Slide 1CHAPTER OUTLINEBalance of PaymentsBalance of Payments United States, 2012Current Account Mirrors the Balance of TradeSlide 6Trade Requires CurrencyForeign Exchange MarketsModeling Foreign ExchangeVarious Exchange RatesVarious Exchange RatesAlternative Foreign Exchange SystemsFixed Exchange RatesManaged FloatDeterminants of Exchange RatesCurrency Manipulation18-1©2015 McGraw-Hill Education. All Rights Reserved ©2015 McGraw-Hill Education. All Rights Reserved Chapter 18International Finance and Exchange Rates18-2©2015 McGraw-Hill Education. All Rights Reserved CHAPTER OUTLINE•International Financial Transactions•Foreign Exchange Markets•Alternative Foreign Exchange Systems•Determinants of Exchange Rates18-3©2015 McGraw-Hill Education. All Rights Reserved Balance of Payments•Balance of Payments: the accounting system for how money moves between countries to facilitate the purchase of goods, services, financial instruments, and physical investments.•Current Account: The portion of the Balance of Payments accounting that represents that impacts of trade, short-term investment payments, and American payments of foreign taxes, foreign payments of American taxes, and the net transfer of private money.•The Capital Account represents the changes in holding of longer term financial and physical assets by citizens of one country in another country.18-4©2015 McGraw-Hill Education. All Rights Reserved Balance of Payments United States, 2012Major Accounting ItemSub Accounting ItemSub Acct componentComponent AmountSub Acct BalanceBalanceCurrent AccountBalance of TradeExports2936 -341 -276Imports3277Balance of Short-term Investment IncomeIncome to the US742 199Payments from the US543Capital AccountChange in the Ownership of AssetsUS owned assets abroad18 367 276Foreign owned assets in the US385Financial Derivatives NetStatistical Discrepancy & Net Derivatives-3-8818-5©2015 McGraw-Hill Education. All Rights Reserved Current Account Mirrors the Balance of Trade18-6©2015 McGraw-Hill Education. All Rights Reserved Foreign Purchases of US Assets & US Purchases of Foreign Assets18-7©2015 McGraw-Hill Education. All Rights Reserved Trade Requires Currency•Trade between countries is beneficial.•International trade requires that the currency of the trading partners be exchanged. •The market where people come to trade currencies is called the foreign exchange market.•E.g. the production and export of a radio can require several currency transactions.18-8©2015 McGraw-Hill Education. All Rights Reserved Foreign Exchange Markets•The demand for a currency (say the dollar) is also the supply of the other currency (say the yen).•The supply for a currency (say the dollar) is also the demand of the other currency (say the yen).18-9©2015 McGraw-Hill Education. All Rights Reserved Modeling Foreign ExchangeA curve which represents the willingness of those who have Yuan to trade them for U.S. dollarsA curve which represents the willingness of those who have Yuan to trade them for U.S. dollars Quantity of YuanPrice of Yuan in U.S.dollarsequilibriumexchangerate18-10©2015 McGraw-Hill Education. All Rights Reserved Various Exchange RatesForeign CurrencyAmount of Currency needed to get $1Amount of US Dollars needed to get one unit of the CurrencyBritish Pound0.656532 1.523154Canadian Dollar1.022890 0.977623Chinese Yuan6.211902 0.160981Euro0.770168 1.298419Hong Kong Dollar7.763435 0.128809Japanese Yen94.41402 0.010592Mexican Peso12.37608 0.080801Russian Ruble30.83405 0.032432South Korean Won1118.892 0.00089418-11©2015 McGraw-Hill Education. All Rights Reserved Various Exchange Rates18-12©2015 McGraw-Hill Education. All Rights Reserved Alternative Foreign Exchange Systems•floating exchange rate system: a system whereby markets determine the value of a currency relative to all other currencies.•fixed exchange rate system : a system whereby a government sets the value of a currency relative to all other currencies and uses its reserve of foreign currencies or gold to maintain the exchange rate.•Gold standard: one means by which a country can execute a fixed exchange rate.•Managed Float exchange rate system: a system whereby governments decide the range of exchange rates they will allow the market to create, and act only when either the top end or the bottom end of that range is breached.18-13©2015 McGraw-Hill Education. All Rights Reserved Fixed Exchange RatesPrice of Yuan in DollarsYuanS1D1ERfixedYuan*D2S218-14©2015 McGraw-Hill Education. All Rights Reserved Managed FloatPrice of Yuan in DollarsYuanS1D1ERtargetYuan*D2S2ERceilingERfloor18-15©2015 McGraw-Hill Education. All Rights Reserved Determinants of Exchange Rates•Desire to hold one currency or another to •Facilitate trade•Facilitate the purchase of financial assets•Interest Rates•Projected Inflation Rates•Relative safety of the currency18-16©2015 McGraw-Hill Education. All Rights Reserved Currency Manipulation•Currency manipulation is the active buying and selling of currencies with the goal of artificially altering the relative value of those currencies.•The Chinese do this (by definition) because they engage in a fixed exchange rate policy.•The U.S., Japan, and Europe have done it so as to maintain favorable exchange rates that allow them greater exports than would exist under a purely flexible exchange rate