CHAPTER 3

How Exchange Rates Are Determined

Trade, capital flows and expectations

Opening question

“Why does the dollar rise when US interest rates go up?”

In this chapter

The exchange rate as a price that balances currency supply and demand
Trade, investment and remittance flows in the balance of payments
Purchasing power parity as a long-run anchor, with a worked example on the dong
The Big Mac idea and what it can and cannot tell an investor
Why capital chases yield, and the risks of the carry trade
Expectations, risk-on and risk-off, and safe-haven currencies
How the State Bank of Vietnam manages the dong with a central rate and a band
Which drivers matter at which horizon

🔒

This chapter is in the full book

Chapter 1 is free to read online. The full text of chapter 3 — with its tables, figures, worked examples and practice lab — is available in the complete edition of Forex and Crypto Investing: From Theory to Practice (Volume 3, NXW Investment Library).

Read Chapter 1 free Get the full book — [email protected]

Sections of this chapter

3.1 An exchange rate is a price

3.2 Flows: the balance of payments

3.3 Purchasing power parity: the long-run anchor

3.4 The Big Mac idea

3.5 Interest rates: capital chases yield

3.6 Expectations, risk appetite and safe havens

3.7 Crypto-assets and the dollar

3.8 The dong: a managed exchange rate

3.9 Which driver matters when?

← Chapter 2: A Short History of Money, Exchange Rates and Bitcoin Chapter 4: The Foreign Exchange Market: Spot, Forwards and Swaps →