Exchange Rates an the Freign Exchange Market An Asset Apprach 国际金融英文.ppt

* * * * * * * * * * * * * * * * * * * * * * * * * 13-* The Demand for Currency Deposits (cont.) The difference in the rate of return on dollar deposits and euro deposits is R$ - (R€ + (Ee$/€ - E$/€)/E$/€ ) = R$ - R€ - (Ee$/€ - E$/€)/E$/€ expected rate of return = interest rate on dollar deposits interest rate on euro deposits expected rate of return on euro deposits expected exchange rate current exchange rate expected rate of appreciation of the euro 13-* The Market for Foreign Exchange We use the demand for (rate of return on) dollar denominated deposits and the demand for (rate of return on) foreign currency denominated deposits to construct a model of the foreign exchange market. The foreign exchange market is in equilibrium when deposits of all currencies offer the same expected rate of return—— interest parity. interest parity implies that deposits in all currencies are deemed equally desirable assets. Interest parity implies that arbitrage in the foreign exchange market is not possible. 13-* The Market for Foreign Exchange (cont.) Interest parity says: R$ = R€ + (Ee$/€ - E$/€)/E$/€ Why should this condition hold? Suppose it didn’t. Suppose R$ R€ + (Ee$/€ - E$/€)/E$/€ . Then no investor would want to hold euro deposits, driving down the demand and price of euros. Then all investors would want to hold dollar deposits, driving up the demand and price of dollars. The dollar would appreciate and the euro would depreciate, increasing the right side until equality was achieved. 13-* The Market for Foreign Exchange (cont.) (1) How do changes in the current exchange rate affect the expected rate of return of foreign currency deposits? 13-* The Market for Foreign Exchange (cont.) Depreciation of the domestic currency today lowers the expected rate of return on foreign currency deposits. Why? When the domestic currency depreciates, the initial cost of investing in foreign currency deposits increases, thereby lowering the exp