Foreign Exchange Rate

Determination and intervention

Jhoanna Agravante
Patricia Borromeo 2023
Shean Bucay
Exchange Rate Determination:
The Theoretical thread
Currency Market Intervention

Disequilibrium:
Rates in Emerging Markets
Forecasting in Practice
Determinants of the Foreign Exchange Rates
1. Purchasing Power Parity (PPP)
Most widely accepted of all exchange rate determination
theories.
Oldest and most widely followed of the exchange rate
theories.
The long-run equilibrium exchange rate is determined by the
ratio of domestic prices relative to foreign prices
Different versions of PPP:
• The Law of One Price
• Absolute Purchasing Power Parity (APPP)
• Relative Purchasing Power Parity (RPPP)
 2. Balance of Payments
(flows) Approach

After PPP, the most These exchange Relative stocks

frequently used theoretical rate flows reflect of money or
approach to exchange rate current account financial assets
determination is probably and financial play no role in
that involving the supply account exchange rate
and demand for currencies transactions determination in
in the foreign exchange recorded in a this theory.
market. nation’s balance of
payments.
3. Asset Market Approach
Sometimes called the
relative price of bonds
or portfolio balance
approach.

Exchange rates are Changes in monetary and

determined by the fiscal policy alter expected
supply and demand returns and perceived
for financial assets of relative risks of financial
a wide variety. assets, which in turn alter
rates.
Monetary Approach
the exchange rate is determined by the supply and demand for national
monetary stocks, as well as the expected future levels and rates of growth
of monetary stocks
focuses on changes in the supply and demand for money as the primary determinant
of inflation.

the monetary approach is also criticized for its omission of a number of factors
(1) the failure of PPP to hold in the short to medium term;

(2) money demand appears to be relatively unstable over time; and

(3) the level of economic activity and the money supply appears to be interdependent, not independent.
Technical Analysis 2023

the assumption that exchange rates, or for that matter

all market-driven prices, follow trends.
forecasting inadequacies of fundamental theories has
led to the growth and popularity of technical analysis,
the belief that the study of past price behavior
provides insights into future price movements.
The Asset Market Approach to 2023
Forecasting
asset market approach assumes that whether
foreigners are willing to hold claims in
monetary form depends on an extensive set of
investment considerations or drivers.
 Currency Market
Intervention
Currency market definition

Understanding currency market

intervention

Motivations for intervention

CURRENCY MARKET
The foreign exchange market (forex, FX, or
currency market) is a global decentralized or
over the counter (OTC) market for the trading
of currencies. This market determines foreign
exchange rates for every currency. It includes
all aspects of buying, selling, and exchanging
currencies at current or determined prices.
CURRENCY MARKET
INTERVENTION

Foreign currency intervention—the active

management, manipulation, or intervention in
the market’s valuation of a country’s currency—
is a component of currency valuation and
forecast that cannot be overlooked.
CURRENCY MARKET INTERVENTION
Understanding: When a central bank increases the
money supply through its various
means of doing so, it must be
careful to minimize unintended
effects such as runaway inflation
(upward price spiral, sometimes
called “runaway inflation” or
“hyperinflation”)
 MOTIVATIONS FOR
INTERVENTION
• central bank or government may assess that its
Synching currency currency has slowly become out of sync with the
with country’s country's economy and is having adverse effects on it.
economy

• A one-off event may cause a countries currency to

Short-term reaction
move in one direction in a very short space of time.
to a certain event
Intervention Methods
There are many ways in which an individual
or collective set of governments and central
banks can alter the value of their currencies. It
should be noted, however, that the methods of
market intervention used are very much
determined by the size of the country’s
economy, the magnitude of global trading in its
currency, and the depth and breadth of
development in its domestic financial markets.
1. Direct Intervention
• This is the active buying and selling of the domestic currency
against foreign currencies.
• This traditionally required a central bank.
• If the goal were to increase the value of the domestic
currency, the central bank would purchase its own currency
using its foreign exchange reserves, at least to the acceptable
limits that it could endure depleting its reserves.
• If the goal were to decrease the value of its currency- to
fight an appreciation of its currency’s value on the foreign
exchange market—it would sell its own currency in
exchange for foreign currency, typically a major hard
currency like the dollar and euro.
• Direct intervention was the primary method used for many
years, but beginning in the 1970s, the world’s currency
markets grew enough that any individual player, even a
central bank, could find itself with insufficient resources to
move the market.
2. Indirect Intervention
• Is the alteration of economic or financial fundamentals that are
thought to be drivers of capital to flow in and out of specific
currencies.
• A logical development for market manipulation given the growth
in size of the global currency markets relative to the financial
resources of central banks.
• The most obvious and widely used factor here is interest rates.
• Higher real rates of interest attract capital.
• Indirect intervention uses tools of monetary policy.
3. Capital Controls
• Is the restriction of access to foreign currency by government
• This involves limiting the ability to exchange domestic
currency for foreign currency.
• Governments will limit access to foreign currencies to
commercial trade.
• Access to the exchange is limited by a difficult and timely
bureaucratic process for approval, and limited to commercial
trade transactions.
Failure
• It is also important to remember that
intervention may—and often does—
fail.
• The Turkish currency crisis of 2014
is a classic example of a drastic
indirect intervention that ultimately
only slowed the rate of capital flight
and currency collapse.
 European Monetary System (ESM)

European monetary system was created by countries in the EU to

establish a zone of exchnage rate stability and with a view to
encourage trade and growth, so that integration of economic policies
in EU would be speeded up.
“Snake in the Tunnel”
 Disequilibrium: Exchange Rates in
Emerging Markets

-changes in an exchange rate when a country's currency is revalued

or devalued -inflation or deflation, changes in the foreign exchange
reserves, population growth, and political instability.
 The Asian Crisis of 1997
On July 2, 1997, Thailand devalued its currency
relative to the U.S. dollar. This development,
which followed months of speculative pressures
that had substantially depleted Thailand's official
foreign exchange reserves, marked the beginning
of a deep financial crisis across much of East
 Causal Complexities.

-The Asian economic crisis-for it was more than just a currency

collapse - had many roots besides traditional balance of payments
difficulties. The causes were different in each country, yet there were
specific underlying similarities, which allow comparison. corporate
socialism, corporate governance, and banking stability.
 The Argentine Crisis of 2002
On July 2, 1997, Thailand devalued its currency relative to the
U.S. dollar. This development, which followed months of
Argentina was plunged into a devastating economic crisis in
December 2001/January 2002, when a partial deposit freeze, a
partial default on public debt, and an abandonment of the fixed
exchange rate led to a collapse in output, high levels of
unemployment, and political and social turmoil. pressures that had
substantially depleted Thailand's official foreign exchange
 Economic Crisis

DEVALUATION
 Forecasting in Practice

Predictions can be The chances of these

based on forecasts being
2023 econometric consistently useful or
models, technical profitable depend on
analysis, intuition, whether one believes
and a certain the foreign exchange
measure of gall market is efficient.
Short-run forecast
2023
typically motivated by a desire to hedge a receivable, payable,
or dividend for a period of perhaps three months.

Others base their short-term forecasts on a technical analysis

similar to that conducted in security analysis.

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Long-run forecast
2023
forecasts may be motivated by a multinational firm’s desire to initiate
a foreign investment, or perhaps to raise long-term funds or a
portfolio manager may be considering diversifying for the long term
in securities

The longer the time horizon of the forecast, the more

inaccurate, but also the less critical the forecast is likely to be.

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TECHNICALANALYSIS

Technical analysis is the study of historical

price action in order to identify patterns and
determine probabilities of future
movements in the market through the use of
technical studies, indicators, and other
analysis tools.
EXCHANGE RATE MOVEMENT
PERIOD
(1) day-to-day movement, which is seemingly random.
(2) short-term movements, ranging from several days to
trends lasting several months; and
(3) long-term movements, characterized by up and down
long-term trends
 Cross - Rate Consistency in Forecasting

International financial managers must often forecast their

home currency exchange rates for the set of countries in
which the firm operates, not only to decide whether to hedge
or to make an investment, but also as part of preparing multi-
country operating budgets in the home country’s currency.
Exchange Rate Dynamics: Making Sense of Market
Movements
Thank
you!