Foreign Exchange

Exchange rate The price of one currency in

terms of another currency

Exchange Rates

Exchange rates are expressed as the number of units of one type of currency needed to buy one unit of another currency

It used to take 8 francs to buy $1, so the exchange rate was 8f/$

Determinants of Exchange Rates

1. Investment 2. Payment for Imports and

Exports 3. Travel 4. Speculation

Brief History of Foreign Exchange By the 1880’s most

currencies were backed by gold. This gold standard set a price for gold in all currencies.

This meant that the money supply had to be equal to the gold supply

End of the Gold Standard

World War One ended the gold standard in many countries.

No one wants to trade gold in a national crisis.

England suspended the conversion of the pound into gold in 1933, and the price of gold went from $20.67 per ounce in 1900 to $35 in the US.

Bretton Woods

The Bretton Woods Agreement set the price of each currency in gold.

The International Monetary Fund (IMF) was created to help nations with emergency loans of currency.

The End of the US Gold Standard IN the 1960’s as trade increased,

currency grew faster than gold. 1971, Nixon ended dollar to gold

conversion, canceling the Bretton Woods Agreement.

Gold became just another commodity, and the price of gold rose to over $300 per ounce

Currency Float

Since 1973, currencies have been traded in an International Currency Market

Sometimes governments will intervene in the market, buying or selling currencies to avoid a financial crisis.

Exchange rates

Now Exchange rates are determined by supply and demand

Changes in price

Let’s say that the Japanese Yen is trading for 120Y/$.

Put another way it takes 120 Y to buy $1

If the Yen price of the dollar changes, we say the yen either appreciates or depreciates.

Appreciation

If the yen price of dollar increases, from 120Y/$ to 130Y/$, then the dollar has appreciated. The dollar “buys more yen.”

Depreciation

If the yen price of dollar goes from 120Y/$ to 110Y/$, then the dollar has depreciated, as the dollar now buys fewer yen.

Appreciate/Depreciate

Of course if the dollar appreciates, the yen depreciates.

If the dollar depreciates the yen appreciates.

Determining prices of goods

If we know the dollar price of a good, we can use the exchange rate to calculate the price of the good in another currency.

The equation we use:Dollar Price X exchange rate = foreign price

Use the foreign currency price of the dollar rate

An example

A Ford Ranger costs $10,000 in the US. How much does the truck cost in Canada if the exchange rate is 1.50Can/$ ?

$10,000 x 1.50CD/$ = 15,000 Canadian dollars

Who wants to be a Millionaire?

How many US $ would you need to be a millionaire in the following countries?

Japan 120 yen / $ Chile 688 peso / $ South Korea 1203 won / $ Venezuela 1401 bolivar / $