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WK11.1 Agenda• News, Daily good deeds• Project: Homework: Topic by Friday January
14, 2011. How and where to find the impact information?
• Presentation: Friday January 21, 2011.• Exam Part II: Wednesday January 26, 2011.• Session III will start January 12, 2011• Last week article• Monday Discovery
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Article• Read the article and answer the questions.• What do you call Chinese exporters that
promote their products to US or EU through Thailand?
• Do you think it’s ok? Will this benefit Thailand?
• What is rule of origin? What is custom union?• What’s 10 billion Yuan equal to Thai baht?
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Picture Discovery
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Picture Discovery
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Picture Discovery
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Picture Discovery• What are the major currencies?
Why should we study about it?• What’s the trend in
2010?
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Picture Discovery• What’s this? • What’s the meaning of
this chart?
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IMF Games
• Play Monetary Mania from the IMF website.
• http://www.imf.org/external/np/exr/center/econed/index.htm
• Jot down the important information(Money, Economics, Monetary, etc.).
• Report your group knowledge on the board.
• Play World Trader from IMF.
• What score did you get?
• Did you achieve your goal?
• What did you learn?
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WK11.2 Agenda
• News, Daily good deeds• Next Wednesday January 19, 2010:
Meditation• Project Next Friday January 21, 2010• Exam Part II Next Wednesday 26, 2010.• More Discovery
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Big Mac Exercise• Law of one price: In an efficient market, the price of the same product
should be the same everywhere, else the process of arbitrage will occur.• If we want the same price as in the US., what should be the exchange
rate?
Countries Big Mac PriceUS= 3.73 $
Theoretical Exchange Rate
Current Exchange Rate
Thailand 70
China 13.2
Japan 320
Australia 4.35
Euro Area 3.38
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Big Mac Exercise• Law of one price: In an efficient market, the price of the same product
should be the same everywhere, else the process of arbitrage will occur.• In the long run what would happen to the exchange rate of each
country?• What are the limitations of using Big Mc index?• Differences in tax, cost of production(rent & labor), consumer
preferencesdifference market position and price
Countries Big Mac PriceUS= 3.73 $
Theoretical Exchange Rate (Implied PPP)
Current Exchange Rate
Thailand 70 18.77 30.4
China 13.2 3.54 6.6
Japan 320 85.7 83.1
Australia 4.35 1.17 1.01
Euro Area 3.38 (1.1)(0.9) (1.3)
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Interest, Inflation and Exchange Rate• Fisher Effect• Real interest rate=Nominal
interest rate-Inflation
• International Fisher Effect
• Concept that the interest rate differentials for any two currencies will reflect the expected change in their exchange rate.
• Where will you invest?• Thailand: Nominal interest 2%,
inflation 5%• China: Nominal interest 3%,
inflation 1%• How can you make money?• Japan: interest rate 1%• Australia: bond yield 6%• According to the Fisher effect,
real interest rate of countries should be the same, what would happen to the exchange rate?
• What are the relationship of interest rate, inflation, and exchange rate?
¥ ¥
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Video Clip Discovery
• US-China currency dispute• What does the US want? Why?• Where does China put the money from trade?• What is hot money? Why they are afraid of it?• What happens when the currency appreciate?
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Reading Discovery
• Read the following article and answer the questions.
• US BOP: Is the sky falling?
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Article: U.S. BOP Deficit
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WK11.3 Agenda• News, Daily good deed• Project update, information, grading criteria• Working on campus• Meditation class on Wednesday January 19,
2011• Lecture• Class wrap up
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International Monetary System• The international monetary system:• Establishes the rules by which countries value and exchange
their currencies and provides a mechanism for correcting imbalances between a country’s international payments and receipts.
IMS IMS
Institutions
Agreements
Process
Rules
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History of IMS
Gold Standard
1880
Bretton Woods Agreement (Fixed
Rate System)1945
Floating Currency Exchange Rate
System1972
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Gold Standard• Each country set its par value(unit of
its currency) to an ounce of gold. Currencies were pegged to gold. The ratio of the two currencies equal to the gold equivalence establishes the exchange rate between the two countries.
• Gold Specie: gold coin as money • Gold Bullion: the government can
print out the money equal to the gold reserve
• Discipline, Security, Flexibility
• WW period, great depression, beggar-thy-neighbor policies
• Bank couldn’t redeem the money for gold at the par value.
• UK: 1 once of gold=4 £
• US: 1 once of gold=20 $
• France: 1 once of gold = 10 franc
• Exchange rate UK/US=? US/France?
• 4/20=1 £ per 5 $, 2 $ per franc
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Bretton Woods AgreementAfter WWII governmental representatives met at Bretton Woods NH, USA. to arrange the plan for post war economic environment to promote peace and prosperity.
The fixed exchange rate restored the gold standard and tied to US dollar. Only the US dollar would be redeemable for gold. US dollar became a mean for international payment and reserve currency for other governments. Each country pledged to maintain the value of its currency + 1% of its par valueAdjustable peg.
Creation of International Bank for Reconstruction and Development (the World Bank): to help finance reconstruction of European economies, build economies of the world’s developing countriesCreation of IMF: To promote international monetary cooperation, facilitate the expansion and balanced growth of international trade, promote exchange stability, maintain orderly exchange arrangements among members, avoid competitive exchange depreciation, assist in the establishment of a multilateral system of payments, give confidence to members, shorten the duration and lessen the degree of disequilibrium in their BOPSpecial Drawing Rights (SDR): An international reserve asset , the unit of account for the IMF and other international organizations
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Bretton Woods System• Triffin Paradox:• A national currency that is also a
reserve currency will eventually run a deficit, which eventually inspires a lack of confidence in the reserve currency and leads to a financial crisis.
• The deficit was financed partly by the shrinking gold reserve and liabilities to other foreign central banks.
• End of Bretton Woods: President Richard Nixon announcement: U.S. dollar inconvertible to gold
• G10 Smithsonian Conference
USA
UK
France
Japan
China
Confidence
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Floating Currency Exchange Rate System
• Floating currency exchange rates:
• Rates that are allowed to float against other currencies and are determined by market forces.
• Which direction is for depreciation?
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Summary of Currency Arrangements
System Gold Bretton Woods Floating
Pros Simplicity, Widely trusted, Monetary discipline
Fixed rates,Supported trade growth
Flexibility, Reflect market forces, Handle huge volume
Cons Impractical with large trade flow, Holding costs
BOP deficit for U.S.,Shrinking U.S. gold reserve, U.S. government liabilities to foreign central banks
Wide swings in currency values
ControllingMechanism
Gold flows Government adjusted rates against dollar, Dollar constant against gold
Market forces with some government intervention
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Current Currency Arrangements• Categorized by IMF 1) Exchange arrangement with no separate legal tender: one country adopt the
currency of another(Timor, Panama) or a group of countries adopting a common currency(Euro).
2) Currency board arrangements: the board legislate the fixed exchange rate and control the domestic money supply through foreign reserves(Brunai).
3) Other conventional fixed peg arrangements: fixed rate with + 1% (Saudi)4) Pegged exchange rates within horizontal band: the exchange rate could
fluctuate greater than 1% (Denmark)5) Crawling pegs: the currency is readjusted periodically at a fixed, preannounced
rate6) Crawling banks: the currency readjustments to maintain fluctuation margins
around a central rate.7) Managed floating with no preannounced path for the exchange rate: the
government actively intervene the exchange rate depending on the economic indicators(BOP, reserve, interest rate, etc.) China, Malaysia, Singapore
8) Independently float exchange rates: There maybe government intervention to moderate the rate of change not the rate establishment (USA, Japan, UK)
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Exchange Rate QuotationsBid price: buying price
Ask price, offer rate: sales price
Spot rate: the exchange rates between two currencies for delivery within 2 business days
Forward rate: the exchange rate between 2 currencies for delivery in the future, usually 30, 60, 90, or 180 days.
Spot rate: 1$/30 Baht
Forward premium: 1$/35 Baht
Forward discount: 1$/28 Baht
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Exchange Rate Quotations• Direct rate: one unit of the local
currency to foreign currency (1 Baht/0.033$)
• Examples of the indirect rate: (1$/30 Baht), (1€/40 Baht), (1Yuan/4.8 Baht)
• Cross rate: calculate the exchange rate of the two countries using the third major currency ($/Yuan=?)
• Arbitrage:?• purchase of a product in one market
for immediate resale in a second market in order to profit from a price discrepancy.
• In the market 1$/6.6 Yuan, how can we profit from Yuan, Baht, and Dollar?
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Exchange Rate Movement
Exchange Rate
Currency Supply& Demand
Interest Rate
Inflation Rate
E(future)Tax Rate
Trade Policies
World Events
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Theories of Exchange Rate
Law of one price:In an efficient market, like products will have like prices.
Fisher effect:The real interest rate will be the nominal interest rate minus the expected rate of inflation.
International Fisher effect:
The interest rate differentials for any two currencies will reflect the expected change in their exchange rates.
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Big Mac Exercise• Law of one price: In an efficient market, the price of the same product
should be the same everywhere, else the process of arbitrage will occur.• In the long run what would happen to the exchange rate of each
country?• What are the limitations of using Big Mc index?• Differences in tax, cost of production(rent & labor), consumer
preferencesdifference market position and price
Countries Big Mac PriceUS= 3.73 $
Theoretical Exchange Rate (Implied PPP)
Current Exchange Rate
Thailand 70 18.77 30.4
China 13.2 3.54 6.6
Japan 320 85.7 83.1
Australia 4.35 1.17 1.01
Euro Area 3.38 (1.1)(0.9) (1.3)
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Interest, Inflation and Exchange Rate• Fisher Effect• Real interest rate=Nominal
interest rate-Inflation• International Fisher Effect• Concept that the interest rate
differentials for any two currencies will reflect the expected change in their exchange rate.
• Where will you invest?• Thailand: Nominal
interest 2%, inflation 5%• China: Nominal interest
3%, inflation 1%• How can you make
money?• Japan: interest rate 1%• Australia: bond yield 6%• What would happen to
the exchange rate?
¥ ¥
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Balance of Payment• The BOP accounting system is
a double-entry bookkeeping system designed to measure and record all economic transactions between residents of one country and residents of all other countries during a particular time period.
• Assists policy makers in designing appropriate public policies.
• In theory: Current Account + Capital Account + Official Reserves Account = 0
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Summary• History• Theories to explain the direction of:• Interest Rate Inflation
Exchange rate• Balance of payment• Exchange rates affect business operations in three
primary areas: marketing, production, and finance. Examples?
α
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Class Wrap Up• Change?• News, knowledge• Daily good deeds• Language skills• Responsive
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Video Clip Review• US Trade deficit controversial plan.• What’s the government plan to fix the
problem?• What are the pros and cons of the plan?