Tuesday,
October 2
What is money? What does it do?
The major currencies of the world (see figure 7-2 p. 169)
The Gold Standard (late XIXth century-WWI)
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fixed exchanged rates for participating countries
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convertibility into gold
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adjustments made by transfer of gold
1919-1939
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disappearance of the gold standard
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no convertibility
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economic depression in participating countries
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protectionism and isolationism
Bretton Woods: the International Monetary
System (1944-1971)
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Fixed exchange rates for participating countries
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1 % flexibility and gold exchange rate of
$35 per oz
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creation of the IMF and World Bank
1971-1976: the troubled years
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Smithsonian Agreement (1971): 8.57% devaluation
of the dollar ($38/ounce and 2.25% flexibility)
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1971: Nixon announces the end of the convertibility
of the dollar into gold
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Jamaica IMF meeting (1976): institutionalization
of flexible or floating exchange rates
1976-Today:
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deregulation
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gains in technology and transaction cost efficiency
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impossibility of direct intervention
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Plaza agreement (1985): G5 countries coordinated
intervention to lower the value of the dollar
An exchange rate is the domestic money
price of foreign money. It is the price of one currency in terms of another.
Foreign Exchange Terminology
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spot rate: exchange rate for immediate
transaction (executed in 2 business days)
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direct quote: amount of number of units
of the domestic currency for one of the foreign currency
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indirect quote: amount of units of
the foreign currency for one unit of the domestic currency
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European terms and American terms
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offer rate: to sell
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bid rate: to buy (spread = offer-bid)
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cross rate: foreign currencies vis-a-vis
each other (triangular arbitrage)
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forward rate: transaction will take
place in the future (forward spread = spot rate– forward rate) (discount
and premium rates)
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eurocurrency: any foreign currency-denominated
deposit or account at a financial institution outside of the country of
the currency's issuance.
Determinants of foreign exchange rates
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supply and demand
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economic and political conditions
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purchasing power parity, because there is
parity among products produced in different countries, PPP is an exchange
rate at which an equivalent amount of different currency buys the same
basket of goods (if only one good: law of one price)
Factors influencing foreign exchange rates
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Relative inflation
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Balance of payments
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Foreign exchange reserves
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Economic growth
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Government spending
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Money supply growth
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Interest rate policy
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Exchange rate control
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Election year or leadership change
Types of rate based on governmental involvement
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floating exchange rate
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fixed exchange rate
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managed float exchange rate
Types of Exchange Risk
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Transaction exposure
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Economic exposure
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Translation exposure
Managing transaction exposure (hedging)
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Natural hedging
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Currency forwards
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Options
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