国际金融学课件：Lecture 6 The Foreign Exchange Rate Determinants

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TheForeignExchangeRateDeterminants(Chapter6)EssentialReadingsP139-140P148-1571Valueof£Quantityof£D:Demandfor£$1.55$1.50$1.60S:Supplyof£equilibriumexchangerateEquilibriumExchangeRateAnexchangeraterepresentsthepriceofacurrency,whichisdeterminedbythedemandforthatcurrencyrelativetothesupplyforthatcurrency.MainContentsPurchasingPowerParityInterestRateParityTheInternationalFisherEffects3PurchasingPowerParityThetheoryofpurchasingpowerparity(PPP)isbasedontheThelawofoneprice.Thelawofonepricestatesthatonebasketofgoodsshouldcostthesameregardlessofthecurrencyinwhichitissold.4PurchasingPowerParityAbsolutePurchasingPowerParityRelativePurchasingPowerParity5PurchasingPowerParityAbsolutePurchasingPowerParitystatesthattheexchangeratebetweentwocurrenciesshouldequaltheratioofthecountries’pricelevels.

S($/£)=P$P£E.g.Thestandardbasketofgoodscosts$225intheUS,and£150intheUK,theexchangeratebetween$and£is:S=$225/£150=$1.5/£6PurchasingPowerParityRelativePurchasingPowerParitystatesthattherateofchangeinanexchangerateisequaltothedifferencesintheratesofinflation. e=$-£Alternatively,supposethebaseyearpriceindexisidenticalbetweentwocountries,theequilibriumexchangerateatt:

St=S0(Pht/Pft)IfU.S.inflationis5%andU.K.inflationis8%,thepoundshoulddepreciateby3%.7PurchasingPowerParitySupposethattherateofsterlingandUSDatthebeginningoftheyearisatUSD1.50/£OvertheyeartheinflationrateintheUKis15%,thesamebasketcosts£11,500attheendoftheyear.USpricesroseby3%andtheUSdomesticcostofabasketwillbeUSD15,450.8PurchasingPowerParityIftheexchangerateremainsat$1.50/£:AUKconsumerhastwochoices:tobuy£11,500ofUKproducedgoodsorexchange£11,500intodollarsandbuyUSgoods.£11,500willbuy$17,250at$1.50/£,morethanonebasket.Astheinflationratedifferenceis15%-3%=12%$/£1

=$/

£0x(1-12%)=1.5x0.88=1.32

9PurchasingPowerParityTheUSdollarappreciatesagainststerlingbyabout12%.AbasketofgoodscostingUSD15,450intheUSAhasasterlingcostof15,450/1.32=£11,500andthusPPPmaintained.10TestOnPPPIfbigMacrepresentsalltradedgoodsandservicesthenthePPPshouldholdtrueifusingPPPtotest.TheeconomistshaveusedBigMactotest.Overvalueandundervalueagainstdollarsarefound.11TestonPPPTheHamburgerStandard

BigMacPrices

impliedPPP

Actualrate

ValuedifferenceUSA$2.54ChinaRMB9.90$3.908.28-53%BritainGBP1.99$1.281.4312%HongkongHK$10.70$4.217.80-46%CanadaC$3.33$1.311.56-16%12DoesPPPholdTrue?PPPholdsbetterinthefollowingcircumstances:LongrunratherthanshortrunGeographicallyclosecountriesWhenthecountryhasaveryhighinflationrate-PPPbecomesdominant.Fortradedgoodsratherthannon-tradedgoods(inflationindexbasedontradedgoodsonly)13DoesPPPholdtrue?Longrun-Yes.Shortrun-rarelyWhydoesn'titworkallthetime?Itonlyappliestogoodsfreelytradedinternationally(therearenon-tradedgoods,transportationfee,andtradebarriers).SpeculationGovernment’smanageexchangerate.ManyotherfactorslikeFDI,portfolioinvestment.14WhyisPPPstillwidelyused？OnecanusePPPdeterminedexchangerateasabenchmarkinjudgingwhetheracountry’scurrencyisundervaluedorovervalued.OnecanusePPPdeterminedexchangerateingettingmoremeaningfulinternationalcomparisonofeconomicdata.15InterestRateParityIRPisa“no

arbitrage”condition.IfIRPdidnothold,thenitwouldbepossibleforanastutetradertomakeunlimitedamountsofmoneybyexploitingthearbitrageopportunity.Sincewedon’ttypicallyobservepersistentarbitrageconditions,wecansafelyassumethatIRPholds.Almostallthetime!16InterestRateParityTheIRPholdsthattheequilibriumexchangeratereacheswhentheexpectedreturnoftwocurrenciesareequalintermsofthesamecurrency.17InterestRateParityIRPholdsthatdifferencesinnominalinterestratesbetweencurrenciesdeterminethepremiumordiscountoncurrenciesintheforwardexchangerates.

18InterestRateParityTheformulawhichlinkstogetherthespot,forwardandinterestratedifferencesis:19InterestRateParityDefinedSupposeyouhave$100,000toinvestforoneyear.YoucaneitherinvestintheU.S.ati$.Futurevalue=$100,000(1+

ius)tradeyourdollarsforyenatthespotrate,investinJapanati¥andhedgeyourexchangerateriskbysellingthefuturevalueoftheJapaneseinvestmentforward.Thefuturevalue=$100,000(F/S)(1+i¥) Sincebothoftheseinvestmentshavethesamerisk,theymusthavethesamefuturevalue—otherwiseanarbitragewouldexist.(F/S)(1+i¥)=(1+

ius)20InterestRateParityDefinedFormally, (F/S)(1+i¥)=(1+

ius)orifyouprefer,IRPissometimesapproximatedas21InterestRateParityDefinedInotherwords,IRPholdswhenthedifferencesbetweenspotandforwardexchangerateisequaltothedifferencesininterestratesbetweenthetwocountrieswhoseforwardratesarequoted,butintheoppositesign.22InterestRateParityIfthefollowinginterestratesareassumed:C$=15%,£=10%,andspotrateis1£=C$2.20,Whatwillthe12monthforwardratebe?

0.15-0.10=(F-2.20)/2.20Forward1£=C$2.31

23InterestRateParityDoestheinterestrateparitytheoryholdinpractice?Generallyyes.Ithasbeenempiricallytestedandprovedbysomeresearch.24ReasonsforDeviationsfromIRPTransactionsCostsTheinterestrateavailabletoanarbitrageurforborrowing,ib,mayexceedtheratehecanlendat,il.Theremaybebid-askspreadstoovercome,Fb/Sa<F/S

Thus(Fb/Sa)(1+i¥l)(1+i¥b)0CapitalControlsGovernmentssometimesrestrictimportandexportofmoneythroughtaxesoroutrightbans.25TheFisherEffectsAnincrease(decrease)intheexpectedrateofinflationwillcauseaproportionateincrease(decrease)intheinterestrateinthecountry.FortheU.S.,theFishereffectiswrittenas:i$=$+E($)Where

$isthe“real”U.S.interestrate E($)istherateofU.S.inflation i$isthenominalUSinterestrate.26TheFisherEffectsSupposetheexpectedrealinterestrateis2%peryearintheUS.Andtheexpectedinflationrateis4%peryear,thenominalinterestratewillbesetas6%.27InternationalFisherEffectIftheFishereffectholdsintheU.S.i$=$+E($)andtheFishereffectholdsinJapan,i¥=¥+E(¥)andiftherealratesarethesameineachcountry$=¥thenwegettheInternationalFisherEffectE(e)=i$-i¥.28InternationalFisherEffectInconclusion,InternationalFisherEffectmeansthespotrateofexchangeshouldchangeanamountequalto,butintheoppositedirectionofthedifferenceininterestratesbetweenthetwocountries.29InternationalFisherEffectIf theInternationalFisherEffectholds,E(e)=i$-i¥

andifIRPalsoholdsthenforwardparityholds.30ForwardParityInconclusion,forwardrateisunbiasedpredicatorofthefuturespotrate.31ForwardParityIftheforeignexchangemarketquotesa5%premiumonaforeigncurrency,thefutureexchangespotrateforthatmaturityshouldappreciateby5%betweennowandthematuritydate.Onthecontrary,itindicates5%depreciate.32EquilibriumExchangeRateRelationships$-£IRPPPPFEFRPPPIFEFP33GovernmentControlsGovernmentsmayinfluencetheequilibriumexchangerateby:imposingforeignexchangebarriers,imposingforeigntradebarriers,interveningintheforeignexchangemarket,andaffectingmacrovariablessuchasinflation,interestrates,andincomelevels.FactorsthatInfluence

ExchangeRates$/£Quantityof£S0D0r0

U.S.incomelevelU.S.demandforBritishgoods,andhence£.D1r1OtherFactorsthatInfluence

ExchangeRatesRelativeIncomeLevelsNoexpectedchangeforthesupplyof£.,S135ExpectationsForeignexchangemarketsreacttoanynewsthatmayhaveafutureeffect.Forexample,newsofpotentialincreaseinUSinflationmaycausetraderstoselldollars,anticipatingafuturedeclineinthedollar’svalue.Thiswouldplacesimmediatedownwardpressureonthedollars.OtherfactorsthatInfluence

ExchangeRates:ExpectationOtherfactorsthatinfluenceexchangerate:ExpectationBecauseofspeculativetransactions,foreignexchangecanbeveryvolatile.37InteractionofFactorsTrade-relatedfactorsandfinancialfactorssometimesinteract.Exchangeratemovementsmaybesimultaneouslyaffectedbythesefactors.Forexample,anincreaseinthelevelofincomesometimescausesexpectationsofhigherinterestrates.FactorsthatInfluence

ExchangeRates38InteractionofFactorsFactorsthatInfluence

ExchangeRatesThesensitivityoftheexchangeratetothesefactorsisdependentonthevolumeofinternationaltransactionsbetweenthetwocountries.Overaparticularperiod,differentfactorsmayplaceopposingpressuresonthevalueofaforeigncurrency.39PerformanceoftheForecastersForecastingisdifficult,especiallywithregardtothefuture.Asawhole,forecasterscannotdoabetterjobofforecastingfutureexchangeratesthantheforwardrate.ThefounderofForbesMagazineoncesaid: “Youcanmakemoremoneysellingadvicethanfollowingit.”40ExercisesWhileyouwerevisitingLondon,youpurchasedaJaguarfor£35,000,payableinthreemonths.YouhaveenoughcashatyourbankinNewYorkCity,whichpays0.35%interestpermonth,compoundingmonthly,topayforthecar.Currently,thespotexchangerateis$1.45/£andthethree-monthforwardexchangerateis$1.40/£.InLondon,themoneymarketinterestrateis2.0%forathree-monthinvestment.TherearetwoalternativewaysofpayingforyourJaguar.(a)KeepthefundsatyourbankintheU.S.andbuy£35,000forward.(b)BuyacertainpoundamountspottodayandinvesttheamountintheU.K.forthreemonthssothatthematurityvaluebecomesequalto£35,000.Evaluateeachpaymentmethod.Whichmethodwouldyouprefer?Why?41ExercisesCurrently,thespotexchangerateis$1.50/£andthethree-monthforwardex