T4 Foreign Exchange Market Flashcards
ER
price of one currency in terms of another
Foreign Exchange Market
FM where ER are determined
Spot transactions
Immediate (2 day) exchange of bank deposits
Forward transaction
exchange of bank deposits at some specified future date
Appreciation
currency rises in value relative to another country
SPICED
Law of one price
understanding how ER are determined is an idea called law of one price. If 2 countries produce and identical good and transportation costs and trade barriers are very low, the price of the good should be the same throughout the world
Theory of Purchasing power parity
States ER between 2 currencies will adjust to reflect changes in price levels of the 2 countries. It is simply an application of the law of one price
PPP assumptions
All goods identical in both countries
Trade barriers and transportation costs are low
Many goods & services are traded across borders
Factors that ER in LR
Supply curve for domestic assets
Assume amount of domestic assets is fixed: The quantity of dollar assets supplied is the quantity of bank deposits, bonds and equities in US.
Demand curve for domestic assets
Most important determinant is the relative expected return of domestic assets
At lower current values of the dollar, the quantity demanded of dollar assets is higher
Increase in domestic IR
Increase in Foreign IR
Increase in expected future ER
Factors that shift demand curve for domestic assets and affect ER
Effect of a rise in domestic IR as a result of increase in expected inflation
