Foreign exchange market

determined.

Exchange rate – the price of one currency in terms of another.

Spot transactions involve the immediate (two-day) exchange of bank deposits.
Forward transactions involve the exchange of bank deposits at some specified future date.
Spot exchange rate is the exchange rate for the spot transaction.
Forward exchange rate is the exchange rate for the forward transaction. When a currency increases in value, it experiences appreciation; when it falls in value and is worth fewer U.S. dollars, it undergoes depreciation.
FX swap – the combination of an offsetting spot transaction and a new forward contract

Basic terms

transportation costs and trade barriers are very low, the price of the good should be the same throughout the world no matter which country produces it.

Example 1. Recently, the yen price of Japanese steel has increased by 10% (to 11,000 yen) relative to the dollar price of American steel (unchanged at $100).
By what amount must the dollar increase or decrease in value for the law of one price to hold true?

one country’s price level rises relative to another’s, its currency should depreciate (the other country’s currency should appreciate).

Purchasing Power Parity, United States/United Kingdom 1973–2010 (Index: March 1973=100)

Levels
Trade Barriers
Preferences for Domestic Versus Foreign Goods
Productivity

If a factor increases the demand for domestic goods relative to foreign goods, the domestic currency will appreciate; if a factor decreases the relative demand for domestic goods, the domestic currency will depreciate

Summary Factors That Affect Exchange Rates in the Long Run

occurs at point B, the intersection of the demand curve D and the supply curve S. The equilibrium exchange rate is E* = 1 euro per dollar.

to an Increase in the Domestic Interest Rate

Response to an Increase in the Foreign Interest Rate

Response to an Increase in the Expected Future Exchange Rate