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Chapter 25

ECON102 Chapter 25: 25- the foreign exchange market


Department
Economics
Course Code
ECON102
Professor
Maria Viola
Chapter
25

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To buy G&S produced in another country we need
-
The Foreign Exchange Market
money of that country. Foreign bank notes, coins, and bank deposits
are called
foreign currency
.
Everybody can be from the demand or supply side of the market
-
We get foreign currency in the
foreign exchange market.
We get foreign currency and foreigners get Canadian dollars in the foreign exchange market.
-
The
foreign exchange market
is the market in which the currency of one country is exchanged for the
currency of another.
-
Trading Currencies
The price at which one currency exchanges for another is called a
foreign exchange rate.
-
foreign exchange rate is a
relative price
: the price of a currency in terms of another currency.
-
We refer to Canadian
Ratio between currencies, one increases, other decreases.
-
A fall in the value of one currency in terms of another currency is called
currency depreciation.
(ratio
decreases)
-
A rise in value of one currency in terms of another currency is called
currency appreciation.
(more
expensive), MORE USD to buy same CAD
-
Exchange Rates
In the market:
1.
With many traders and no restrictions, the foreign exchange market is a
competitive market.
a.
The exchange rate responds instantly to news about changes in the variables that influence demand
and supply in the foreign exchange market.
b.
Demand for a currency is a derived demand: it depends on the demand of goods and services
c.
Factors that affect demand of a currency can also affect the supply of a currency
d.
Many factors affecting demand in market, affect supply in same market. If demand more, supply less
-
Among Markets:
2.
Exchange rates are tied together so that no profit can be made by buying one currency, selling it for a
second one, and then buying back the first one.
a.
Characteristics of the Foreign Exchange Market
When people who are holding one money want to exchange it for Canadian dollars, they demand
Canadian dollars and they supply that other country's money.
So the factors that influence the
demand for Can
adian dollars also influence the
supply of Canadian
dollars, E. u. euros etc.
And the factors that influence the demand for another country's money also influence the supply of
Canadian dollars.
Exchange rates are tied together: The Demand for One Money Is the Supply of Another Money
Demand in the Foreign Exchange Market
The quantity of Canadian dollars that traders plan to buy in the foreign exchange market during a given
period depends on:
C25
-
The Foreign Exchange Market
February 6, 2016 7:24 PM
Econ102 Page 1

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Canadian dollars.
Demand in the Foreign Exchange Market
The exchange rate
1.
World demand for Canadian exports (+)
2.
Interest rates in Canada and other countries (+)
3.
The expected future exchange rate (+)
4.
The quantity of Canadian dollars that traders plan to buy in the foreign exchange market during a given
period depends on:
The demand for dollars is a derived demand: people buy Canadian dollars so that they can buy
Canadian-produced goods and services or Canadian assets.
Other things remaining the same, the higher the exchange rate, the smaller is the quantity of
Canadian dollars demanded in the foreign exchange market.
The Law of Demand for Foreign Exchange
The lower the exchange rate, the greater is the value of Canadian exports.
The larger the value of Canadian exports, the greater is the quantity of Canadian dollars
demanded on the foreign exchange market.
Exports effect
1.
Expected profit effect
2.
The lower today's exchange rate, other things remaining the same, the larger is the expected profit
from buying Canadian dollars and the greater is the quantity of Canadian dollars demanded today.
The larger the expected profit from holding Canadian dollars, the greater is the quantity of Canadian
dollars demanded today.
The exchange rate influences the quantity of Canadian dollars demanded for two reasons:
Supply in the Foreign Exchange Market
The exchange rate
1.
Canadian demand for imports (+)
2.
Interest rates in Canada and other countries
3.
The expected future exchange rate (
-
)
4.
The Qcad.s in the foreign exchange market is the amount that traders plan to sell during a given time
period at a given exchange rate. This quantity depends on many factors but the main ones are:
The Law of Supply of Foreign Exchange
Other things remaining the same, the higher the exchange rate, the
greater is the quantity of Canadian dollars supplied in the foreign
exchange market.
The exchange rate influences the quantity of Canadian dollars
supplied for two reasons:
The higher the exchange rate, the greater is the value of Canadian imports.
The larger the value of Canadian imports, the larger is the quantity of Canadian dollars supplied
on the foreign exchange market.
1 . Imports effect
For a given expected future Canadian dollar exchange rate, the lower the current exchange rate,
the greater is the expected profit from holding Canadian dollars
the smaller is the quantity of Canadian dollars supplied on the foreign exchange market.
Exchange rate too high, surplus of canadian dollars drives DOWN
-
Exchange rate too low, shortage of CAD drives UP
-
Market QUICKLY to equil exchange rate at which there is neither shortage nor surplus
-
2. Expected profit effect
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Exchange Rate Fluctuations
Changes in the Demand for Canadian dollars
World demand for Canadian exports
-
Canadian interest rate relative to the foreign interest rate
-
The expected future exchange rate
-
A change in any influence on the quantity of Canadian dollars that people plan to buy, other than the exchange rate, brings a
change in the demand for Canadian dollars. These other influences are:
At a given exchange rate, if world demand for Canadian exports increases, the demand for Canadian dollars increases.
-
World Demand for Canadian Exports
The Canadian interest rate minus the foreign interest rate is called the Canadian interest rate differential.
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If the Canadian interest differential rises, the demand for Canadian dollars increases.
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Canadian Interest Rate Relative to the Foreign Interest Rate
(Buy more yen, sell canadian dollars so supply increase
Demand decrease because demanding less ) ir earn on assets in japan higher than if hold on CAD, immediate depreciation
between yen and cad.
At a given current exchange rate, if the expected future exchange rate for Canadian dollars rises, .
-
the demand for Canadian dollars increases and the demand curve for Canadian dollars shifts rightward.
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The Expected Future Exchange Rate
2. Exchange Rate Fluctuations
Canadian exports
-
The Canadian interest rate differential
-
The expected future exchange rate
-
The demand curve for Canadian dollars shifts in response to changes in
Changes in the Supply of Canadian Dollars
Canadian demand for imports
-
Canadian interest rates relative to the foreign interest rate
-
The expected future exchange rate
-
A change in any influence on the quantity of Canadian dollars that people plan to sell, other than the exchange rate, brings
a
change in the supply of dollars. These other influences are:
At a given exchange rate, if the Canadian demand for imports increases, the supply of Canadian dollars on the foreign
exchange market increases and the supply curve of Canadian dollars shifts rightward.
-
Canadian Demand for Imports
If the Canadian interest differential rises, the supply for Canadian dollars decreases and the supply curve of Canadian dolla
rs
shifts leftward.
-
Canadian Interest Rate Relative to the Foreign Interest Rate
At a given current exchange rate, if the expected future exchange rate for Canadian dollars rises, .
-
the supply of Canadian dollars decreases and the demand curve for dollars shifts leftward.
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The Expected Future Exchange Rate
1. Exchange Rate Fluctuations
Canadian demand for imports
-
The Canadian interest rate differential
-
The expected future exchange rate
-
Figure 25.5 shows how the supply curve of Canadian dollars shifts in response to changes in
If demand for Canadian dollars increases and supply does not change, the exchange rate rises.
1.
Changes in the Exchange Rate
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