Finance
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- Date Submitted: 10/23/2011 05:19 PM
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WEEK 4&5
Factors That Influence Exchange Rates
The equilibrium exchange rate will change over time as supply and demand schedules change. The factors that cause currency supply and demand schedules to change are discussed here by relating each factor’s influence to the demand and supply schedules graphically displayed in Exhibit 4.4. The following equation summarizes the factors that can influence a currency’s spot rate:
Relative Inflation Rates
Changes in relative inflation rates can affect international trade activity, which influences the demand for and supply of currencies and therefore influences exchange rates.
In reality, the actual demand and supply schedules, and therefore the true equilibrium exchange rate, will reflect several factors simultaneously. The point of the preceding example is to demonstrate how to logically work through the mechanics of the effect that higher inflation in a country can have on an exchange rate. Each factor is assessed one at a time to determine its separate influence on exchange rates, holding all other factors constant. Then, all factors can be tied together to fully explain why an exchange rate moves the way it does.
Relative Interest Rates
Changes in relative interest rates affect investment in foreign securities, which influences the demand for and supply of currencies and therefore influences exchange rates.
In the 1999– 2000 period, European interest rates were relatively low compared to U. S. interest rates. This interest rate differential encouraged European investors to invest money in dollar- denominated debt securities. This activity resulted in a large supply of euros in the foreign exchange market and put downward pressure on the euro. In the 2002– 2003 period, U. S. interest rates were lower than European interest rates. Consequently, there was a large U. S. demand for euros to capitalize on the higher interest rates, which placed upward pressure on the euro....
Factors That Influence Exchange Rates
The equilibrium exchange rate will change over time as supply and demand schedules change. The factors that cause currency supply and demand schedules to change are discussed here by relating each factor’s influence to the demand and supply schedules graphically displayed in Exhibit 4.4. The following equation summarizes the factors that can influence a currency’s spot rate:
Relative Inflation Rates
Changes in relative inflation rates can affect international trade activity, which influences the demand for and supply of currencies and therefore influences exchange rates.
In reality, the actual demand and supply schedules, and therefore the true equilibrium exchange rate, will reflect several factors simultaneously. The point of the preceding example is to demonstrate how to logically work through the mechanics of the effect that higher inflation in a country can have on an exchange rate. Each factor is assessed one at a time to determine its separate influence on exchange rates, holding all other factors constant. Then, all factors can be tied together to fully explain why an exchange rate moves the way it does.
Relative Interest Rates
Changes in relative interest rates affect investment in foreign securities, which influences the demand for and supply of currencies and therefore influences exchange rates.
In the 1999– 2000 period, European interest rates were relatively low compared to U. S. interest rates. This interest rate differential encouraged European investors to invest money in dollar- denominated debt securities. This activity resulted in a large supply of euros in the foreign exchange market and put downward pressure on the euro. In the 2002– 2003 period, U. S. interest rates were lower than European interest rates. Consequently, there was a large U. S. demand for euros to capitalize on the higher interest rates, which placed upward pressure on the euro....