international finance and exchange ratesssc.wisc.edu/~ctaber/100/interfin.pdf · the trading...

INTERNATIONAL FINANCE AND EXCHANGE RATES

• C H A P T E R 1 6

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Thursday, October 20, 11

CHAPTER OUTLINE

• International Financial Transactions• Foreign Exchange Markets• Alternative Foreign Exchange Systems

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YOU ARE HERE

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CURRENCY

• In the last set of lecture notes we looked at trade between nations

• We talked about trading burgers for buns and apples for coffee, but of course that is not what really happens

• Usually we sell apples for money and use the money to buy coffee

• However, this is complicated in international trade because there are different currencies

• In general people don’t like to just hold foreign currency• Its not very useful to have Yuan in Brazil• It doesn’t earn any interest just sitting there-would rather invest it or spend

on other stuffy

• The Balance of Payments keeps track of the accounting

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BALANCE OF PAYMENTS

• Balance of Payments: the accounting system for how money moves between countries to facilitate the purchase of goods, services, financial instruments, and physical investments.

• Current Account: The portion of the Balance of Payments accounting that represents that impacts of trade, short-term investment payments, and American payments of foreign taxes, foreign payments of American taxes, and the net transfer of private money.

• The Capital Account represents the changes in holding of longer term financial and physical assets by citizens of one country in another country.

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BALANCE OF PAYMENTS UNITED STATES, 2007

Major Accounting Item

Sub Accounting Item

Sub Acct component

Component Amount Sub Acct Balance Balance

Current Account

Balance of TradeExports $1,645,726

-$700,258

-$731,214Current Account

Balance of TradeImports $2,345,984

-$700,258


Balance of Short-term Investment Income

Income to the US $817,779

$81,749-$731,214Current

AccountBalance of Short-term Investment Income Payments from

the US -$736,030$81,749


Net Transfers (taxes, private payments) Net Transfers (taxes, private payments) Net Transfers (taxes, private payments) -$112,705

-$731,214

Capital Account

Change in the Ownership of Assets

US owned assets abroad $1,289,854

$767,849-$731,214Capital

Account

Change in the Ownership of Assets

Foreign owned assets in the US

$2,057,703$767,849

-$731,214Capital Account

Statistical Discrepancy & Net DerivativesStatistical Discrepancy & Net DerivativesStatistical Discrepancy & Net Derivatives -34,791

-$731,214

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CURRENT ACCOUNT MIRRORS THE BALANCE OF TRADE

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FOREIGN PURCHASES OF US ASSETS & US PURCHASES OF FOREIGN ASSETS

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TRADE REQUIRES CURRENCY

• Trade between countries is beneficial.• International trade requires that the currency of

the trading partners be exchanged. • The market where people come to trade

currencies is called the foreign exchange market.• E.g. the production and export of a radio can require

several currency transactions.

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FOREIGN EXCHANGE MARKETS

• The demand for a currency (say the dollar) is also the supply of the other currency (say the yen).

• The supply for a currency (say the dollar) is also the demand of the other currency (say the yen).

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Quantity of Yuan held by Americans

Price of Yuan in U.S.dollars

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Supply of Yuan to Americans given the price of Yuan in Dollars



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Demand of Yuan by Americans given the price of Yuan in Dollars



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Demand of Yuan by Americans given the price of Yuan in Dollars



Equilibriumexchangerate

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We Could do this Completely the other way around and it won’t matter


Quantity of Dollars held by Chinese

Price of U.S.dollarsin Yuan

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Supply of Dollars to Chinese given the price of Dollars in Yuan



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Demand of Dollars by Chinese given the price of Dollars in Yuan



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Demand of Dollars by Chinese given the price of Dollars in Yuan



Equilibriumexchangerate

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EXCHANGE RATE CHANGES

So what happens when exchange rate changes?

•Suppose the Dollar appreciates relative to the Euro-that means we can get more Euros for our dollar•This decreases the price of European goods relative to U.S. goods so:

•Imports should rise•Exports should fall


VARIOUS EXCHANGE RATES

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Table

American Dollar GO

Graph

American DollarAmerican Dollar GO

120 days2011 monthly average

Oct 18 - Oct 19

EUR/USD -1.099 %

CAD/USD -1.361 %

JPY/USD +0.050 %

AUD/USD -1.737 %

GBP/USD -0.559 %

GBP/EUR +0.546 %

JPY/EUR +1.162 %

GBP/AUD +1.199 %

JPY/AUD +1.819 %

USD GBP CAD EUR AUD 1 1.58043 0.98906 1.3828 1.03178 0.632738 1 0.625816 0.87495 0.65285 1.01106 1.59791 1 1.39809 1.04319 0.72317 1.14292 0.715259 1 0.746156 0.969193 1.53174 0.95859 1.3402 1 Wednesday, October 19, 2011

Top 10 Currencies

. American Dollar . Australian Dollar

. British Pound . Canadian Dollar

. Euro . Indian Rupee

. Mexican Peso . Singapore Dollar

. South African Rand . Thai Baht

More Currencies

Currency

. American Dollar . Argentine Peso

. Australian Dollar . Bahraini Dinar

. Botswana Pula . Brazilian Real

. British Pound . Brunei dollar

. Bulgarian Lev . Canadian Dollar

. Chilean Peso . Chinese Yuan

. Colombian Peso . Croatian Kuna

. Czech Koruna . Danish Krone

. Euro . Hong Kong Dollar

. Hungarian Forint . Iceland Krona

. Indian Rupee . Indonesian Rupiah

. Iranian Rial . Israeli New Shekel

. Japanese Yen . Kazakhstani Tenge

. Kuwaiti Dinar . Latvian Lat

. Libyan Dinar . Lithuanian Litas

. Malaysian Ringgit . Mauritius Rupee

. Mexican Peso . Nepalese Rupee

. New Zealand Dollar . Norwegian Kroner

. Omani Rial . Pakistan Rupee

. Philippine Peso . Polish Zloty

. Qatari Rial . Romanian Leu

. Russian Ruble . Saudi Riyal

. Singapore Dollar . South African Rand

. South Korean Won . Sri Lanka Rupee

. Swedish Krona . Swiss Franc

. Taiwan Dollar . Thai Baht

. Trinidad/Tobago Dollar . Turkish Lira

. Utd. Arab Emir. Dirham . Venezuelan Bolivar

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The Way to Read this is 1 US Dollar buys 0.72 Euros


VARIOUS EXCHANGE RATES

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ALTERNATIVE FOREIGN EXCHANGE SYSTEMS

• Floating exchange rate system: a system whereby markets determine the value of a currency relative to all other currencies.

• Fixed exchange rate system : a system whereby a government sets the value of a currency relative to all other currencies and uses its reserve of foreign currencies or gold to maintain the exchange rate.

• Managed Float exchange rate system: a system whereby governments decide the range of exchange rates they will allow the market to create, and act only when either the top end or the bottom end of that range is breached.

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