International parity conditions approach Covered vs uncovered interest arbitrage Covered interest arbitrage:the profit is known with certainty (covered against exchange rate risk). Uncovered interest arbitrage:the profit depends on the future exchange rate. Uncovered interest arbitrage is risky since the future exchange rate is unknown (the actual exchange rate may turn out to be different from the expected exchange rate)
International parity conditions approach Covered vs uncovered interest arbitrage Covered interest arbitrage: the profit is known with certainty (covered against exchange rate risk). Uncovered interest arbitrage: the profit depends on the future exchange rate. Uncovered interest arbitrage is risky since the future exchange rate is unknown (the actual exchange rate may turn out to be different from the expected exchange rate)
The balance of payments approach The second most utilized theoretical approach in exchange rate determination: The basic approach argues that the equilibrium exchange rate is found when currency flows match up vis a vis current and financial account activities. 留 This framework has wide appeal as BOP transaction data is readily available and widely reported. Critics may argue that this theory does not take into account stocks of money or financial assets
The balance of payments approach The second most utilized theoretical approach in exchange rate determination: The basic approach argues that the equilibrium exchange rate is found when currency flows match up vis a vis current and financial account activities. This framework has wide appeal as BOP transaction data is readily available and widely reported. Critics may argue that this theory does not take into account stocks of money or financial assets
The balance of payments approach Current Account Capital Account Financial Account NEO FXB A DE A+B+C Basic Balance A B+C+D=Overall Balance A+B+C+D+E=0
The balance of payments approach Current Account + Capital Account + Financial Account + NEO + FXB A B C D E A + B + C = Basic Balance A + B + C + D = Overall Balance A + B + C + D + E = 0
The balance of payments approach Demand for the home country's currency: Exports of goods and services. Selling assets Supply of the home country's currency: --Imports of goods and services --Buying assets
The balance of payments approach Demand for the home country’s currency: --Exports of goods and services. --Selling assets. Supply of the home country’s currency: --Imports of goods and services. --Buying assets
The balance of payments approach Floating exchange rate regimes: --Allow market forces to balance supply and demand for a currency. --The exchange rate is free to move to its equilibrium. Fixed exchange rate regimes: --The monetary authorities must react to imbalances and intervene in the FX market. --In case of a surplus demand of domestic currency, the monetary authorities sell domestic currency in the FX market. --In case of too low demand of domestic currency,the monetary authorities buy domestic currency in the FX market
The balance of payments approach Floating exchange rate regimes: --Allow market forces to balance supply and demand for a currency. --The exchange rate is free to move to its equilibrium. Fixed exchange rate regimes: --The monetary authorities must react to imbalances and intervene in the FX market. --In case of a surplus demand of domestic currency, the monetary authorities sell domestic currency in the FX market. --In case of too low demand of domestic currency, the monetary authorities buy domestic currency in the FX market