1. Another factor affecting exchange rates is market expectations of future exchange rates.

Like other
financial markets, foreign exchange markets react to any news that may have a future effect. *baca slide*
Day-to-day speculation on future exchange rate movements is commonly driven by signals of future
interest rate movements,but it can also be driven by other factors. Signals of the future economic
conditions that affect exchange rates can change quickly, so the speculative positions in currencies may
adjust quickly, causing unclear patterns in exchange rates.

2. Trade-related foreign exchange transactions are generally less responsive to news. Financial flow
transactions are very responsive to news, however, because decisions to hold securities denominated in a
particular currency are often dependent on anticipated changes in currency values. Sometimes trade-
related factors and financial factors interact and simultaneously affect exchange rate movements.

Exhibit 4.8 separates payment flows between countries into trade-related and financerelated flows and
summarizes the factors that affect these flows

3. In some periods, most currencies move in the same direction against the dollar. This is typically because
of a particular factor in the United States that is having impact on the demand and supply conditions
across all currencies in that period. It is common for these European currencies to move in the same
direction against the dollar because their economic conditions tend to change over time. However, it is
possible for one of the countries to experience different economic conditions in a particular period, which
may cause its currency’s movement against the dollar to deviate from the movements of the other
European currencies.

4. The cross exchange rate changes when either currency’s value changes against the
dollar. the following relationships for two non-dollar currencies called currency A and currency B:

5. Anticipation

Some large financial institutions attempt to anticipate how the equilibrium exchange rate will change in
the near future based on existing economic conditions. They need to consider the prevailing interest rates
at which they can invest or borrow, along with their expectations of exchange rates, in order to determine
whether to take a speculative position in a foreign currency.

6. individuals whose careers have nothing to do with foreign exchange markets speculate in foreign
currencies. They can take positions in the currency futures market or options market.

7. One of the most commonly used strategies by institutional and individual investors to speculate in the
foreign exchange market is the “carry trade,” whereby investors attempt to capitalize on the differential in
interest rates between two countries. Specifically, the strategy involves borrowing a currency that has a
low interest rate, and investing the funds in a currency that has a high interest rate.