Ch4 Exchange Rate Determination

LO:

  1. Explain how exchange rate movements are measured

  2. Explain how the equilibrium exchange rate is determined

  3. Examine factors that affect the equilibrium exchange rate

  4. Explain the movements in cross exchange rates

  5. Explain how financial institutions attempt to capitalize on anticipated exchange rate movements

  • Financial managers of MNCs that conduct intl business must continuously monitor exchange rates because their CF are highly dependent on them

  • Need to understand what factors influence exchange rates to anticipate how exchange rates may change in response to specific conditions

LO1 : Measuring exchange rate movements

  • It affects an MNC’s value because they can affect the amount of cash inflows received from exporting products or services or from a subsidiary

    • Can also affect amount of cash outflows needed to pay for imports of products or servers

  • Exchange rate measures the value of one currency in units of another currency

  • Depreciation : decline in currency’s value

  • Appreciation : increase in currency value

  • Ex: British pound depreciates against US dollar; means US dollar is strengthening relative to the pound

  • Positive % = appreciation, negative % = depreciation

    • Find standard deviation of the sample (excel stdev.s) and higher the percentage, higher volatile

  • Foreign exchange rate movements tend to be larger for longer time horizons

    • If yearly exchange rate data were assessed, more volatile

    • If daily, less volatile

LO2 : Exchange rate equilibrium

  • Equilibrium exchange rate : exchange rate at which demand for a currency is equal to the supply of the currency for sale

    • Ex : in a demand and supply graph, the equilibrium exchange rate is the intersecting point

    • Exchange rate (at a given time) : is the price of a currency or the rate at which one currency can be exchanged for another

    • With a focus in the US, it will always be the US demands for the foreign currency whereas the foreign country will be the supplier