3.2 Foreign Exchange Markets Flashcards
Ronaldo de Assis Moreira lives in Porto Alegre, Brazil. One summer, he met Ivan Zamorano from Chile. Over Carnaval break, Ronaldo decides to visit Ivan in Santiago de Chile for a one week. Ronaldo’s parents give him some spending money, BRL 4,500. Ronaldo wants to exchange it for Chilean pesos (CLP). He collects the following rates from a local bank:
Spot rate on the CLP/USD = CLP673.26 / 1 USD
Spot rate on the USD/BRL = USD0.30737 / 1 BRL
Question: What is the Chilean peso/Brazilian real cross rate?
CLP 206.94 / 1 BRL
Remember that the cross-exchange rate is any currency exchange in which neither of the currencies is the U.S. dollar.
How do you find the cross rate between BRL/CLP? First, put the foreign currencies in terms of one USD. Then. divide CLP/1USD over BRL/1USD.
How many Chilean pesos (CLP) will Ronaldo get for his BRL 4,500 (ignore transaction costs)?
About 931229.67 CLP
Multiply the BRL 4,500 that Ronaldo has times the cross-exchange rate you found in the previous question.
The Venezuelan government officially floated the Venezuelan bolivar (VEF) in February of 2002. Within weeks, its value had moved from the pre-float fix of VEF778/USD to VEF1025/USD.
By what percentage did its value change if you are a pro-Venezuelan government reporter without lying?
Use this formula using USD per 1 VEF to minimize the impact of the depreciation: % Change = (New Price – Old Price) / (Old Price)
The USD appreciated by 24.10% (or +24.10%)
The terms “devaluation” and “depreciation” are often used interchangeably, but they have distinct meanings depending on the type of exchange rate system in place.
There are two types of exchange rate systems: fixed and floating (variable).
When the exchange rate is fixed and a new rate is established, we have a devaluation when it loses value against the foreign currency. This is usually a policy decision made by the central bank of the devaluing country.
When the exchange rate is floating (variable) and the rate changes, we say we have a depreciation or an appreciation (if it gains value vs. the foreign currency). Unlike devaluation, depreciation is not a result of a deliberate policy action but rather the outcome of economic factors like inflation, interest rates, and investor expectations.
The Venezuelan government officially floated the Venezuelan bolivar (VEF) in February of 2002. Within weeks, its value had moved from the pre-float fix of VEF778/USD to VEF1025/USD.
By what percentage did its value change if you are an opposition-leaning reporter? Use the formula expressing exchange rates as VEF per one USD:–> (New price - Old Price) / (Old Price)
The bolivar depreciated by 31.75% (or -31.75%)
You plan to visit Cancun next Thanksgiving. Visit Bank of America’s currency exchange site and find the bid/ask spread for the USD/MXN pair.
Ask: https://www.bankofamerica.com/foreign-exchange/currency-converter.go
Bid: https://www.bankofamerica.com/foreign-exchange/exchange-rates.go
The bid/ask spread formula = (Ask rate - Bid rate) / Ask rate
Remember the order of operations (PEMDAS rule).
Ask= 0.0542
Bid= 0.0485
(Ask rate - Bid rate) / Ask Rate)
(0.0542 - 0.0485) / 0.0542 = 0.1052
