ADM 3318 Lecture Notes - Lecture 11: Efficient-Market Hypothesis, Foreign Exchange Spot, Foreign Exchange Market
16 Jun 2018
School
Department
Course
Professor
The Foreign Exchange Market (FEM)
Constructs to understand FEX rate determination
Investor psychology
Like most theories, it is hard to estimate the effect of
psychology on FEX rates
□
Some people/firms seem to have a multiplier effect on rates
and can cause havoc
The Tipping Point
Probability of chance - on seemingly synchronised
behaviour
◊
®
□
Unpredictable
§
Move as a herd
§
Triggered at macro level by politics, economic factors and correct or
incorrect perception of such effects
§
○
•
FEX rate forecasting
This is a critical issue for enterprises and business operating in multiple
geographies/countries with their own exchange regimes
Two directions to predict rates
§
○
The efficiency market school
This is one in which prices reflect all available information
§
There have been a large number of empirical tests of the efficient
market hypothesis
§
So followers of this school will typically accept market rates as they
are
§
○
The inefficient market school
This is one in which prices do not reflect all available information
§
In such scenario, forward exchange rates will not be the best
possible predictor of future spot exchange rate
§
It may be worthwhile for international enterprises to invest in
forecasting services
§
Forecasting approaches
Fundamental analysis
Fundamental analysis draw upon economic theories to
predict future exchange rates, including factors like
interest rates, monetary policy, inflation rates, or
balance of payments information
®
It literally takes a bird's eye view of many factors
®
□
Technical analysis
Typically chart trends, and the belief is that past trends
and waves are reasonable predictors of future trends
and waves
®
□
§
○
•
Forex, currency and convertibility
Sovereign and government control restrictions
Freely convertible
Minority of the global nations□
§
Externally convertible
Most countries□
§
Non-convertible
Some countries□
§
○
Where tradeable currency is limited by availability, countertrade is
possible
USSR and many other countries engaged in this form of activity to
overcome the exchange issue
§
It is classical barter of a kind
§
Both nations and enterprises are involved
§
○
The big issue
Foreign exchange reserves of a country is probably the most touchy
subject for a vast majority for of countries
§
This has major implications for business
Repatriating, profits, or investing in USD, or getting paid in
local currency may not be worth as much
□
§
For many corporations it is a huge gamble to invest in any country
§
It is hardly surprising that corporates go to countries where other
corporates are already present
§
○
•
The Global Monetary System
The international money system
The international monetary system refers to the institutional
arrangements that countries adopt to govern exchange rates
○
The demand and supply of currencies is influenced by their respective
countries' relative inflation rates and interest rates
○
When the foreign exchange market determines the relative value of a
currency, we say that the country is adhering to a floating exchange rate
regime
The exchange rate for converting one currency to another
§
○
The world's four major currencies, all are free to float against each other
USD
§
EUR
§
JPY
§
GBP
§
○
Pegged exchange rates
The rate at which currency value is fixed relative to a reference
currency
§
○
Dirty float system
A system in which a country's currency is nominally allowed to float
freely against other currencies, but the government will intervene,
buying and selling currency, if it believes that the currency has
deviated too far from its fair value
It is a float because in theory, the value of the currency is
determined by market forces, but it is a dirty float because of
the central bank of a country will intervene in the foreign
exchange market to try to maintain the value of its currency
□
§
○
•
Central banks
A central bank usually has the responsibility for
Issuing currency
§
Administering monetary policy
§
Holding member banks' deposits
§
Facilitating the nation's banking industry
§
○
•
The Bretton Woods System
IMF
Their purpose is to lend foreign currencies to members to tide them
over during short periods of balance-of-payments deficits
§
In order to receive such money, countries must abide by certain
regulations and economic restraint
§
○
World Bank
This is not a single entity, but rather a group of five institutions
§
The World Bank Group consists of five closely associated institutions
IBRD
The International Bank for Reconstruction and
Development
®
The activity of most interest to people in international
business
®
□
IDA
International Development Association
®
□
IFC
International Finance Corporation
®
□
MIGA
Multilateral Investment Guarantee Agency
®
□
ICSID
International Centre of Settlement of Investment
Disputes
®
□
§
○
•
Fixed vs. Floating exchange Rates
Fixed exchange rates
Monetary discipline
§
Speculation
§
Uncertainty
§
Trade balance adjustments
§
○
Floating exchange rates
There are two main elements
Monetary policy autonomy□
Automatic trade balance adjustments □
§
○
•
Exchange rate regimes in practice
Governments around the world pursue a number of different exchange
rate policies
○
21% of IMF's members allow their currency to float freely
○
Another 23% intervene in only a limited way
○
43% use more inflexible systems, including a fixed peg arrangement
○
•
Class 11 - Feb. 12th
Monday, February 12, 2018
10:03
Document Summary
Like most theories, it is hard to estimate the effect of psychology on fex rates. Some people/firms seem to have a multiplier effect on rates and can cause havoc. Probability of chance - on seemingly synchronised behaviour. Triggered at macro level by politics, economic factors and correct or incorrect perception of such effects. This is a critical issue for enterprises and business operating in multiple geographies/countries with their own exchange regimes. This is one in which prices reflect all available information. There have been a large number of empirical tests of the efficient market hypothesis. So followers of this school will typically accept market rates as they are. This is one in which prices do not reflect all available information. In such scenario, forward exchange rates will not be the best possible predictor of future spot exchange rate. It may be worthwhile for international enterprises to invest in forecasting services.
