The role of exchange rates in foreign direct investment : a United States perspective

International transactions of goods, service and assets determine a country's exchange rate but the exchange rate for seemingly good reasons does not influence the international purchases and sale of assets. If a foreign asset generates a future stream of profits denominated in foreign currency and if the profits will be converted back into the domestic currency at the same exchange rate, the present discounted value of the investment will not be affected by the level of the exchange rate. This chapter presents recent developments in the academic literature on FDI with specific references to Froot and Stein (1991) and Blonigen (1997). The studies show that when selected conditions under perfect markets are relaxed, exchange rates perform a definite role in explaining FDI flows. Under these conditions, the connection between real exchange rate levels and FDI become clearly unambiguous.