SUBMITTED BY MOHD SADAF AHMED ELVY ALEX GEORGE SNEHAL KALE

The market where the commodity traded is

Currencies.
Price of each currency is determined in term of other

currencies

Exchange Rate is the price of one country's currency expressed in another country's currency. In other words, the rate at which one currency can be exchanged for another. e.g. Rs. 44.50 per one USD Major currencies of the World
USD EURO YEN POUND STERLING

 FX traded in over-the-counter market

1.

Most trades involve buying and selling bank deposits denominated in different currencies.
Trades in the foreign exchange market involve transactions in excess of $1 million. Typical consumers buy foreign currencies from retail dealers, such as American Express.

2.

3.

FX volume exceeds $3 trillion per day

 Exchange rates are determined in markets by the

interaction of supply and demand.

An important concept that drives the forces of supply

and demand is the Law of One Price.

 The Law of One Price states that the price of an

identical good will be the same throughout the world, regardless of which country produces it.

Example: American steel costs $100 per ton, while

Japanese steel costs 10,000 yen per ton.

If E = 50 yen/$ then price are:

American Steel In U.S. In Japan $100 5000 yen Japanese Steel $200 10,000 yen

If E = 100 yen/$ then price are:

American Steel In U.S. In Japan $100 10,000 yen Japanese Steel $100 10,000 yen

 The theory of PPP states that exchange rates between

two currencies will adjust to reflect changes in price levels.

PPP Domestic price level 10%, domestic currency

10% , exchange rate

 Basic Principle- If a factor increases demand for

domestic goods relative to foreign goods, the exchange rate

Four Factors: Relative price levels Tariffs and quotas Preferences for domestic v. foreign goods Productivity

 Relative price levels: A rise in relative price levels cause

a countrys currency to depreciate.

Tariffs and quotas: Increasing trade barriers causes a

countrys currency to appreciate

 Preferences for domestic v. foreign goods: Increased

demand for a countrys good causes its currency to appreciate;

Increased demand for imports causes the domestic

currency to depreciate.
Productivity: If a country is more productive relative to

another, its currency appreciates.

FACTORS

CHANGE IN FACTORS

RESPONSE OF EXCHANGE RATE

DOMESTIC PRICE LEVEL TRADE BARRIERS

IMPORT DEMAND EXPORT DEMAND PRODUCTIVITY

1. Demand curve shifts left

2. This causes domestic currency to appreciate.

1. Demand curve shifts right

2. This causes domestic currency to depreciate.

 Two commonly used models for exchange rates

forecasting are :
Fundamental Approach

Technical Approach

 It forecasts exchange rates after considering the factors

that give rise to long term cycles.

Elementary data related to a country, such as GDP,

inflation rates, productivity indices, balance of trade and unemployment rate, are taken into account.
This approach is based on the premise that the true

worth of a currency will eventually be realized. Hence, this approach is suitable for long term investments

 This approach is based on the premise that it is

investor sentiment that determines changes in the exchange rate and makes predictions by charting out patterns.
Other tools used in this approach are positioning

surveys, moving-average trend-following trading rules and FX dealer customer-flow data.

Fund managers use these patterns to take informed

decisions for short term investments

 Purchasing Power Parity (PPP) Model

Uncovered Interest Rate Parity Model Random Walk Model

 This

method involves studying exchange rate movements based on the price level changes in each country.

 This model forecasts exchange rate movements in

accordance with returns from investment in the two currencies.

The UIP creates an arbitrage mechanism that sets an

exchange rate which equalizes returns from domestic and foreign assets.

 This approach assumes that all available information

on exchange rate movements in the future is reflected in the current exchange rate.
Also, any future event leading to a change in exchange

rates is purely random from todays perspective.

Thus, the best possible forecast of a currencys value is

its value today. This is the simplest approach for exchange rate forecasting

THANK YOU