International Corporate Finance Foreign Exchange Rate Determination Xin Chen Visiting Associate Professor Aarhus School of Business
1 International Corporate Finance Foreign Exchange Rate Determination Xin Chen Visiting Associate Professor Aarhus School of Business
Foreign Exchange Rate Determination Three major approaches to exchange rate determination: --International parity conditions. --Balance of payments. --Asset market approach. These are not competing theories but rather complementary theories
Foreign Exchange Rate Determination Three major approaches to exchange rate determination: --International parity conditions. --Balance of payments. --Asset market approach. These are not competing theories but rather complementary theories
Foreign Exchange Rate Determination the complexities of international political economy; societal and economic infrastructures;and, random political,economic,or social events affect the exchange rate markets
Foreign Exchange Rate Determination the complexities of international political economy; societal and economic infrastructures; and, random political, economic, or social events affect the exchange rate markets
Exhibit 7.1 The Determinants of Foreign Exchange Rates Parity Conditions 1.Relative inflation rates 2.Relative interest rates 3.Forward exchange rates 4.Interest rate parity Is there a well-developed Is there a sound and secure and liquid money and capital Spot banking system in place to market in that currency? Exchange support currency trading Rate activities? Asset Market Balance of Payments 1.Relative real interest rates 1.Current account balances 2.Prospects for economic growth 2.Portfolio investment 3.Supply and demand for assets 3.Foreign direct investment 4.Outlook for political stability 4.Exchange rate regimes 5.Speculation and liquidity 5.Official monetary reserves 6.Political risks and controls
Exhibit 7.1 The Determinants of Foreign Exchange Rates
International parity conditions approach The most widely accepted theory of all exchange rate determination theories. If all the international parity conditions are satisfied,then the expected change in the spot rate equals: The expected difference in inflation rates The difference in interest rates. The forward premium or discount
International parity conditions approach The most widely accepted theory of all exchange rate determination theories. If all the international parity conditions are satisfied, then the expected change in the spot rate equals: The expected difference in inflation rates. The difference in interest rates. The forward premium or discount