Download - Foreign Exchange and Currencies
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Foreign Exchange and Currencies
Economics 71aSpring 2007
Mayo, Chapter 6 (skim)Lecture notes 2.6
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International Money Flows
Funds flow between countriesTwo basic reasons
Trade flows Investment (capital) flows
Central banks also intervene in these markets
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The Demand and Supply of Foreign Currency
Example: U.S. ($) and France (euros) U.S. consumer buys French wine
+ demand for euros U.S. firm sells ipod to French consumer
+supply for euros U.S. investor buys French stock
+demand for euros U.S. firm sells stock to French investor
+supply for euros
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Supply and Demand for Euros
P = $/euro
Q = euros
D
S
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The Demand and Supply of Foreign Currency
Example: U.S. ($) and France (euros) U.S. consumer buys French wine
+ demand for euros ($/euro rises) U.S. firm sells ipod to French consumer
+supply for euros ($/euro falls) U.S. investor buys French stock
+demand for euros ($/euro rises) U.S. firm sells stock to French investor
+supply for euros ($/euro falls)
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$/euro = exchange rate
Amount of $’s required to purchase 1 euro When this rises
$ price of euro goods rises (imports more expensive)
US consumers of imports worse off Euro price of $ goods falls (U.S. exports cheaper)
US firms exporting better off
And investors feel $ price of euro investments (stocks) rises
US investors holding foreign assets better off Euro price of $ investments (stocks) falls
Foreign investors holding US assets worse off
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More Supply/Demand
In the end it is the aggregate of all of these that matters
One other key player: Central bank
Some central banks actively intervene to move (or fix) the exchange rate
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Foreign Exchange Markets
Huge marketsOpen 24 hoursMoving both trade and investment flows
Important to international investors
As exchange rates move, values of investments change
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Balance of Payments(Measured over fixed period)
Exports - Imports = Trade account >0 Trade surplus <0 Trade deficit
Net new foreign investments = Capital account
<0 net investment flows out of country >0 net investment flows into country
Trade account + net investment income + Capital account = 0
Investment income relatively small
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U.S. Balance of Payments
Large trade deficitRelatively small income flowsLarge capital inflows
Borrowing from rest of world Trading IOU’s for goods