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Authors: Brian Kettell
Published by: Centre for Islamic Banking and Finance
Published in: 1999

Abstract

The determination of exchange rates can be viewed from the viewpoint of both the long run and the short run. The approach to viewing exchange rates from the short run is known as the asset market approach and is the subject matter of this case. Central to understanding the short run behaviour of exchange rates is to recognise that an exchange rate is the price of domestic bank deposits (those denominated in the domestic currency) in terms of foreign bank deposits (those denominated in the foreign currency). The modern asset approach to explaining exchange rate determination does not emphasise the flows of purchases of exports and imports over short periods, because these transactions are quite small relative to the amount of domestic and foreign bank deposits at any given time. Foreign exchange transactions are very large as compared with flows associated with trading. The effect of this is that over short time periods decisions to hold domestic versus foreign assets play much greater role in exchange rate determination than does the foreign currency flows associated with exporting and importing. This case is suitable for undergraduate and postgraduate courses with an international finance, international banking or international business component. The themes covered also provide an analytical framework in which multi-national company decision making has to be analysed whether from the point of view of international finance, international marketing or international corporate strategy. It is particularly suitable for business situations where foreign exchange hedging and arbitrage decisions are being discussed.

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Abstract

The determination of exchange rates can be viewed from the viewpoint of both the long run and the short run. The approach to viewing exchange rates from the short run is known as the asset market approach and is the subject matter of this case. Central to understanding the short run behaviour of exchange rates is to recognise that an exchange rate is the price of domestic bank deposits (those denominated in the domestic currency) in terms of foreign bank deposits (those denominated in the foreign currency). The modern asset approach to explaining exchange rate determination does not emphasise the flows of purchases of exports and imports over short periods, because these transactions are quite small relative to the amount of domestic and foreign bank deposits at any given time. Foreign exchange transactions are very large as compared with flows associated with trading. The effect of this is that over short time periods decisions to hold domestic versus foreign assets play much greater role in exchange rate determination than does the foreign currency flows associated with exporting and importing. This case is suitable for undergraduate and postgraduate courses with an international finance, international banking or international business component. The themes covered also provide an analytical framework in which multi-national company decision making has to be analysed whether from the point of view of international finance, international marketing or international corporate strategy. It is particularly suitable for business situations where foreign exchange hedging and arbitrage decisions are being discussed.

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