Determination of exchange rates 3 major approaches

Factors affecting exchange rates Current supply and demand flows in the foreign exchange market Current events

Expectations about future exchange rate movements

Central Bank behaviour Price stability Low interest rate Target currency value

Why do exchange rates move? Effects over time of Capital flows

Why do exchange rates move? An understanding of how long-term economic fundamentals interrelate with short-term political or other factors is essential to understanding boyh why exchange rates move and the rationale behind the forecasts made by economists

Exchange rate of a freely floating currency Viewed as having 2 constituents: Economic performance( the currency in relation to other currencies)

Predictability of a currency vis-a vis other currencies Short-term shocks are difficult both to predict and to quantify in terms of their likely impact on the exchange rates.

Predictability of a currency vis-a vis other currencies Other short-term factors that influence exchange rates temporarily can be: Banks open position/reserve requirements

Effect of capital flows

Balance of payments Current account balances Portfolio investments Foreign direct investment

Parity conditions

Asset approach Relative interest rate Prospects foe economic growth Supply and demand for assets Outlook for political stability Speculation and liquidity

Factors influencing spot and forward rates