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CFA Level II Economics

Currency Exchange Rates: Determination and Forecasting- Curriculum Examples

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Graphs, charts, tables, examples, and figures are copyright 2012, CFA Institute. Reproduced
and republished with permission from CFA Institute. All rights reserved.
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Example 1: Bid-offer Rates

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Example 2: Calculating the Forward Premium (Discount)

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Example 3: Forward Rates and the Mark-to-Market of


Forward Positions

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Example 4: Covered and Uncovered Interest Parity; Predictors of


Future Spot Rates

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More on PPP
Relative version of PPP: actual changes in exchange rates are driven by
actual differences in national inflation rates in a given time period.

Ex ante version of PPP: expected changes in exchange rates are driven by


expected differences in national inflation rates in a given time period.
Based on empirical evidence, PPP appears to be a valid framework to assess
long-run fair value in the FX markets, even though the path to PPP
equilibrium is excruciatingly slow.
Real exchange rate

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Example 5: PPP, Real Exchange Rates, and the International


Fisher Effect
AUD is the base currency

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Example 6: The Relations among the International Parity


Conditions

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Example 7: Long-Run Equilibrium Exchange Rates

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Example 8: Carry Trade

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Example 11: Capital Flows and Exchange Rates

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Example 12: Monetary Policy and Exchange Rates


Monique Kwan, the currency strategist at a major foreign exchange dealer, is preparing a report on the
outlook for several currencies that she follows. She begins by considering the outlook for the currency of a
developed market (DM) country. This DM country has high capital mobility across its borders and a flexible
exchange rate. It also has low levels of public and private debt. Given these conditions, Kwan tries to assess
the impact of each of the following policy changes using the MundellFleming model and the Taylor Rule.

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Expansionary
Monetary Policy

Restrictive
Monetary Policy

Expansionary
Fiscal Policy

Restrictive
Fiscal Policy

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C is correct because (1) capital mobility is low so the


induced increase in interest rates is likely to exert
only weak upward pressure on the currency, (2) the
combined impact on aggregate demand is
ambiguous, and (3) if aggregate demand increases,
the downward pressure on the currency due to a
worsening trade balance may or may not fully offset
the upward pressure exerted by capital flows.

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Example 13: Fiscal Policy and Exchange Rates


Monique Kwan is continuing her analysis of the foreign exchange rate outlook for selected countries. She
examines a DM country that has a high degree of capital mobility and a floating-rate currency regime. Kwan
notices that although the current outstanding stock of government debt is low, as a percentage of GDP, it is
rising sharply as a result of expansionary fiscal policy. Moreover, projections for the government debt-to-GDP
ratio point to further increases well into the future. Kwan uses the MundellFleming and portfolio balance
models to form an opinion about both the short-run and long-run implications for the DM countrys exchange
rate.

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Example 14: Exchange Rate Management: Intervention and


Controls

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Example 15: Currency Crises

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Example 16: Technical Analysis and Flow, Sentiment, and


Positioning Indicators

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THE END

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