• These terms relate to the market process and are different from devaluation and revaluation (Chapter 3).
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Appreciating and Depreciating Currencies
• We use the percentage change formula to calculate the amount of appreciation or depreciation. • Example, suppose on Monday the Mexican peso traded at 11.3855 MXN/USD, whereas on Tuesday it traded at 11.1245 MXN/USD. • The peso has appreciated, as it now takes fewer pesos to purchase each dollar. • The amount of appreciation is: [(11.1245 – 11.3855)/11.3855] •100 = -2.29%
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Appreciating and Depreciating Currencies
• A currency that has lost value relative to another currency is said to have depreciated. • A currency that has gained value relative to another currency is said to have appreciated.
• Approximately $US1.4 - 1.6 trillion daily in global transactions.
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A Foreign Exchange Transaction
• Toshiba receives a dollar denominated payment from Best Buy, which they present to Fuji Bank. • To exchange the dollar payment for the yen equivalent, Fuji Bank may contact another bank, such as Citigroup, or contact a FX broker.
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Bid - Ask Spreads
• The bid is the price the bank is willing to pay for the currency, e.g., 1.2148 $/€ is the bid on the euro in terms of the dollar. • The ask is what the bank is willing to sell the currency for, e.g. 1.2158 $/€, is the ask on the euro in terms of the dollar. • The typical rate quoted in a daily publication is the midpoint of these two values, e.g., 1.2153.
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Currency Trading Tables
• Typical FX tables in a daily business publication provide spot and forward rates. • US $ equivalent or US $ per currency is the dollar price of a unit of foreign currency (eg., $/€).
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Cross-Rates: Unobserved Rates
• A cross-rate is an unobserved rate that is calculated from two observed rates. • For example, the spot rate for the Canadian dollar is 1.3176 C$/$, and the spot rate on the euro is 1.2153 $/€. What is the Canadian dollar price of the euro (C$/€)? • Note that (C$/$)· ($/€) = C$/€. • In this example, (1.3176)· (1.2153) = 1.6013 C$/€.
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Bid - Ask Spread and Margin
• The bid - ask spread of a currency reflects, in general, the cost of transacting in that currency. • It is calculated as the difference between the ask and the bid. • For example, 1.2158 – 1.2148 = 0.001. • The bid - ask spread can be converted into a percent to compare the cost of transacting among a number of currencies. • The margin is calculated as the spread as a percent of the ask. (Ask - Bid)/Ask * 100 • Example, (1.2158 – 1.2148)/1.2158 * 100 = 0.082%.
• Primarily an interbank market, which is the trading of foreigncurrency-denominated deposits between large banks.
– Global banks account for about two-thirds of the market volume, while foreign exchange brokers and dealers account for approximately 20 percent.
• A real exchange rate is an index. Hence, we compare its value for one period relative to its value in another period, or the change in the index from one period to another. 13
• Currency per US $ is the foreign currency price of one US dollar (eg., €/$).
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Some Additional Terminology: Direct - Indirect Quot home currency price of a foreign currency. • Indirect quote is the foreign currency price of the home currency.
The Foreign Exchange Market
• Exchange Rate
– The value of one currency relative to another currency as the number of units of one currency required to purchase one unit of the other currency.
Real Exchange Rates
• A nominal exchange rate indicates the rate of exchange between one nation‘s currency with the currency of another nation.
• Real exchange rates indicate the purchasing power of a nation‘s residents for foreign goods and services relative to their purchasing power for domestic goods and services.
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Spot Market Characteristics
• It is the oldest and largest financial market in the world:
– Has no central trading floor where buyers and sellers meet. – Is open twenty-four hours a day, except for short gaps on weekends. – The spot market is a market for immediate delivery (2 to 3 days).
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Real Exchange Rates
Real Measures
• Nominal variables, such as an exchange rate, do not consider changes in prices over time.
• Real variables, on the other hand, compensate for price changes. • A real exchange rate, therefore, accounts for relative price changes, or in other words, for differences in inflation between the two nations. 12