Chapter 14 (3) Exchange Rates and the Foreign Exchange Market: An Asset Approach Preview • The basics of exchange rates • Exchange rates and the prices of goods • The foreign exchange markets • The demand of currency and other assets • A model of foreign exchange markets – role of interest rates on currency deposits – role of expectations of exchange rates Copyright ©2015 Pearson Education, Inc. All rights reserved. 14-2 Definitions of Exchange Rates • Exchange rates are quoted as foreign currency per unit of domestic currency or domestic currency per unit of foreign currency. – How much can be exchanged for one dollar? ¥97.385/$ – How much can be exchanged for one yen? $$0.01027/¥ • Exchange rates allow us to denominate the cost or price of a good or service in a common currency. – How much does a Nissan cost? ¥2,500,000 – Or, ¥2,500,000 x $0.01027/¥ = $25,672.50 Copyright ©2015 Pearson Education, Inc. All rights reserved. 14-3 Table 14-1: Exchange Rate Quotations Copyright ©2015 Pearson Education, Inc. All rights reserved. 14-4 USD GBP CAD EUR AUD 1 0.81392 1.32366 0.93756 1.32693 GBP 1.22863 1 1.62629 1.15191 1.63030 CAD 0.75548 0.61490 1 0.70831 1.00247 EUR 1.06660 0.86812 1.41182 1 1.41531 AUD 0.75362 0.61338 0.99754 0.70656 1 Copyright ©2015 Pearson Education, Inc. All rights reserved. 14-5 Depreciation and Appreciation • Depreciation is a decrease in the value of a currency relative to another currency. – A depreciated currency is less valuable (less expensive) and therefore can be exchanged for (can buy) a smaller amount of foreign currency. – $1/€ → $1.20/€ means that the dollar has depreciated relative to the euro. It now takes $1.20 to buy one euro, so that the dollar is less valuable. – The euro has appreciated relative to the dollar: it is now more valuable. Copyright ©2015 Pearson Education, Inc. All rights reserved. 14-6 Depreciation and Appreciation (cont.) • Appreciation is an increase in the value of a currency relative to another currency. – An appreciated currency is more valuable (more expensive) and therefore can be exchanged for (can buy) a larger amount of foreign currency. – $1/€ → $0.90/€ means that the dollar has appreciated relative to the euro. It now takes only $0.90 to buy one euro, so that the dollar is more valuable. – The euro has depreciated relative to the dollar: it is now less valuable. Copyright ©2015 Pearson Education, Inc. All rights reserved. 14-7 Depreciation and Appreciation (cont.) • A depreciated currency is less valuable, and therefore it can buy fewer foreign produced goods that are denominated in foreign currency. – A Nissan costs ¥2,500,000 x $0.01027/¥ = $25,672.50 – Less expensive than $27,962.50 at $0.011185/¥ • A depreciated currency means that imports are more expensive and domestically produced goods and exports are less expensive. • A depreciated currency lowers the price of exports relative to the price of imports. Copyright ©2015 Pearson Education, Inc. All rights reserved. 14-8 Depreciation and Appreciation (cont.) • An appreciated currency is more valuable, and therefore it can buy more foreign produced goods that are denominated in foreign currency. – A Nissan costs ¥2,500,000 = $27,962.50 at $0.011185/¥ – becomes less expensive $25,000 at $0.010/¥ • An appreciated currency means that imports are less expensive and domestically produced goods and exports are more expensive. • An appreciated currency raises the price of exports relative to the price of imports. Copyright ©2015 Pearson Education, Inc. All rights reserved. 14-9 Table 14-2: $/£ Exchange Rates and the Relative Price of American Designer Jeans and British Sweaters Copyright ©2015 Pearson Education, Inc. All rights reserved. 14-10