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Determination of Exchange Rates Balance of Payments
Determination of Exchange Rates Balance of Payments
Lecture Objectives
Determination of Exchange Rates Currency Forecasting Introduction to Balance of Payments Balance of Payments Accounting BOP & Exchange Rates
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Interest rates:
Higher domestic (real) interest rates attract investment funds causing a decrease in demand for foreign currency and an increase in supply of foreign currency.
Economic growth:
Stronger economic growth attracts investment funds causing a decrease in demand for foreign currency and an increase in supply of foreign currency.
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Government intervention:
Maintain weak currency to improve export competitiveness.
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Forecasting in Practice
Numerous foreign exchange forecasting services exist, many of which are provided by banks and independent consultants.
Forecasting in Practice
Technical analysts, traditionally referred to as chartists, focus on price and volume data to determine past trends that are expected to continue into the future. The single most important element of technical analysis is that future exchange rates are based on the current exchange rate.
Forecasting in Practice
The longer the time horizon of the forecast, the more inaccurate the forecast is likely to be. Whereas forecasting for the long run must depend on the economic fundamentals of exchange rate determination, many of the forecast needs of the firm are short to medium term in their time horizon and can be addressed with less theoretical approaches.
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Forecasting in Practice
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Then you conclude with your overall prediction based on all of these methods and allocate funds to your trading strategy.
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Balance of Payments
The BOP is a statistical record of the flow of all of the payments between the residents of a country and the rest of the world in a given year. Transactions are recorded on the basis of double entry bookkeeping by definition it has to balance.
Every source must have a use.
Balance of Payments
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Official Reserves
Records the purchase or sale of official reserve assets by the central bank. These assets include
Commercial paper, Treasury bills and bonds Foreign currency Money deposited with the IMF
This account shows the change in foreign exchange reserves held by the central bank. The Balance of Since the BOP must balance Payments Identity CA + KA + RFX = 0
CA + KA = RFX
For floating rate regime countries, such as the U.S., official reserves are relatively unimportant.
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CA -KA
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BOP in Total
A surplus in the BOP implies that the demand for the countrys currency exceeded the supply and that the government should allow the currency value to increase in value or intervene and accumulate additional foreign currency reserves in the Official Reserves Account. A deficit in the BOP implies an excess supply of the countrys currency on world markets, and the government should then either devalue the currency or expend its official reserves to support its value.
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Accounting Principles
1. Any transaction resulting in a payment to foreigners is entered in the BOP accounts as a debit and is given a negative sign. Any transaction resulting in a receipt from foreigners is entered as a credit and given a positive sign. Current Account records transactions involving exports and imports of goods and services Capital Account records transactions involving the purchase and sale of assets. Double-Entry book keeping: Every international transaction automatically enters twice, once as a credit and once as a debit.
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2. 3. 4.
5.
Examples of Transactions
Credit Transactions (+ve): Provision of goods and services to non-residents
Income receivable from non-residents A decrease in foreign financial assets An increase in foreign financial liabilities
Examples of Transactions
An Australian company exports goods worth US$1 million to the United States:
Export of goods is credit for the current account. Increase in foreign asset (US$1 million) is debit for capital account.
Australian company then coverts US$ into A$ and buys government bonds back in Australia:
Decrease in foreign asset is credit for the capital account. Increase in government liability is debit for official reserves account. Increase in foreign liabilities is credit for the capital account. Import of goods is debit for current account.
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BOP & Macroeconomic Variables A nations balance of payments interacts with nearly all of its key macroeconomic variables. Interacts means that the BOP affects and is affected by such key macroeconomic factors as:
Gross Domestic Product (GDP) Exchange rate Interest rates Inflation rates
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