CHP#7 Foreign Exchange

Money Banking and Finance
Topic: FOR`EIGN EXCHANGE
By: Riaz Hussain Ansari

Lecturer Department of Business Administration
University of Sahiwal
1
Learning Objectives
You will be able:

 What is foreign exchange and its
importance?
 What is foreign exchange market?
 How foreign exchange rate determine?
 How is the rate of exchange determined
under gold standard?
2
Foreign Exchange
Meaning of Foreign Exchange
Foreign exchange, also known as forex, is the conversion
of one country's currency into another. The value of any
particular currency is determined by market forces related
to trade, investment, tourism, and geopolitical risk.
H.E Evit, ” the meaning and methods by which rights to

wealth expressed in terms of the currency of one country
are converted into rights to wealth in terms of the
currency of another country are known as foreign
exchange
3
Foreign Exchange
Importance of Foreign Exchange

 Strength of the economy
 Balance of the payment
 Make international trade easy
 Rate of exchange
 Hard currency nation
 Credit worthiness
4
Foreign Exchange Market and its
function
What is Foreign Exchange Market?

In the words of Kindleberger, “Foreign
Exchange market is a place where foreign
moneys are bought and sold.
5
Functions of Foreign Exchange
Market
Transfer Function.
 The basic function of foreign exchange market is to transfer foreign
moneys between countries.
Credit Function
 Another function of the foreign exchange market is to provide credit to
the importer who is a debtor.
Hedging Function
 Foreign exchange market provides the facility to the importer to pay for
the goods at the foreign exchange rate prevailing in the market called
spot rate or at the future date called forward rate called hedging
6
Theories of Rate of Exchange
There are three main theories which have been developed for
explaining the determination of rate of exchange.
 Mint Par Parity Theory

 Purchasing Power Parity Theory
 Balance of Payment Theories
7
Mint Par Parity Theory
What is mint parity theory?

Mint parity theory explains the determination of exchange rate
between the two countries which are on gold standard.
Determination of Exchange Rate
The rate of exchange between the gold standard countries is
determined on a weight basis of the gold contents of their
currencies. In other words the exchange rate is determined by the
gold equivalents of the currencies involved. In the words of
Thomas , the mint par is an expression of the ratio weights of
gold used for the coinage of the currencies.
The gold points refers to the limits within which the market
rate of exchange between two gold standard countries
fluctuates from the mint parity equilibrium
8
Calculation of the gold points

 The gold points determined by the costs of
transporting gold from one country to another. The
upper gold point of exchange. The lower gold point
is arrived at by deducting the cost of shipping gold
to the mint parity rate of exchange.
 For example , the mint parity rate of exchange
between England and America is 1 euro =$4.866.
9
Gold Export Point and Gold Import Point

 The upper point is also called gold export point. It is
the rate of exchange above which the gold will be
exported.
 The Lower point is also called he import point it is
the rate of exchange below which gold will be

imported
The mint par parity theory has been discarded since
the gold standard broke down in 1931. As no country
is now on the gold standard, therefore, the mint parity
theory has now, an academic interest only.
10
Gold Export Point and Gold Import Point
11
The Purchasing power Parity Theory
The Purchasing power parity theory was first stated by john

Whitely in 1882. it was restated by David Ricardo. However, it
was developed on scientific lines by Gustav Cassel, a Swedish
Economist, in 1918.
The theory explains that so long there is free trade among nations
and exchange rates are allowed to adjust freely, exchange rate
between two currencies will adjust in the long run to the
purchasing power of two currencies.
 Absolutely Version
 Relative Version
12
The Purchasing power Parity Theory
Criticism
 Rate of change is not determined by the relatives price
levels alone.
 Theory bases analysis on domestic price only.
 Theory confines to the internationally traded goods.
 Effect of changes in foreign exchange rate ignored.
 The theory ignored the capital account.
 Valid only under free trade conditions.
 It fails to consider the elasticities of reciprocal conditions.
 It neglects the influence of aggregate income and
expenditures
13
Balance of Payments Theory
Criticism
The balance of payment theory of exchange rate is also
named as general equilibrium theory of exchange rate.
According to this theory, the exchange rate of the currency of
a country depends upon its demand for and supply of foreign
exchange
 The debits items in the balance of payment theory.
 Import of goods and services.
 Loan and investment made abroad.
 The supply of foreign exchange arises from the credit side
of the balance of payments.
14
15
Assessment of the Theory

Merits
 The balance of payment is consistent with the demand and
supply analysis.
 The theory is more realistic as it considers other variables
which affect domestic price of foreign money.

 The theory offers explanation of marginal adjustments in
exchange rate by devaluation or revaluation.
16

Demerits
 The theory assume perfect competition between countries
which is not realistic.

 The theory assumes balance of payments as the cause
and the rate of exchange as the effect. The fact, however,

is that the rate of exchange has more influence on the
balance of payments.
17

Demerits
 The theory assumes causal relationship between the
exchange rate and the domestic price level. In fact there

exists relationship between the two.
 According Haberler, the balance of payments, as assumed
in the theory, is of fixed quantity. The fact is that the

balance of payments are influenced by the changes in the
rates of exchange.
18
Factors Influence Rate of Exchange
 Trade movements
 Capital flows
 Banking influences
 Speculation
 Policy of protection
 Exchange control
 Monetary policy
 Political Condition
 Peace and Security
 Industrial Conditions
19
What is Exchange Control?
Exchange control is the state regulation excluding the free
play of economic forces from the free play of foreign
exchange market. the exchange control usually take the
following three forms.
 The monetary authority or the government of a country manages the
foreign exchange rate and buys and sells foreign currency at the rate
fixed by it.
 All foreign exchange earned by the exports are surrendered to the
central bank which pays the money in local currency.
 The importer of goods are allocated foreign exchange at the official rate
for enabling them to make payments for the imported goods
20
What is Exchange Control?
Objectives of Exchange Control
 To correct an adverse balance of payments
 To conserve foreign exchange
 To protect home industry
 To stabilize exchange rate
 To prevent the flight of capital abroad
 To practice discrimination in international trade
 To check the import of non essential items
 Important for planning
 Overvaluation
 Under valuation
21
Methods of Exchange Control
A. Unilateral Method
B. Be lateral and Multilateral Method
22
Method of Exchange Control
 Unilateral Methods
 Exchange pegging
 Exchange equalization account.
 Clearing agreement
 Stand still agreement
 Compensation agreement
 Blocked accounts
 Payments agreement
 Rational of foreign exchange
 Multiple Exchange rate
23
Method of Exchange Control
 Bilateral and Multilateral Methods

 Clearing Agreement
 Transfer Moratoria
 International liquidity
Linking rupees with a basket of currencies
24
Any Question?
25
Many Thanks
26

CHP#7 Foreign Exchange

Uploaded by

Copyright:

Available Formats

CHP#7 Foreign Exchange

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

CHP#7 Foreign Exchange

Uploaded by

Copyright:

Available Formats

Money Banking and Finance

Topic: FOR`EIGN EXCHANGE

By: Riaz Hussain Ansari

You will be able:

 How foreign exchange rate determine?

 How is the rate of exchange determined

under gold standard?

H.E Evit, ” the meaning and methods by which rights to

Importance of Foreign Exchange

What is Foreign Exchange Market?

 Mint Par Parity Theory

What is mint parity theory?

Calculation of the gold points

Gold Export Point and Gold Import Point

the rate of exchange below which gold will be

Gold Export Point and Gold Import Point

The Purchasing power parity theory was first stated by john

Assessment of the Theory

which affect domestic price of foreign money.

exchange rate by devaluation or revaluation.

Assessment of the Theory

which is not realistic.

and the rate of exchange as the effect. The fact, however,

Assessment of the Theory

exchange rate and the domestic price level. In fact there

in the theory, is of fixed quantity. The fact is that the

 Bilateral and Multilateral Methods

Linking rupees with a basket of currencies

You might also like