International finance

1
International finance

• Exchange rates
• dr. Vasja Rant

2
How are exchange rates determined?
USD/EUR
EUR (quantity)
3
How are exchange rates determined?
USD/ EUR
Cas
t1
t2
t3
t4
4
What are the sources of foreign exchange?

• Supply
• Foreign demand for domestic goods services
  (exports of goods services)
• Foreign demand for domestic financial assets
  (capital inflows)
• Use of reserves by the central bank
• Demand
• Domestic demand for foreign goods services
  (imports of goods services)
• Domestic demand for foreign financial assets
  (capital outflows)
• Build up of reserves by the central bank

5
What are the factors that influence market
exchange rates?

• Relative inflation rates
• Changes in exports imports
• Relative (real) interest rates
• Changes in capital flows
• Relative economic growth rates
• Changes in exports imports and capital flows
• Political and economic risk

6
Which are the four different types of exchange
rates?

• Nominal bilateral exchange rate (NBER)
• Nominal exchange rate of H currency vis-a-vis one
  F currency
• Real bilateral exchange rate (RBER)
• Nominal bilateral exchange rate
• Corrected for inflation differenctial between H
  and F currency
• Nominal effective exchange rate (NEER)
• Nominal exchange rate of H currency vis-a-vis a
  basket of F currencies
• Real effective exchange rate (REER)
• Nominal effective exchange rate
• Corrected for inflation differentials between H
  and F currencies

7
What are spot and forward rates?

• Spot rate
• Price of base currency (H or F) traded for
  immediate delivery (up to 2 days in the interbank
  market).
• Forward rate
• Price of base currency (H or F) quoted for
  delivery at a specified future date

8
How do we describe changes in value of a currency
over time?

• Appreciation market increase in value of
  currency
• Depreciation market decrease in value of
  currency
• Devaluation official decrease in value of
  currency (change in central parity)
• Revaluation official increase in value of
  currency (change in central parity)

9
How do we describe differences in forward vs.
spot currency value?

• Forward premium
• Currency is valued more in the forward market
  relative to the spot market
• Example spot rate 1,35 USD/EUR, forward rate
  1,40 USD/EUR ? EUR in forward premium
• Forward discount
• Currency is valued less in the forward market
  relative to the spot market
• Example spot rate 1,35 USD/EUR, forward rate
  1,30 USD/EUR ? EUR in forward discount

10
What are exchange rate regimes?
11
Nominal and real bilateral exchange rate SIT/EUR
(ex. 10e)
239,64 SIT/EUR
171,78 SIT/EUR
156,88 SIT/EUR
12
Nominal and real effective exchange rate of EUR
(ex. 11e)
13
Nominal bilateral and effective exchange rate of
EUR (ex. 11e)
14
Real bilateral and effective exchange rate of EUR
(ex. 11e)