ABSTRACT
In this chapter we continue our analysis of the financial markets in our global economy model by combining the various sectoral demand and supply functions for financial assets associated with trading a good or asset denominated in one country’s unit of account for a good or asset denominated in the other country’s unit of account. These transactions are divided into spot contracts, in which parties agree to trade assets denominated in different units of account during the current period, and forward contracts, in which agents agree during the current period to exchange goods or assets denominated in different units of account next period. First, we derive separate equilibrium conditions for the spot and forward markets and discuss the factors affecting each of these conditions. Then we combine these equilibrium conditions, producing an SF locus, showing for a given spot rate the combinations of the forward exchange rate and the home and foreign bond rates consistent with simultaneous equilibrium in the spot and forward markets. Then we discuss the impacts of environmental factors upon these simultaneous equilibria.
