Foreign Exchange Market

Kanjaraj Tangtatswas

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Foreign Exchange
• Exchange rate: price of one currency in terms of
another

Exchange rates affect the relative price

of domestic and foreign goods.

How foreign exchange is traded

• Over-the-counter market
Dealers (mostly banks) stand ready to buy and sell deposit
denominated in foreign currency

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Exchange Rate Regimes
• Fixed exchange rate regime
Value of a currency is pegged relative to
the value of one other currency (anchor
currency)
• Floating exchange rate regime
Value of a currency is allowed to fluctuate
against all other currencies
• Managed float regime (dirty float)
Attempt to influence exchange rates by
buying and selling currencies

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Foreign Exchange
• Exchange rate: price of one currency in terms of
another
• Appreciation: a currency rises in value relative to
another currency
• Depreciation: a currency falls in value relative to
another currency
• When a country’s currency appreciates, the country’s
goods abroad become more expensive and foreign
goods in that country become less expensive and vice
versa

Exchange rates affect the relative price

of domestic and foreign goods.
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Appreciation VS Depreciation

USD/THB = 32.00 USD/THB = 33.00

USD has appreciated against THB.

THB has depreciated against USD.

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Foreign Exchange

• Revaluation: Resetting of the fixed value of a

currency at a higher level
• Devaluation: Resetting of the fixed value of a
currency at a lower level

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Market Quotations
USD/THB = 33.00
Commodity Terms
Currency Currency

Commodity currency: currency being priced; fixed

number
Terms currency: the “other” currency; variable number

USD/THB = 33.00 means USD 1 is worth THB 33.00.

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CNBC Wall Street Journal

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Currency Quotations Example

• USD/JPY • EUR/USD
• USD/CHF • GBP/USD
• USD/SGD • AUD/USD
• USD/HKD • NZD/USD
• USD/KRW
• USD/CNY • EUR/JPY
• USD/THB • GBP/JPY

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Book Quotations
USD/THB = 0.030 or 1/33.00
Terms Commodity
Currency Currency

Commodity currency: currency being priced; fixed

number
Terms currency: the “other” currency; variable number

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USD/THB movement
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Law of one price
If 2 countries produce an identical good,
and transportation costs and trade barriers
are very low, the price of the good should
be the same throughout the world no matter
which country it produces

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• The Big Mac index is The Economist’s exchange-rate gauge.
• It is based on the theory of purchasing-power parity (PPP), which
says that in the long run exchange rates should adjust so that the
price of an identical basket of goods and services is the same
across borders.
• The basket contains a single good: the Big Mac, which uses the
same ingredients almost everywhere (India’s Maharaja Mac, which
contains chicken, not beef, is an exception).

https://www.economist.com/big-mac-index 15
https://www.economist.com/big-mac-index

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https://www.economist.com/news/2020/07/15/the-big-mac-index 17
Theory of Purchasing Power Parity (PPP)
The exchange rates between any two currencies
will adjust to reflect changes in the price levels
(inflation) of the two countries.
PPP suggests that if one country’s inflation rises
relative to another’s, its currency should depreciate.
Assumes:
• All goods are identical in both countries
• Trade barriers and transportation costs are low
Many goods and services are not traded across
borders

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A Supply and Demand Analysis

• An exchange rate is the price of commodity currency

in term currency.
• Supply curve for commodity-currency assets
Assume amount of commodity-currency assets is fixed
(supply curve is vertical)
• Demand curve for commodity-currency assets
Most important determinant is the relative expected return of
commodity-currency assets
At lower current values of the commodity-currency asset
(everything else equal), the quantity demanded of commodity-
currency assets is higher
Market Equilibrium
Price of USD in term of THB

USD/THB

34 (EA)

I
33

☒
32 (EB)

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Factors that Affect Exchange Rates
in the Long Run

• Relative price levels (inflation)

- Purchasing Power Parity
• International trade and investment
Import and export
Productivity

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Argentina Monetary Aggregates and CPI

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Argentinian Peso

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Argentinian Peso

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Inflation and USDCNY

Kanjaraj Tangtatswas 25
Current account and FX

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Why are Exchange Rates So
Volatile?

• The volatility of exchange rates is due, in

part, to the fact that they are based on
unstable expectations regarding an
uncertain future.
Exchange Rates in the Short Run

• Relative return of assets and expectation

FX rate movement
Asset price
Relative interest rate
• Expected relative price level
• Expected import/ export demand

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 Expected foreign exchange rate

Price of USD in THB S • USD is expected to

appreciate against THB

E2 B

E1
A

D2
D1

Quantity of USD assets

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Asset Price

There is sovereign debt crisis in Europe.

What will happen to EUR? Appreciate?

Depreciate? Why?

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Investment flows and FX
Thailand

Source: ANZ 31
Investment flows and FX
South Korea

Source: ANZ 32
 Relative interest rate

Price of USD in THB S • USD interest rate increases

relative to THB interest rate
• THB interest rate decreases
E2 B relative to USD interest rate

E1
A

D2
D1

Quantity of USD assets

33
 BOT MPC meeting (Aug 4, 2021)

Source: Barclays (August 4, 2021) 34

MPC meeting impact on THB government bond yield

After MPC meeting with 2

Before MPC members voting for a rate
cut + growth downgrade

Aug 3, 2021 Aug 4, 2021

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FX and economic data

• The euro depreciated against the dollar

after economic data showed Germany
and Eurozone economy contracted in
the second quarter, suggesting a
faltering economy that was hit by the
worsening US-China trade war, Brexit
and geopolitical tensions.
 Expected Inflation and Exchange
Rate
Price of USD
S • The market expects
inflation in the US to be
higher.
• USD depreciates.

E1
A

E2
B

D2 D1

Quantity of USD assets

38
 Expected export/import demand

Price of USD in THB S • Expect higher Thai import.

E2 B

E1
A

D2
D1

Quantity of USD assets

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 Expected export/import demand
Price of USD in THB
S • Expected higher Thai export.

E1
A

E2
B

D2 D1

Quantity of USD assets

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USDTHB and COVID-19 (July 2021)
• This morning the baht opened at 32.11/13 THB/USD, depreciating from
yesterday's close as health authorities reported new Covid-19 infections reached
a record highest number of 6,087 today.
• The dollar slightly gained as US initial jobless claims declined by 51,000 to
364,000, suggesting the labor market continued to recover from the pandemic.
However, the dollar movement was limited since the market focus is on the US
nonfarm-payroll data which is due to release today following which investors will
see whether the Fed will start to reduce monetary stimulus sooner rather than
later.