Chap 26 Exchange rate
Currency Overview :
Major Currencies: Dollar ($), Euro (€), Yen (¥)
Importance: Most international payments are made using these currencies.
Global Perspective: Over 100 different currencies exist.
Key Question: What determines the value of the Saudi Riyal in relation to others?
The Foreign Exchange Market
Definition: Foreign currency refers to foreign bank notes, coins, and bank deposits.
Function: To buy international goods and services, one needs the currency of the respective country.
Role of Foreign Exchange Market: A marketplace where currencies are exchanged.
Page 4: Trading Currencies
Process of Exchange: Foreign currency is exchanged for Saudi Riyals in this market.
Functionality: This market facilitates international trade between currencies overall.
Page 5: Exchange Rates
Concept: The price at which one currency can be exchanged for another.
Definitions:
Currency Depreciation: A fall in the value of one currency relative to another
Currency Appreciation: A rise in value of one currency relative to another.
Page 6: Exchange Rate as a Price
Understanding: An exchange rate is essentially the price of one currency in terms of another.
Market Dynamics: Determined within the competitive foreign exchange market—traders determine the demand and supply.
Page 7: Exchange Rate Policies
Overview of Policies:
Flexible exchange rate
Fixed exchange rate
Managed exchange rate
Focus: Understanding different exchange rate determination methods and their implications.
Page 8: Fixed Exchange Rate
Definition: A policy that pegs the exchange rate at a predetermined value.
Mechanism: Requires active government or central bank intervention to maintain the rate.
Page 9: Managed Exchange Rate
Definition: A system situated between flexible and fixed exchange rates.
Mechanism: Primarily determined by market forces with occasional government intervention.
Page 10: Supply and Demand in the Market
Framework: Analyzing the foreign exchange through the supply and demand model.
Terminology: Exchange rate (e) signifies price, while the quantity indicates dollars traded.
Page 11: Law of Demand for Foreign Exchange
Concept: Demand for Saudi Riyal arises from the need to purchase Saudi goods, services, or assets.
Relationship: As the exchange rate increases, the quantity of Riyals demanded decreases.
Page 12: Demand Curve for U.S. Dollars
Relationship: A higher exchange rate results in decreased demand for U.S. dollars, while a lower exchange rate increases demand.
Visual Representation: Demand curve illustrates this relationship.
Page 13: Law of Supply of Foreign Exchange
Concept: Supply of Saudi Riyal is also derived, aimed at purchasing foreign goods, services, or assets.
Relationship: As the exchange rate rises, the quantity of Riyals supplied increases.
Page 14: Supply Curve for U.S. Dollars
Relationship: An increase in the exchange rate translates to greater dollar supply, while a decrease results in reduced supply.
Visual Representation: The curve reflects the dynamics.
Page 15: Market Equilibrium
Concept: The equilibrium exchange rate is determined by the interaction of demand and supply forces in the foreign exchange market.
Page 16: Adjustments towards Equilibrium
Dynamics:
Surplus: Results when the exchange rate is high—market corrects toward equilibrium.
Shortage: Results when the exchange rate is low—market rises back to equilibrium.
Page 17: Equilibrium in Currency Exchange
Example Scenario:
Surplus occurs at 150 yen per U.S. dollar
Equilibrium at 100 yen per U.S. dollar
Shortage at 50 yen per U.S. dollar
Page 18: Changes in U.S. Dollar Demand
Influencing Factors: Other influences that can change demand include world demand for exports, U.S. interest rates relative to foreign rates, and expected future exchange rates.
Page 19: Demand Influences Explained
World Demand for Exports: Increased global demand leads to greater demand for U.S. dollars.
Interest Rate Differential: A higher U.S. interest rate relative to foreign rates increases dollar demand.
Page 20: Expected Future Exchange Rate
Concept: If the anticipated future exchange rate for U.S. dollars increases, immediate demand for dollars also surges.
Page 21: Demand Curve Response
Visual Reference: Demonstrates shifts in the demand curve due to changes in exports, interest rates, and expectations.
Page 22: Changes in U.S. Dollar Demand
Graphical Analysis: Illustrates increased and decreased demand scenarios with demand curve shifts in response to external factors.
Page 23: Changes in Supply of U.S. Dollars
Influencing Factors: A change in variables influencing the supply includes U.S. demand for imports and expected future exchange rates.
Page 24: U.S. Demand for Imports
Concept: Increased demand for imports leads to a rightward shift in the supply curve of U.S. dollars.
Page 25: Expected Future Exchange Rate Impact
Concept: If future exchange rates for U.S. dollars are expected to rise, overall supply decreases, shifting the curve leftward.
Page 26: Supply Curve Response
Visual Reference: Displays shifts of the supply curve in response to changes in imports and anticipated rates.
Page 27: Changes in U.S. Dollar Supply
Graphical Analysis: Indicates shifts in supply scenarios based on demand and expectations.
Page 28: Changes in the Exchange Rate
Dynamics:
Increased demand with unchanged supply leads to a rise in exchange rates.
Conversely, increased supply under unchanged demand results in lowered rates.
Page 29: Changes in Demand for Saudi Riyal
Influencing Factors: World demand for Saudi exports, interest rates differentials, and expected future exchange rates affect Saudi Riyal demand.
Page 30: Demand for Saudi Exports
Effect: Higher world demand for Saudi exports increases the demand for Saudi Riyal imports and increases its value.
Page 31: Changes in Supply of Saudi Riyal
Influencing Factors: Domestic demand for imports, interest rates differentials, and anticipated exchange rates affect supply.
Page 32: Fixed Exchange Rate in Saudi Arabia
Historical Context: Saudi Arabia has maintained a fixed exchange rate since 1986, currently set at 3.75 SAR to 1 USD, with the Central Bank managing this rate.
Page 33: Fixed Exchange Rate Overview
Functionality: Demonstrates the pegged value and the supply dynamics of dollars against the Yuan in the market.
Page 34: Fixed Exchange Rate Example—Peso
Similar Dynamics: Analyzes the pegged rate for the Peso against the Dollar, showing market interactions.
Page 35: Foreign Currency Reserves
Historical Data: Trends in Saudi foreign currency reserves, demonstrating stability and growth over various years.
Page 36: Evaluating Exchange Rate Policies
Comparison:
Floating exchange rates prioritize low inflation and unemployment.
Fixed rates offer stability and attract foreign investments but can hinder monetary policy flexibility.
Recommendations: Fixed exchange rates may be more advantageous for developing countries with volatile past exchange rates.
Changes in U.S. Dollar Demand
Influencing Factors
World Demand for Exports: An increase in global demand results in greater demand for U.S. dollars.
Interest Rate Differential: A higher U.S. interest rate in comparison to foreign rates raises the demand for U.S. dollars.
Expected Future Exchange Rate: Anticipating a future rise in the exchange rate leads to increased immediate demand for U.S. dollars.
Demand Curve Response
Visual Reference: Demonstrates shifts in the demand curve due to changes in exports, interest rates, and expectations.
Changes in Supply of U.S. Dollars
Influencing Factors
U.S. Demand for Imports: An increase in imports shifts the supply curve of U.S. dollars to the right.
Expected Future Exchange Rate Impact: If future exchange rates for U.S. dollars are expected to rise, the overall supply decreases, shifting the curve leftward.
Supply Curve Response
Visual Reference: Displays shifts in the supply curve in response to changes in imports and anticipated rates.
Changes in U.S. Dollar Demand
Influencing Factors
World Demand for Exports: An increase in global demand results in greater demand for U.S. dollars.
Interest Rate Differential: A higher U.S. interest rate in comparison to foreign rates raises the demand for U.S. dollars.
Expected Future Exchange Rate: Anticipating a future rise in the exchange rate leads to increased immediate demand for U.S. dollars.
Demand Curve Response
Visual Reference: Demonstrates shifts in the demand curve due to changes in exports, interest rates, and expectations.
Changes in Supply of U.S. Dollars
Influencing Factors
U.S. Demand for Imports: An increase in imports shifts the supply curve of U.S. dollars to the right.
Expected Future Exchange Rate Impact: If future exchange rates for U.S. dollars are expected to rise, the overall supply decreases, shifting the curve leftward.
Supply Curve Response
Visual Reference: Displays shifts in the supply curve in response to changes in imports and anticipated rates.
Changes in U.S. Dollar Demand
Influencing Factors
World Demand for Exports: An increase in global demand results in greater demand for U.S. dollars.
Interest Rate Differential: A higher U.S. interest rate in comparison to foreign rates raises the demand for U.S. dollars.
Expected Future Exchange Rate: Anticipating a future rise in the exchange rate leads to increased immediate demand for U.S. dollars.
Demand Curve Response
Visual Reference: Demonstrates shifts in the demand curve due to changes in exports, interest rates, and expectations.
Changes in Supply of U.S. Dollars
Influencing Factors
U.S. Demand for Imports: An increase in imports shifts the supply curve of U.S. dollars to the right.
Expected Future Exchange Rate Impact: If future exchange rates for U.S. dollars are expected to rise, the overall supply decreases, shifting the curve leftward.
Supply Curve Response
Visual Reference: Displays shifts in the supply curve in response to changes in imports and anticipated rates.
Changes in U.S. Dollar Demand
Influencing Factors
World Demand for Exports: An increase in global demand results in greater demand for U.S. dollars.
Interest Rate Differential: A higher U.S. interest rate in comparison to foreign rates raises the demand for U.S. dollars.
Expected Future Exchange Rate: Anticipating a future rise in the exchange rate leads to increased immediate demand for U.S. dollars.
Demand Curve Response
Visual Reference: Demonstrates shifts in the demand curve due to changes in exports, interest rates, and expectations.
Changes in Supply of U.S. Dollars
Influencing Factors
U.S. Demand for Imports: An increase in imports shifts the supply curve of U.S. dollars to the right.
Expected Future Exchange Rate Impact: If future exchange rates for U.S. dollars are expected to rise, the overall supply decreases, shifting the curve leftward.
Supply Curve Response
Visual Reference: Displays shifts in the supply curve in response to changes in imports and anticipated rates.