19.2 The Foreign-Exchange Market Flashcards
What does trade between countries normally require?
Trade between countries normally requires the exchange of one national currency for another.
What is the exchange of one currency for another called?
The exchange of one currency for another is called a foreign-exchange transaction.
In Canada, what is the exchange rate?
The exchange rate is the Canadian-dollar price of one unit of foreign currency. For example, in April 2021, the price of one U.S. dollar was 1.25 Canadian dollars. Thus, the Canada–U.S. exchange rate was 1.25.
How is the exchange rate usually expressed in the media?
Note that in the Canadian news media the exchange rate is usually expressed in the opposite way—as the number of U.S. dollars that it takes to buy one Canadian dollar.
So instead of reporting that the Canadian–U.S. exchange rate in April 2021 was 1.25, the press would say that the Canadian dollar was “worth” 80 U.S. cents . ( 1/1.25)
How are we always going to define the exchange rate in this book?
In this book we always define the exchange rate in the way Canadian economists usually do—as the Canadian-dollar price of one unit of foreign currency. This definition makes it clear that foreign currency, like any good or service, has a price expressed in Canadian dollars. In this case, the price has a special name—the exchange rate.
What does an appreciation of the Canadian dollar mean?
An appreciation of the Canadian dollar means that the Canadian dollar has become more valuable so that it takes fewer Canadian dollars to purchase one unit of foreign currency.
For example, if the Canadian dollar appreciates against the U.S. dollar from 1.25 to 1.15, it takes 10 fewer Canadian cents to purchase one U.S. dollar.
Thus, an appreciation of the Canadian dollar implies a fall in the exchange rate.
What does a depreciation of the Canadian dollar mean?
A depreciation of the Canadian dollar means that the Canadian dollar has become less valuable so that it takes more Canadian dollars to purchase one unit of foreign currency.
Thus, a depreciation of the Canadian dollar means a rise in the exchange rate.
What does a demand and supply of forieign currency imply?
Because Canadian dollars are traded for euros in the foreign-exchange market, a demand for euros implies a supply of Canadian dollars, and a supply of euros implies a demand for Canadian dollars.
Do we deal with supply or demand when learning theory of exchange rates?
For this reason, a theory of the exchange rate between dollars and euros can deal either with the demand and supply of dollars or with the demand and supply of euros; both need not be considered.
What is the “product” and “price” in foreign-exchange?
Thus, the market we will be considering (in general terms) is the foreign-exchange market—the “product” is foreign exchange (euros in our case) and the “price” is the exchange rate (the Canadian-dollar price of euros).
Are transations that generate a receipt for canada “supply” or “demand”?
recall that in the market for foreign exchange, transactions that generate a receipt for Canada in its balance of payments represent a supply of foreign exchange. Foreign exchange is being supplied by the foreigners who need Canadian funds to purchase Canadian goods or assets.
Are transations that are a payment from Canada “Supply” or “Demand”?
Transactions that are a payment from Canada in the balance of payments represent a demand for foreign exchange.
Foreign exchange is being demanded by the Canadians who are purchasing foreign goods or assets.
What assumption do we make concerning the Bank of Canada and the foreign-exchange market?
In what follows we make the (realistic) assumption that the Bank of Canada makes no transactions in the foreign-exchange market.
What does the supply of foreign exchange arise from?
Whenever foreigners purchase Canadian goods, services, or assets, they supply foreign currency to the foreign-exchange market and demand, in return, Canadian dollars with which to pay for their purchases.
Thus, the supply of foreign exchange (and the associated demand for Canadian dollars) arises from Canada’s sales of goods, services, and assets to the rest of the world.
What is an important sorce of supply of foreign exchange? What are some examples?
One important source of supply of foreign exchange is foreigners who wish to buy Canadian-made goods and services.
A French importer of Canadian lumber is such a purchaser; an Austrian couple planning a vacation in Canada is another; the Hungarian government seeking to buy Canadian engineering services is a third. All are sources of supply of foreign exchange, arising out of international trade.
What is a second source of supply of foreign exchange?
A second source of supply of foreign exchange comes from foreigners who want to purchase Canadian assets, such as government or corporate bonds, real estate, or shares in a Canadian firm.
How do holders of foreign currency buy Canadian assets?
To buy Canadian assets, holders of foreign currencies must first sell their foreign currency in return for Canadian dollars. As we saw earlier in the chapter, when Canadians sell assets to foreigners, we say there is a capital inflow to Canada.
How is reserve currency a supply of forgien exchange?
Firms, banks, and governments often accumulate and hold foreign-exchange reserves, just as individuals maintain savings accounts. These reserves may be in several different currencies. For example, the government of Poland may decide to increase its reserve holdings of Canadian dollars and reduce its reserve holdings of euros; if it does so, it will be a supplier of euros (and a demander of Canadian dollars) in foreign-exchange markets.
What is the supply of foreign exchange the sum of?
The supply of foreign exchange (or the demand for Canadian dollars in the foreign-exchange market) is the sum of the supplies for all the purposes just discussed
- For purchases of Canadian goods and services
- Canadian assets.
- The purchase of Canadian dollars to add to currency reserves.
What is the demand for any one currency a combination of?
Because people, firms, and governments in all countries purchase goods and assets from many other countries, the demand for any one currency will be the aggregate demand of individuals, firms, and governments in a number of different countries.
How is the supply of foreign exchange represented graphically?
The supply of foreign exchange on the foreign-exchange market is represented by a positively sloped curve.
This figure plots the Canadian-dollar price of euros (the exchange rate) on the vertical axis and the quantity of euros on the horizontal axis.
Moving up the vertical axis, more dollars are needed to purchase one euro—the Canadian dollar is depreciating.
Moving down the vertical axis, fewer dollars are needed to purchase one euro—the dollar is appreciating.
Graph of the Foreign-Exchange Market
The demand for foreign exchange is negatively sloped, and the supply of foreign exchange is positively sloped, when plotted against the exchange rate, measured as the Canadian-dollar price of one unit of foreign currency.
What does the blue line on the Foreign-Exchange graph represent?
The demand for foreign exchange is given by the blue line D. It represents the sum of transactions on both current and capital accounts that require payments to foreigners.
What does the red line in the Foreign-exchange graph represent?
The supply of foreign exchange is given by the red line S. It represents the sum of transactions on both current and capital accounts that represent receipts from foreigners.
