Tài chính doanh nghiệp - Chapter 16: Determinants of the foreign exchange value of a currency

Chapter 16Determinants of the Foreign Exchange Value of a CurrencyCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonLearning ObjectivesExplain how exchange rates are determinedDescribe the factors responsible for movements in the exchange rateCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation16.1 Introduction16.2 FX Market and the Equilibrium Exchange Rate16.3 Factors Influencing Exchange Rate Movements16.4 Sensitivity of the Exchange Rate to Changes in Economic Variables16.5 Purchasing Power Parity16.6 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.1 IntroductionThe structure and operations of the FX markets are considered in Chapter 15Attention is now focused on the factors that influence the value of a currency (in a floating exchange rate regime) in order to attempt to forecast future exchange rates with some reliability and accuracyCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.1 Introduction (cont.)A floating exchange rate regime is one in which the value of the currency is determined by demand and supply conditionsA pegged exchange rate regime is where a domestic currency is locked into a multiple of another currency such as the USD e.g. Hong Kong dollarCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation16.1 Introduction16.2 FX Market and the Equilibrium Exchange Rate16.3 Factors Influencing Exchange Rate Movements16.4 Sensitivity of the Exchange Rate to Changes in Economic Variables16.5 Purchasing Power Parity16.6 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.2 FX Market and the Equilibrium Exchange RateDemand for a currencyTo purchase Australian goods and services, foreigners must buy AUDDownward sloping demand curve occurs as the devaluation of AUD results in a greater demand by foreignersFor foreigners, a fall in the price of the AUD is equivalent to a reduction in the price of everything in AustraliaCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.2 FX Market and the Equilibrium Exchange Rate (cont.)Supply of a currencyUpward sloping supply curve occurs as the quantity of AUDs supplied to the FX market increases as the price of the AUD increasesAs the AUD appreciates, the price of foreign currency falls, making foreign goods cheaper for Australian residentsThe demand for foreign currency increases and, therefore, the supply of AUDCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.2 FX Market and the Equilibrium Exchange Rate (cont.)Equilibrium exchange rateThe equilibrium exchange rate is the rate at which the quantity of AUD supplied to the market is equal to the demand for AUDIt shows the unique rate at which both the demanders and suppliers of AUD will be satisfiedCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.2 FX Market and the Equilibrium Exchange Rate (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation16.1 Introduction16.2 FX Market and the Equilibrium Exchange Rate16.3 Factors Influencing Exchange Rate Movements16.4 Sensitivity of the Exchange Rate to Changes in Economic Variables16.5 Purchasing Power Parity16.6 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.3 Factors Influencing Exchange Rate MovementsRelative inflation ratesRelative national income growth ratesRelative interest ratesExchange rate expectationsGovernment or central bank interventionCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonRelative inflation ratesRelative inflation rates influence the price and, therefore, the demand for foreign goods by residentsThe change in demand for imported goods, in turn, affects the demand for foreign currency used to buy these goodsThis view of the determination of the value of a currency is called purchasing power parity (PPP) and is discussed in detail laterCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonRelative inflation rates (cont.)Example: increase in US rate of inflation relative to AustraliaEffect for Australian residentsUS imports more expensive, decreasing demand for these goods; therefore, reducing the supply of AUDEffect for foreign residentsSome US demand for goods and services, and assets will switch to Australian items, increasing demand for AUD to pay for these itemsNet effect is an appreciation of the AUDCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonRelative inflation rates (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonRelative national income growth ratesExample: Australian income growth rates rise relative to the USAAustralian demand for imports increases, increasing the supply of AUD, causing the AUD to depreciateA secondary effect could be an increase in foreign investment in Australia, increasing the demand for AUD, causing the AUD to recover some valueCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonRelative national income growth rates (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonRelative interest ratesExample: if Australian interest rates rise, relative to the USA Effect for US residentsUS residents and companies may redirect some of their cash into Australian interest bearing instruments, increasing the demand for the AUDCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonRelative interest rates (cont.)Effect for Australian residentsAustralian investors and businesses are more likely to keep their surplus funds invested in Australia, causing a decrease in the supply of the AUDNet effectAUD will appreciateCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonRelative interest rates (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonRelative interest rates (cont.)The role of interest rates on the exchange rate ignores expectations about the value of the currency during the investment periodTable 16.1 illustrates the interaction of interest rate differentials and expected changes in the exchange rate over the investment period on currency valueCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonRelative interest rates (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonRelative interest rates (cont.)From Table 16.1 the following impact on the value of the AUD would be evidentScenario 1: AUD would depreciateScenario 2: AUD would appreciateScenario 3: AUD would not changeScenario 4: AUD would appreciateCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonRelative interest rates (cont.)The analysis has ignored whether a change in nominal interest rates is due to a change in the real rate of return or a change in the inflation expectations premiumCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonRelative interest rates (cont.)Example: if nominal interest rates rise due to an increase in the inflation expectations premiumThe currency may not appreciate, and could depreciate due toThe effect of inflationary expectations (PPP theory)Businesses and individuals seeking to invest cash holdings in overseas’ securities to avoid a loss of valueCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonRelative interest rates (cont.)Example: if nominal interest rates rise due to an increase in the real rate of returnThe currency may appreciateDue to an inflow of funds from the rest of the worldCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonExchange rate expectationsRelatively little of the turnover in the FX market is associated with payments for imports and exports of goods and servicesMost turnover is motivated by changes in exchange rate expectationsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonExchange rate expectations (cont.)Exchange rate expectations are based on expectations about future changes inRelative inflationRelative income growthRelative interest ratesCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonExchange rate expectations (cont.)Example: AUD expected to depreciateEffect for Australian residentsSeek to buy foreign currency before AUD fallsIncreasing supply of AUD on FX marketsEffect for foreign residentsDefer purchases of AUD denominated itemsReduces demand for AUDNet effectAUD depreciates as expectedCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonExchange rate expectations (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonGovernment or central bank interventionPolicies by foreign and/or domestic governments may affect the relative rate of inflation, income growth or interest rates between countriesAlso, the market participants’ expectations that the government will alter it’s policy affecting these variables in the futureCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonGovernment or central bank intervention (cont.)A central bank may also influence the currency byIntervening in international trade flowsIntervening in foreign investment flowsDirectly intervening in the FX marketCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonGovernment or central bank intervention (cont.)International trade flowsIntervention aimed at increasing exports and/or reducing imports by the use ofSubsidies to exporters, making exports more competitiveThereby, increasing demand for Australian exports and increasing demand for AUDTariffs, quotas and embargoes on importsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonGovernment or central bank intervention (cont.)Foreign investment flowsGovernments alter the exchange rate by altering the flow of investment funds between countries byProhibitions on the outflow of funds from a countryImposing penalty taxes to residents who earn income offshoreCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonGovernment or central bank intervention (cont.)Direct FX market interventionInvolves purchases or sales of currencyTwo motivations for doing thisSmoothingRBA tries to remove volatility in the currency caused by speculatorsExchange rate targetingRBA tries to push the equilibrium exchange rate to some levelCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonGovernment or central bank intervention (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation16.1 Introduction16.2 FX Market and the Equilibrium Exchange Rate16.3 Factors Influencing Exchange Rate Movements16.4 Sensitivity of the Exchange Rate to Changes in Economic Variables16.5 Purchasing Power Parity16.6 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.4 Sensitivity of the Exchange Rate to Changes in Economic VariablesRegression analysis can be used to assess how changes in economic variables affect the exchange rateIt is a statistical technique that determines the relationship between a dependent variable (the exchange rate) and independent variables (relative growth, inflation and interest rates etc.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation16.1 Introduction16.2 FX Market and the Equilibrium Exchange Rate16.3 Factors Influencing Exchange Rate Movements16.4 Sensitivity of the Exchange Rate to Changes in Economic Variables16.5 Purchasing Power Parity16.6 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.5 Purchasing Power Parity (PPP)Purchasing power parity (PPP) suggest that exchange rates will adjust to ensure prices on the same goods are equal between countriesi.e. a currency should have equal purchasing power at home or in any foreign country once the currency is exchanged into foreign currency at the current rateCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.5 Purchasing Power Parity (PPP) (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.5 Purchasing Power Parity (PPP) (cont.)PPP provides reasonably accurate results over the long runPoor short-term performance is attributed to factors affecting the mechanism for adjustments in the demand for goods and services between countries with different rates of inflation, includingExistence of substitutesUnknown quality and reliability of new supplyDelivery time from overseasCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.5 Purchasing Power Parity (PPP) (cont.)(16.1)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.5 Purchasing Power Parity (PPP) (cont.)Assume that the home country experiences inflation of 10 per cent per annum, while the foreign country has inflation of 4 per cent per annum. If PPP is maintained, then:Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.5 Purchasing Power Parity (PPP) (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.5 Purchasing Power Parity (PPP) (cont.)That is, the home currency should depreciate by 5.46 per cent in response to the higher rate of inflation in the home country.Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation16.1 Introduction16.2 FX Market and the Equilibrium Exchange Rate16.3 Factors Influencing Exchange Rate Movements16.4 Sensitivity of the Exchange Rate to Changes in Economic Variables16.5 Purchasing Power Parity16.6 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson16.6 SummaryDemand and supply determine the value of a currency in a floating exchange rate regimeFactors that influence the demand and/or supply of a currency areRelative inflation rates (PPP)Relative national income growth ratesRelative interest ratesExchange rate expectationsCentral bank or government interventionCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson