Definitions of Exchange Rates Depreciation

1 Slides prepared by Thomas Bishop Chapter 13 Exchange Rates and the Foreign Exchange Market: An Asset Approach Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 13-2 Preview The basics of exchange rates Exchange rates and the prices of goods The foreign exchange markets The demand for currency and other assets A model of foreign exchange markets ♦ role of interest rates on currency deposits ♦ role of expectations about the exchange rates Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 13-3 Definitions of Exchange Rates Exchange rates are quoted as foreign currency per unit of domestic currency or domestic currency per unit of foreign currency. ♦ How much can be exchanged for one dollar? ¥102/$1 ♦ How much can

be exchanged for one yen? $0.0098/¥1 Exchange rate allow us to denominate the cost or price of a good or service in a common currency. ♦ How much does a Honda cost? ¥3,000,000 ♦ Or, ¥3,000,000 x $0.0098/¥1 = $29,400 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 13-4 Depreciation and Appreciation Depreciation is a decrease in the value of a currency relative to another currency. ♦ A depreciated currency is less valuable (less expensive) and therefore can be exchanged for (can buy) a smaller amount of foreign currency. ♦ $1/€1 ! $1.20/€1 means that the dollar has depreciated relative to the euro. It now takes $1.20 to buy one euro, so that the dollar is less valuable. ♦ The euro has appreciated relative to the dollar: it is now more valuable. 2 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 13-5 Depreciation and Appreciation (cont.) Appreciation is an increase in the value of a currency relative to another currency. ♦ An appreciated currency is more valuable (more expensive) and therefore can be exchanged for (can buy) a larger amount of foreign currency. ♦ $1/€1 ! $0.90/€1 means that the dollar has appreciated relative to the euro. It now takes only $0.90 to buy one euro, so that the dollar is more valuable. ♦ The euro has depreciated relative to the dollar: it is now less valuable. Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 13-6 Depreciation and Appreciation (cont.) A depreciated currency is less valuable, and therefore it can buy fewer foreign produced goods that are denominated in foreign currency. ♦ How much does a Honda cost? ¥3,000,000 ♦ ¥3,000,000 x $0.0098/¥1 = $29,400 ♦ ¥3,000,000 x $0.0100/¥1 = $30,000 A depreciated currency means that imports are more expensive and domestically produced goods and exports are less expensive. A depreciated currency lowers the price of exports relative to the price of imports. Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 13-7 Depreciation and Appreciation (cont.) An appreciated currency is more valuable, and therefore it can buy more foreign produced goods that are denominated in foreign currency. ♦ How much does a Honda cost? ¥3,000,000 ♦ ¥3,000,000 x $0.0098/¥1 = $29,400 ♦ ¥3,000,000 x $0.0090/¥1 = $27,000 An appreciated currency means that imports are less expensive and domestically produced goods and exports are more expensive. An appreciated currency raises the price of exports relative to the price of imports. Copyright...

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