Contents

UNDERSTANDING THE MEXICAN PESO AND ITS MARKET STRUCTURE.............................2

MAJOR DEVALUATIONS OF MEXICAN PESO..............................................................................4
MEXICAN DERIVATIVES EXCHANGE...........................................................................................5
TESTING RPPP and IRP:.....................................................................................................................6
Method Used:................................................................................................................................6
Data Used:.....................................................................................................................................6
Exchange Rate (annual average):.......................................................................................................6
Inflation Rate:....................................................................................................................................7
Exchange rate movement as per RPPP:.............................................................................................7
Interest Rate:......................................................................................................................................9
Exchange rate movement as per IRP:................................................................................................9
COMPARING EXCHANGES RATE OPTAINED:.......................................................................11

1
UNDERSTANDING THE MEXICAN PESO AND ITS MARKET
STRUCTURE

The currency of Mexico was the Mexican Peso (Mex$). The Banco de Mexico (Bank of
Mexico, BOM) together with the Secretariat of Finance and Public Credit (SHCP)
administered all currency matters, including the exchange control system. The intervention
currency was U.S. Dollar. There were no taxes or subsidies on purchases or sales of foreign
exchange, and banks were freely engaged in exchange transactions between the peso and any
other currency.

From 1954, the Official Rate of Mexican Peso was set at $12.50 per U.S. Dollar. Mexico
maintained a fixed peso-dollar exchange rate even after the collapse of the Bretton Woods
system in 1971 and the world oil price shock in 1973. However, the distortions caused by
import substitution policies, the public expenditure-led growth financed mainly by borrowing
from the BOM, the accumulation of foreign debt, high inflation, the overvaluation of the
peso, and a large capital flight led finally to the devaluation of the peso in 1976. This
basically ended the regime of fixed exchange rates. The Peso switched to the managed
floating exchange rates in 1976, which gave more flexibility for discretionary economic
policy. The exchange rates were determined largely on the basis of demand and supply
conditions in the exchange markets. However, the authorities intervened when necessary to
maintain orderly conditions in the exchange market.

In August 1982, the Effective Rate was abolished. There were two exchange markets (the
controlled market and the free market), with 2 Preferential Rate and Free Market Rate. The
exchange rate in the controlled market was adjusted daily, based on the differential between
the rates of inflation expected in Mexico and its main trading partners and other indicators. A
week later, MexDollar rate was also introduced to form three-tier exchange market. However,
this rate was abolished in September. In the same month, the Free Market Rate was changed
to Ordinary Rate.

2
At the end of 1982, the Ordinary Rate converted to Free Market Rate again and a Special
Rate was introduced. However, the Special Rate was abolished in March 1983. In July 1985,
a Super Free Market Rate replaced the Official Free Market Rate and the nationalized
commercial banks were allowed to deal the transactions closer to black market rate.

In the following years, the exchange rate of Mexican Peso depreciated continuously. At the
end of 1991, the Controlled Rate and Super Free Market Rate were unified into Official Rate
while the Controlled Exchange Market was eliminated. Started from the end of 1994, a
floating rate policy was maintained by the government, with BOM intervening in the foreign
exchange market under exceptional circumstances to minimize volatility and ensure an
orderly market.

3
MAJOR DEVALUATIONS OF MEXICAN PESO
1. On 15th august 1971, Following the floating of the U.S. Dollar, the Peso maintained
its links to the American unit, thus effecting devaluation.
2. 31 August 1976, The Peso was devaluated, as the unit was placed on a controlled,
floating basis creating an Effective Rate as well as a Free Market Rate at the exchange
houses.
3. On 18th Febrauary 1982 The Peso was left to float freely in exchange markets before
the Central Bank intervention was resumed on June 5th with a controlled float.
4. On 3rd November 1982, The Peso was again devalued via the creation of a floating
Official Free Market Rate applicable within a special free zone along the United
States border.
In 1994, government fixed rate band increase to 15 percent (up to 4 pesos per US dollar),
by stopping the previous administration's measures to keep it at the previous fixed level.
The government, being unable even to hold this line, decided to let it float.The peso
crashed under a floating regime from four pesos to the dollar to 7.2 to the dollar in the
space of a week. The United States intervened rapidly, first by buying pesos in the open
market, and then by granting assistance in the form of $50 billion in loan guarantees. The
dollar stabilized at the rate of 6 pesos per dollar. By 1996, the economy was growing
(peaked at 7% growth in 1999). In 1997, Mexico repaid, ahead of schedule, all US
Treasury loans.

4
 MEXICAN DERIVATIVES EXCHANGE

The Mexican Derivatives Exchange (MexDer) is an options exchange in Mexico, located in

the same building as the Mexican Stock Exchange and a subsidiary of the same owning group

History

MexDer claims that its formation was first formally discussed in 1994. It actually began
operations December 15th, 1998.

In September 1999, the Board of Directors of MexDer approved a project to create an

electronic trading system. Before that time it had been operating as an open-outcry market.
The new system, "SENTRA-DERIVADOS", was a client–server system using a TCP/IP
network.

In March 2004, MexDer moved its electronic trading to the Spanish "S/MART" system.

Organization

MexDer has a typical corporate structure. It also authorizes special relationships with certain
kinds of entities:

 Brokers
 Clearing Members, "trusts that participate as shareholders of MexDer and contribute to
Asigna's capital; their purpose is to settle and, when applicable, trade Futures and Options
contracts in MexDer on behalf of clients. ... Clearing Members have their own capital,
they specialize in the evaluation of counterpart risk, manage guarantees and, in order to
avoid conflicts of interest, they keep proprietary accounts completely separate from third-
party accounts."

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 TESTING RPPP and IRP:

Method Used:
Trend analysis based on historical data.

Data Used:
Inflation rate (CPI) average annual (USA and Mexico)

Interest rate average annual (USA and Mexico)

Exchange rate direct quotes average annual (MXN/USD)

Exchange Rate (annual average):

MXN/USD Average

YEAR bid ask Average

2000 9.4532 9.4654 9.4593

2001 9.3289 9.3466 9.3378
2002 9.6490 9.6825 9.6658
2003 10.7763 10.8060 10.7911
2004 11.2671 11.3093 11.2882
2005 10.8803 10.9048 10.8926
2006 10.8916 10.9155 10.9035
2007 10.9187 10.9366 10.9277
2008 11.1333 11.1653 11.1493
2009 13.4849 13.5177 13.5013

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Inflation Rate:

MEXICO USA
Inflation rate Inflation rate
Year (consumer Year (consumer
prices) (%) prices) (%)
2000 15 0.15 2000 3.38 0.0338
2001 9 0.09 2001 2.83 0.0283
2002 6.5 0.065 2002 1.59 0.0159
2003 6.4 0.064 2003 2.27 0.0227
2004 4.5 0.045 2004 2.68 0.0268
2005 5.4 0.054 2005 3.39 0.0339
2006 4 0.04 2006 3.24 0.0324
2007 3.4 0.034 2007 2.83 0.0283
2008 4 0.04 2008 3.85 0.0385
2009 5.1 0.051 2009 2.63 0.0263

Exchange rate movement as per RPPP:

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14.0000

12.0000

10.0000
EXCHANGE RATE AS PER
RPPP (C)
8.0000
ACTUAL EXCHANGE RATE
6.0000 PESO/USD (A)

4.0000

2.0000

0.0000
1 2 3 4 5 6 7 8 9 10

8
Interest Rate:

Mexico USA
Interest rate Interest rate
Year Year
(%) (%)
2000 16.94 0.1694 2000 6.03 0.0603
2001 13.79 0.1379 2001 5.02 0.0502
2002 8.54 0.0854 2002 4.61 0.0461
2003 7.37 0.0737 2003 4.02 0.0402
2004 7.74 0.0774 2004 4.27 0.0427
2005 9.28 0.0928 2005 4.29 0.0429
2006 7.51 0.0751 2006 4.79 0.0479
2007 7.6 0.076 2007 4.63 0.0463
2008 8.09 0.0809 2008 3.67 0.0367
2009 5.83 0.0583 2009 3.2 0.032

Exchange rate movement as per IRP:

IRP
EXCHANGE
YEAR differencial
RATE
2000 0.1029 0.9990 9.4495
2001 0.0835 0.9992 9.3300
2002 0.0376 0.9996 9.6621
2003 0.0322 0.9997 10.7876
2004 0.0333 0.9997 11.2844
2005 0.0478 0.9995 10.8874
2006 0.0260 0.9997 10.9007
2007 0.0284 0.9997 10.9245
2008 0.0426 0.9996 11.1445
2009 0.0255 0.9997 13.4979

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14.0000

12.0000
EXCHANGE RATE
10.0000 AS PER IRP (B)
8.0000 ACTUAL
EXCHANGE RATE
6.0000 PESO/USD (A)

4.0000

2.0000

0.0000
1 2 3 4 5 6 7 8 9 10

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COMPARING EXCHANGES RATE OPTAINED:

ACTUAL
EXCHANG EXCHANGE EXCHANGE
DIFFERENCE DIFFERENCE
Year E RATE RATE AS PER RATE AS PER
(A-B) (A-C)
PESO/USD IRP (B) RPPP (C)
(A)
2000 9.4593 9.4495 0.0097 9.4486 0.0106
2001 9.3378 9.3300 0.0078 9.3322 0.0056
2002 9.6658 9.6621 0.0036 9.6611 0.0047
2003 10.7911 10.7876 0.0035 10.7868 0.0044
2004 11.2882 11.2844 0.0038 11.2862 0.0020
2005 10.8926 10.8874 0.0052 10.8904 0.0021
2006 10.9035 10.9007 0.0028 10.9027 0.0008
2007 10.9277 10.9245 0.0031 10.9270 0.0006
2008 11.1493 11.1445 0.0048 11.1491 0.0002
2009 13.5013 13.4979 0.0034 13.4981 0.0032

14.0000
12.0000
10.0000
8.0000 ACTUAL EXCHANGE RATE
PESO/USD (A)
6.0000 EXCHANGE RATE AS PER IRP (B)
4.0000 EXCHANGE RATE AS PER RPPP (C)

2.0000
0.0000
1 2 3 4 5 6 7 8 9 10

In the case of Mexcian Peso both RPPP and IRP hold good. This could be because both hold
good in the long run. The duration considered can be one of the factors behind this. As most
economist suggest longer the duration more is the possibility of both of the parities holding
good.

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