FOREIGN EXCHANGE MARKET

LEARNING OUTCOMES
• Define the following terms:
– Foreign exchange market
– Exchange rate
– Foreign exchange market
• Distinguish between currency depreciation and
appreciation
• State the determinants of foreign exchange rate
• Differentiate between direct quote and in direct
quote.
• Calculate the cross rate
• Discuss the types of exchange rates policies
Foreign Exchange Market
• A foreign exchange market is a
market in which foreign currencies
are exchanged and relative currency
prices are established.
• Buyers and sellers interacting in
international markets will exchange
currencies through the foreign
exchange market.
LO: 12-3

12-3
• An exchange rate is the rate at
which one currency trades for
another.
• In the market for foreign currency,
the intersection of the demand for
foreign currency and the supply of
foreign currency determine the
exchange rate.
 Market for Foreign Currency
(Pounds)
P
Sl Depreciation is a
Exchange decrease in the value
Dollar Price of 1 Pound

$3
Rate: $2 = £1 of a currency relative
Dollar to another currency.
Depreciates
(Pound
Appreciates)

$2 Appreciation is an
Dollar
Appreciates
(Pound
increase in the value
Depreciates) of a currency relative
$1 to another currency.

Dl
0 Ql Q
LO: 12-3 Quantity of Pounds

12-5
 Determinants of Exchange
Rates
• Factors that cause a country’s currency to
appreciate or depreciate are:
– Tastes
– Relative Income
– Relative Price Levels
– Relative Interest Rates
– Speculation

LO: 12-3

12-6
 Money of a country is its symbol and
identity
 USA= dollar ($)
 Germany= Deutschmark (DM)
 Great Britain= British Pound (α)
 Japan= Yen (Y)
 European Union= Euro (€)
• Price of one currency expressed in terms
of another currency
• Direct quote= local /foreign
• Indirect quote= 1/ direct quote
• Ask rate= selling rate by banks
• Bid rate= buying rate by banks
• Cross rate= computation of exchange
rate for a currency from the exchange rate
of two other currencies
 Examples
• $1.608/ £
• €0.6936 /$
• What is the rate for €/£?
TYPES OF EXCHANGE
RATES
• Determined by market forces of demand
and supply
>> FLOATING RATE
• Unless interfered by BSP
>> PEGGED (FIXED)
• INCREASE IN EXCHANGE RATE $ TO
PHP
–DOLLAR APPRECIATED
–PESO DEPRECIATED ( ALSO CALLED
DEVALUATION)
• OVER VALUED BSP RATE < MARKET
RATE
• UNDERVALUED BSP RATE > MARKET
RATE
• PEGGED EXCHANGE RATE
– BSP buys and sells dollars to maintain a certain
exchange rate

• Free- floating or flexible exchange rate

– Price or exchange rate is determined by market forces
of demand and supply

• Managed floating exchange rate

– BSP interferes during disorderly or erratic fluctuations
of exchange rates
• CLEAN FLOAT= interferences only due
to erratic rates

• DIRTY FLOAT=Interference to achieve

objectives other than erratic rates
• FOREIGN EXCHANGE TRADING
CENTER
• BLACK MARKET
• External economic • Internal economic
disturbance disturbance
• Big exports • Open economy ( big
Imports)
• Product diversification
• Similar rate of
inflation with trading
partner
• High reserves
• Inelastic demand or
PEGGED
supply
FLOATING
• Business uncertainties
• Fluctuations in commodity prices
• Cost push inflation
• Increase in foreign debt
• Decline in investments
• Dollar exchange control
• Selective imports
• Tight credit policy
• Sound fiscal policies ( expenditures, taxes
, balanced budget
• Fixed exchange rate ( no speculations)
1. $ exchange rate from PhP 50 to PhP 47
means Peso has appreciated. True or
false. Explain your answer.
2. If the market value of the peso to the
dollar is PhP47 but the BSP pegged the
exchange rate at PhP 43 means the
peso is over valued. True or false.
Explain your answer.