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Intervention into Floating Exchange Rates

A completely floating currency exists only in textbooks. Terms like dirty float or managed float refer to exchange rate regimes in which exchange rates are largely determined in foreign exchange markets [more…]

Countries Manage Economic Development with Soft Pegs

One of the reasons for a country to consider a soft peg is that the country wants to manage its exchange rate, to promote its policy of economic development. In such a case, the country can overvalue or [more…]

The Basics of Interest Rate Parity (IRP)

You need to be aware of three related subjects before you can understand the Interest Rate Parity (IRP) and work with it. The general concept of the IRP relates the expected change in the exchange rate [more…]

Derivation of the Interest Rate Parity (IRP)

Suppose that you consider investing in the home or foreign country for one period. It means that you have some amount of money now (present value or PV) and, given an interest rate, you want to make some [more…]

Covered versus Uncovered Interest Arbitrage

If this speculator relies on his expectations regarding the future spot rate to sell his euros and, therefore, sells those euros in the future spot market, he engages in an [more…]

Graphical Treatment of Arbitrage Opportunities

You can use a graphical way to know which investor, home or foreign, can make use of the covered interest arbitrage to earn excess returns.

In the figure, you see the approximate interest rate differential [more…]

How to Determine Whether the Interest Rate Parity (IRP) Holds

The IRP indicates a long-run relationship between interest rate differentials and forward premium or discount. Although at any given time this relationship may not hold, if appropriate estimation techniques [more…]

Supply and Demand: Bartering Apples per Orange Example

Think about a barter economy that uses no money and in which people exchange oranges for apples. Basically, in the orange market, some people do have a demand for oranges. Other people produce oranges [more…]

How to Determine Exchange Rates through Supply and Demand

The demand–supply framework enables you to predict the next period’s exchange rate. When you understand this framework, you’ll be able to predict the direction of the change in the exchange rate — in other [more…]

Predict Changes in the Euro–Dollar Exchange Rate

Here, you can see how a change in each of the macroeconomic fundamentals (inflation rate, growth rate, interest rate, and government restrictions) is applied to the dollar market. [more…]

The Monetary Approach to Balance of Payment

Following is a discussion regarding the assumptions and the general setup of the Monetary Approach to Balance of Payment (MBOP). You also compare the MBOP’s approach to the demand–supply model. In Economics [more…]

Demand for Money in the Money Market

The demand curve for money is called the liquidity preference,for a good reason. This curve drawn in the real interest rate/real quantity of money space shows how much money you want to keep in your pocket [more…]

Supply of Money in the Money Market

In the money market of the Monetary Approach to Balance of Payment (MBOP), the central bank controls the nominal money supply (MS). Given the average price level, the nominal money supply [more…]

Establish Money Market Equilibrium

A market has a demand and a supply curve that shows the demand for and supply of the good in question. When you put together the money demand and supply curves, you can view the money market. [more…]

Asset Approach to Exchange Rate Determination

You can compare the real returns on dollar-denominated securities with the real returns on euro-denominated securities. The concept that makes this comparison possible is the expected change in the exchange [more…]

The Expected Real Returns Curve, or Parity Curve

The interest parity can be represented as a curve, called the expected real returns curve or the parity curve. This is one of the curves that can be used to describe the foreign exchange market. [more…]

Combine the Money Market with the Foreign Exchange Market

Combining the money market and the foreign exchange market in the Monetary Approach to Balance of Payment (MBOP) makes it possible to relate the change in the money market of one of the countries to the [more…]

Apply Relative Price to Exchange Rates

An exchange rate is a relative price because it represents the price of one currency in terms of another currency. Assume that the dollar is the domestic currency and the euro is the foreign currency. [more…]

What Are Real Exchange Rates?

The real exchange rate (RER) compares the relative price of two countries’ consumption baskets. You may be interested in getting more information than the relative price of two currencies, or the nominal [more…]

What Are Effective Exchange Rates?

Effective exchange rates compare a country’s currency to a basket of other countries’ currencies. The most common way to identify the basket of currencies is to consider a country’s major trade partners [more…]

How to Calculate the Percent Change

The percent change formula is a basic but useful tool. You can apply it to any variable that’s observed at various points in time. For all variables for which you want to measure the percent change, use [more…]

What Are Appreciation and Depreciation?

When you use the term appreciation or depreciation, make sure you’re referring to currencies that are traded in foreign exchange markets with no government interventions. A country may unilaterally peg [more…]

What the Terms Revaluation and Devaluation Mean

The terms revaluation and devaluation are used instead of appreciation and depreciation,respectively. When you read any financial newspaper, you note that a weakening in the dollar is reported as depreciation [more…]

Exchange Rate as the Price of Foreign Currency

The dollar–euro exchange rate implies the price of the euro in dollars. You can use this exchange rate to convert a dollar amount into euros, or vice versa. [more…]

Exchange Rate as the Price of Domestic Currency

Working with the euro–dollar exchange rate implies the price of the dollar in euros. You can use this exchange rate to convert a dollar amount into euros, or vice versa. [more…]


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