1. The Foreign Exchange Market
Chapter 9
The Foreign Exchange Market

2. Contents 1 Introduction The Functions of the Foreign Exchange Market 2
Economic Theories of Exchange Rate Determination 3
Implications for Managers 4

3. Introduction Question: What is the foreign exchange market?
Question: What is the exchange rate?

4. Implications for Managers
Firms must understand the influence of exchange rates on the profitability of trade and investment deals
This exchange rate risk can be divided into
Transaction exposure
Translation exposure
Economic exposure

5. Kurs Bank Mandiri

8. The world's least valuable currencies Ja10
Japanese yen

9. 09
Kenyan shilling

10. 08
Pakistani rupee

11. 07
hungarian-forint

12. 06
Chilean Peso

13. The Functions of the Foreign Exchange Market
Question: What is the purpose of the foreign exchange market?
The foreign exchange market
enables the conversion of the currency of one country into the currency of another
provides some insurance against foreign exchange risk (the adverse consequences of unpredictable changes in exchange rates)

14. Insuring Against Foreign Exchange Risk
The foreign exchange market can be used to provide insurance to protect against foreign exchange risk (the possibility that unpredicted changes in future exchange rates will have adverse consequences for the firm)
A firm that protects itself against foreign exchange risk is hedging

15. Spot exchange rates
Hedging
Forward exchange rates
Currency swaps

16. Economic Theories of Exchange Rate Determination
Question: What factors are important to future exchange rates?
Three factors that have an important impact on future exchange rate movements are
a country’s price inflation
a country’s interest rate
market psychology

17. Mengapa Rupiah Anjlok?

18. Case Study: Tebang Pilih Investasi Pasar Berkembang

19. Prices and Exchange Rates
Question: How are prices related to exchange rate movements?
To understand how prices and exchange rates are linked, we need to understand the law of one price, and the theory of purchasing power parity

20. Prices and Exchange Rates
The law of one price states that in competitive markets free of transportation costs and barriers to trade, identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency
Purchasing power parity theory argues that given relatively efficient markets (markets in which few impediments to international trade and investment exist) the price of a “basket of goods” should be roughly equivalent in each country

21. Case Study
Big Mac price and the exchange rate: An application of purchasing power parity.
Sumber: The Economist

22. Interest Rates and Exchange Rates
Question: How do interest rates affect exchange rates?
The Fisher Effect states that a country’s nominal interest rate (i) is the sum of the required real rate of interest (r ) and the expected rate of inflation over the period for which the funds are to be lent (l )
In other words, i = r + I
So, if the real interest rate is the same everywhere, any difference in interest rates between countries reflects differing expectations about inflation rates

23. Interest Rates and Exchange Rates
The International Fisher Effect suggests that for any two countries, the spot exchange rate should change in an equal amount but in the opposite direction to the difference in nominal interest rates between the two countries
In other words:
(S1 - S2) / S2 x 100 = i $ - i ¥
where i $ and i ¥ are the respective nominal interest rates in two countries (in this case the US and Japan), S1 is the spot exchange rate at the beginning of the period and S2 is the spot exchange rate at the end of the period

24. 05
korean-won

25. 04
Tanzanian Shilling

26. 03
Colombian Peso

27. RUPIAH

28. 01
Vietnamese Dong

29. Summary
Relative monetary growth, relative inflation rates, and nominal interest rate differentials are all moderately good predictors of long-run changes in exchange rates, but poor predictors of short term changes
So, international businesses should pay attention to countries’ differing monetary growth, inflation, and interest rates

30. Implications for Managers
Question: What does the foreign exchange market mean for international firms?

31. Should The UK Be A Member Of The Euro?

32. Is Europe an Optimal Currency Zone?
Price Transparency
Promotes Trade
Currency Stability and Transparency
Promotes Competition

33. UK Entry the Euro
Lost Trade
Lower Foreign Investment
Weaker Financial Market
Reduced Competitiveness
Convergence
Euro Policy and Politics

34. Cu Next Week

35. Exchange Rate Risk Transaction exposure Translation exposure1
Transaction exposure 2
Translation exposure 3
Economic exposure

37. Exchange Rate Risk

38. Insuring Against Foreign Exchange Risk

39. Hot Tip
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