotation or quantity quotation and
are used in British newspapers and are also common in
Australia, New Zealand and the Euro zone.
For example: In New York, USD 1.00 = VND 21,200
=> Indirect quotation: 1 home currency unit = x foreign
currency units
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DISCUSSION
A strong domestic currency: Advantages
or disadvantages? Analyze the case of:
USD
RMB
VND
In terms of:
International trade
International tourism
Foreign capital flow
Reserve
2.1.2. EXCHANGE RATE DETERMINATION
Method1: Gold standard of
currencies
Method 2: Purchasing Power Parity
Method3: Cross exchange rate
approach
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METHOD 1: EXCHANGE RATE DETERMINATION UNDER
THE GOLD STANDARD OF CURRENCIES.
?/ What is gold standard of currencies?
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METHOD 1: EXCHANGE RATE DETERMINATION UNDER
THE GOLD STANDARD OF CURRENCIES.
The phrase “gold standard” is defined as the use
of gold as the standard value for the money of a
country. It means that countries fix the prices of
their domestic currencies in terms of a specified
amount of gold (gold content)
15
METHOD 1: EXCHANGE RATE DETERMINATION UNDER
THE GOLD STANDARD OF CURRENCIES.
Advantages?
Disadvantages?
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METHOD 2: EXCHANGE RATE DETERMINATION UNDER
PURCHASING POWER PARITY
pB i
A / B i n1
pA
i 1
i
In which:
p B: Market price of a basket of goods and services in
i
currency B
p A: Market price of a basket of goods and services in
i
currency A
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METHOD 2: EXCHANGE RATE DETERMINATION UNDER
PURCHASING POWER PARITY
Advantages?
Disadvantages?
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METHOD 3: EXCHANGE RATE
DETERMINATION UNDER CROSS
EXCHANGE RATE APPROACH
Case 1: The intermediary currency is the base in
one currency pair and the term in the other
currency pair
Case 2: The intermediary currency is the base one
in both currency pairs
Case 3: The intermediary currency is the term one
in both currency pairs
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EXERCISES
UPCOMING CLASS
PRESENTATION
1. 10-minute presentation (with slides)
about Asia crisis (1997) and explain
the relationship between monetary
speculation and exchange rate?
2. 10-minute presentation (with slides) to
list down some main features in
current USD/VND policy by SBV?
2.1.3. FACTORS THAT AFFECT EXCHANGE RATE
Supply & Demand of/for foreign currencies in
foreign exchange market
The difference in inflation rate among currencies
The fluctuation in interest rate of currencies
Public psychology
The international monetary speculation
The Government’s interference
• Reserve
• Borrowing
• Changing interest rate
• Reducing inflation rate
(Related material) 22
2.1.4. REGIMES OF EXCHANGE RATE
The regime of exchange rate refers
to the type of exchange rate applied by
one country and measures used to
ensure that type of exchange rate is
implemented.
Type of exchange rate:
- single exchange rate regime
- dual exchange rate regime
- fixed exchange rate regime
- flexible exchange rate regime
+ Completely flexible
+ Managed flexible
2.2. BALANCE OF PAYMENT
The balance of payments is a
bookeeping system for recording all
economic transactions that have
direct bearing between residents and
non-residents of a nation over the
period of time.
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PRESENTATION TASK
1. 10-minute presentation (with slides)
about Asia crisis (1997) and explain the
relationship between monetary
speculation and exchange rate?
2. 10-minute presentation (with slides) to
list down some main features in current
USD/VND policy by SBV?
HOMEWORK
1. What is exchange rate?
2. Analyze factors that affect exchange
rate?
3. Analyze the impacts of foreign
currency demand on exchange rate’s
fluctuation
4. Analyze the impacts of foreign
currency supply on exchange rate’s
fluctuation