Professional Documents
Culture Documents
Lecture Slides Chapter 11
Lecture Slides Chapter 11
Chapter 11
Real Exchange Rate = Nominal Exch. Rate × Foreign Country’s Price Level
Home Country’s Price Level
o better indication
of purchasing
power of dollar
o increase in real
exchange rate
will make it
more difficult for
U.S. firms to
compete
Arbitrage
o exchange arbitrage – simultaneous purchase
and sale of currency in different foreign
exchange markets in order to profit from
exchange rate differential in two locations
o two or three point arbitrage possible
assume: £1 = $1.50; £1 = 4 francs; 1 franc = $0.50
sell $1.5 million for £1 million
sell £1 million for 4 million francs $500,000 profit
sell 4 million francs for $2 million
o such transactions shift supply & demand for
currencies eliminating opportunities for profits
and establishing consistent exchange rates
Forward Market