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International economicsSummary examweek 1
Exchange rates
Exchange rates I II and III
Introduction
Why is it important that managers comprehend the importance of exchange rate mechanisms and
hedging methods?
You often have to enter into contractual agreements with foreign entities (e.g. a foreign shipping
company) to accommodate flows of goods.
o If these foreign entities provide you a service, they most likely want to receive the
agreed monetary compensation in their own currency, which entails that you have to
exchange your currency and obtain theirs in order to honor the deal.
o Naturally, you might be able to use an intermediary to take care of the transaction, but
regardless of that, you will either directly, or indirectly via the intermediary, be
subjected to the exchange rate dynamics when the transaction occurs.
o A good understanding of exchange rate dynamics might, in theory, prevent these nasty
surprises.
Introduction case
The prices of gasoline and diesel don’t change that much in the Netherlands. When the oil prices
drop, the prices of gasoline and diesel (made from crude oil) drop not that much. That’s because oil
is a raw material, a commodity (like, coffee beans, metals, soy beans) something to make something.
More than 70% drop in de oil prices. But the prices of gasoline and diesel dropped only 10% in the
Netherlands, why? the currency USD/EUR
Big commodity exchange NYMEX, Chicago Mex (on industrial level) commodities are priced in
USD $$
Exchange rate:
Now: 1$ = 1€, oil price is $100 so dutch pay €100
Future: $1 = €2, oil price = $50, so dutch pay €100
,Exchange rates
The (nominal) exchange rate of a currency: entails the exchangeable amount of one unit of a
currency for another currency. For instance, at the moment of writing, 1 Euro can be exchanged for
roughly 1.30 US dollars. By analogy, 1 US dollar would then be exchangeable for 1/1.30= 0.77 EUR.
The blue line goes up and down, and this is because of the change in demand and supply.
o Supply goes up, price goes down.
o This is a floating exchange rate, because it goes up and down and up and down.
o Fixed exchange rate just a straight line
ISO codes:
Are commonly accepted abbreviations of currencies that financial decision makers use to save
space (rather than writing US dollar, we may refer to it by its code USD or its symbol $).
Each currency consists of 3 letters (most important: EUR, USD, AUD, NZ, CAD, CHZ, GBP, JPY).
Quote a currency to express the value of one unit of currency A (USD) in currency B (EUR).
We quote two currency ISO codes, separated by /, the first of which is a single unit and the
second of which refers to the amount per aforementioned single unit.
For instance, EUR/USD = 1.30 entails that 1 Euro (referred to as the base currency) buys you 1.30
USD (the quoted currency). The first of the pair is thus a single unit measure.
, Bid/ask discrepancy
Bid / Ask discrepancy = share for ‘market maker’.
The price that somebody bid, is the price that he paid for the car
The ask price is the price that he wants from somebody else, the price that he wants to receive.
Middle rate is somewhere in between the bid and the ask price.
Example:
Market maker → Imkes BMW example she bought it for 6500. Car dealer buys and sells it for a
different price otherwise he cannot eat → this person is a market maker, he created a market where
BMW can be sold and he is rewarded for it with the difference between the buy and the sell amount
Middle rate is in between the bid and the ask rate you also have it with this you as consumer gets
the worst rate you want to change your 1 euro ABN AMRO you get 90 dollar cents and when you
want to change your 90 dollar cents, you don’t get your 1 euro back but less. This is dictated by the
market of supply and demand of the market and a small part with the central bank
Basic point is 1/00 of a cent → look at the 09 at the end of the number
Why are they important? the forex market when you dealing with a huge amount of money every
cent counts and make a huge difference
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