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 / $