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ECON 1010 Lecture Notes - Lecture 25: Foreign Exchange Market, The Foreign Exchange, Canadian Dollar

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whitesalmon848
12 Dec 2017
School
York University
Department
Economics
Course
ECON 1010
Professor
Chowdhury S Mahmoud

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Document Summary

Chapter 25- the exchange rate and the balance of payments. Trading currencies: foreign exchange market, the currency of another country is exchanged for the currency of another in this market, controlled all around the world by foreign exchange brokers, constantly happening around the world. Exchange rates: exchange rate, the price at which one currency exchange for another currency in the foreign exchange market, rise in the exchange rate=appreciation of the dollar, fall in the exchange rate=depreciation of the dollar. Questions about the canadian dollar exchange rate: 1. How is the exchange rate determined: 2. How do the bank of canada and other central banks operate in the exchange market: 3. An exchange rate is a price: the price of one currency in terms of another, determined by the foreign exchange market, foreign exchange market is a competitive market, since many traders and no single trader can in uence price.

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Related Questions

Foreign exchange markets make it possible for trade to be enacted between countries without lengthy negotiations on trade terms. The exchange rate mechanism is a relatively stable process whereby different currencies can be exchanged in an orderly manner in conformity to the rules of currency exchange rates. Factors, such as the relative inflation and unemployment rates between the trading partners, affect the value of each country's currency in relation to the other countries' currency. The country with higher inflation and unemployment will have the lower valued currency.

(A.) Why is the foreign currency exchange market important to a business?

(B.) What is the benefit of the foreign currency exchange market to the U.S. company?

(C.) If the U.S. currency is decreasing versus other currencies of countries it trades with, how will that affect the U.S. company? If the reverse is true, how will that affect the US company?

Answer the following questions. Each sub-part of the question is not related to the other part. Be sure to provide a written explanation in order to receive full credit. a) The foreign exchange market is in equilibrium, and there is a change in the consumption preference such that Canadian households decide to buy fewer American goods. If the Bank of Canada (BOC) wants to keep the exchange rate from changing, what should it do? What happens to the stock of official reserves held by the BOC? What happens to the balance of payments after the intervention by the BOC? Explain. (10 points)

b) Suppose you are a currency trader, and he observes the following exchange rates in the spot market: S£/US$ = 0.5133 SUS$/€ = 1.4568 S£/€ = 0.7192 ? You observe there is an arbitrage opportunity in trading £ and €, what should you do to capture the arbitrage profit? What is your arbitrage profit (measured in £)? Explain. (6 points) ? Also, discuss the adjustment mechanism (i.e., explain how the transactions you would eliminate the arbitrage profit). (9 points)

Assume that the U.S. dollar and the Japanese yen are the only two currencies in the world.

a. A bilateral nominal exchange rate S is the spot (now) exchange value of one currency in terms of the other and S can be written as dollars per 1 yen or yen per 1 dollar. If S = yen/1 dollar = 76.92 then the inverse 1/S gives dollars per 1 yen where 1/S = 1/(yen/1 dollar) = 1/76.92 = .013. If the 1/S increases to .014, has the dollar appreciated (1 dollar is worth more yen) or depreciated (1 dollar is worth less yen)? Explain.

b. Changes in demand and supply in the foreign exchange (FX) market determine the value of floating exchange rates S. If S is expressed as S = yen/1 dollar, then we have the FX market in terms of the demand and supply of dollars. (If S = dollars/1 yen, then we get the FX market in terms of the demand and supply of yen. Note also that no matter which currency the FX market is expressed, it is still an FX market where dollars are exchanged for yen. This means that an upward-sloping supply of dollars curve is exactly the same as a demand for yen curve and a downward-sloping demand for dollars curve is exactly the same as a supply of yen curve). Using S = yen/1 dollar and the FX market in terms of the demand and supply of dollars, an increase in S (dollar appreciation) leads to an increase in the number of dollars supplied (increase in the quantity of yen demanded). For dollar demand (or the supply of yen), an increase in S (dollar appreciation) leads to a decrease in the number of dollars demanded (or an increase in the number of yen supplied). The dollar demand curve shifts to the right if more yen are offered for dollars at any exchange rate S. An increase in dollar demand is caused mostly by private sector transactions in the current and capital accounts. Either an increase in demand for U.S. goods (merchandise trade in the current account) or an increase in demand for U.S. stocks and bonds (capital account inflows) will shift the dollar demand curve to the right. If private transactions in the current and capital accounts also cause shifts in the dollar supply curve, what are the corresponding factors that would lead to an increase in dollars supplied (yen demanded) at any exchange rate S?