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Session 17 Revised

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30 views7 pages

Session 17 Revised

Uploaded by

Vishnu Venugopal
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Exchange Rates

Exchange Rates
 Nominal Exchange Rate: = $/Re or = Re/$ (we will follow the
convention of 1$=50INR, say, that is, Re per $)

 Nominal Appreciation and Depreciation: In our example, if


goes up, the amount of INR needed to buy 1$ goes up
depreciation of Re. Reverse appreciation.
Note that appreciation of $ wrt Re depreciation of Re wrt $.

 Real Exchange Rate: Q = P*/P, P* in $ and P in Re.


1 US commodity basket Q Indian commodity basket. Q goes
up consumers of both countries switch to Indian basket as US
goods become more expensive (Substitution Effect). If P*/P is
constant dQ = d .
n
 Nominal Effective Exchange Rate: NEER = s
i 1 i i
Sunandan Ghosh, CDS, 2013 2
Exchange Rates (Contd.)
 NEER is an weighted average of ‘n’ numbers of nominal exchange
rates .

 The weights si can be chosen in different ways –

Mi Xi Xi Mi
si si si
M X X M

 ‘m’ country NEER m < n where there are (n+1) country world
with n trading partners and 1 Home country.

Sunandan Ghosh, CDS, 2013 3


Exchange Rates (Contd.)
 Spot Exchange Rate: Transactions done on-the-spot.
Consistency Condition: $,Re . Re,$ 1
Arbitrage ensures consistency condition.
Different time zones, transaction costs etc violates this.
Three point/Triangular Arbitrage.

 Forward Exchange Rate: Pre-committed rate for future (pre-


specified like 30, 60, 180 days or year) transaction.
Value Date: The specified date on which transaction will occur.
Sold Re Forward/Bought Re Forward.

 Financial Derivatives: Swap, Futures, Options (Put, Call) – we


will do later.
Sunandan Ghosh, CDS, 2013 4
Exchange Rate Regimes
 Flexible or Floating: Market determined. Examples: $, €, £, ¥
etc.
Clean (Dirty) Float: Accepted (not accepted) all over the world.

 Fixed or Pegged: Exchange rate is fixed by the national


government. Crawling band, crawling peg (mostly 1% of central
rate). Biggest example is CHINA.

 Managed or Mixed Float: Managed within a band by the CB.


Examples: India, Argentina etc.

 Devaluation and Revaluation: Exchange rate adjusted by CB


given pegged or managed regimes.

Sunandan Ghosh, CDS, 2013 5


And the WORLD looks like …

Dark Green: Free Float


Light Green: Managed Float
Blue: Different types of Currency Pegs
Red: Usage of foreign currency
Sunandan Ghosh, CDS, 2013 6
Dollarization and some other notes
 Dollarization means use foreign currency in parallel to or instead of the
domestic currency. The term is not only applied to usage of the United States
dollar, but generally to the use of any foreign currency as the national
currency.

 Major countries using other currencies:


1. US Dollar : El Salvador (since 2001), Ecuador (since 1999), East Timor (since
2002), Panama (since 1904)
2. Euro: Montenegro, Kosovo, Monaco, Vatican City
3. SA Rand: Namibia, Swaziland, Zimbabwe

 Notes:
1. Chile – Peso is free float since 1999
2. Brazil – Real is floating since 1999

Sunandan Ghosh, CDS, 2013 7

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