...EXCHANGE RATE VOLATILITY AND RWANDA’S BALANCE OF TRADE By: MANIRAGABA, Ngabo Vallence vallencengabo@ines.ac.rw &: NKURUNZIZA, Fabrice nkurufabre123@ines.ac.rw ABSTRACT This paper examines the effect of exchange rate volatility and balance of trade sector in Rwanda for the period of January 1996 to December 2013, and tries to find appropriate models for both balance of trade and exchange rate to be used in forecasting for future values.. Some of the developing economies including Rwanda would appear to have exacerbated fluctuations in exchange rates, developing economies are special examples of high exchange rate, The impact of exchange rate levels on trade has been much debated but the large body of existing empirical literature does not suggest an indubitable comprehensive image of the trade impacts of exchange rate volatility in Rwanda. The review of the theoretical literature on this issue indicates that there is no clear-cut relationship between exchange rate volatility and balance of trade. This study examines the effect of exchange rate volatility and balance of trade sector in Rwanda The analysis followed the empirical methods (econometrics and time series analysis). The researchers used UBJ time series analysis to accomplish all stages (stationarity, identification, estimation, diagnostic checking and forecasting) of the models and models validation was of good quality and can be used in forecasting for future values. Polynomial regression model helped to establish...
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...Volatility of exchange rate The main objective of this research is to present a rationalized concept of the theory and composition of exchange rate that are compulsory to solve the important economic problems facing the economy in the country, like volatile exchange rate, unbalanced financial circumstances and frustration of government to have control over domestic money market. “Exchange rate” shows that how much unit of onenation’s currency can be purchased with one unit of domestic currency. More precisely, exchange rate is a conversion factor that determines rate of change of currencies. While exchange rates volatility shows that exchange rate is settled on demand and supply of one nation’s currency, it may turn out fastest moving price of currency and bring all the foreign capital in the economy. Exchange rate volatility can influence the decisions of policy makers and affect the volume of exports and imports. It can also affect the allocation of manufacturing of goods, reserve money, exports, imports and balance of payments. Exchange rate volatility provides chances to domestic investors to invest in foreign currency to obtain higher profits and thus domestic currency undervalue and foreign currency gain values. Moreover, this volatility of exchange rate directly influences the prices of exports, imports, reserve money, manufacturing productions and their growth rates. Traders and investors always support the system where the discrepancy of the difference between actual...
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...IMPACT OF OIL TRADE ON EXCHANGE RATE OF INDIA Introduction India in the 21st century is one of the fastest growing countries of the world. Oil being the bloodline of the growing economy, is a necessary commodity and has a very inelastic demand, steadily growing with time. In 2011, India was the fourth largest energy consumer in the world after the United States, China, and Russia. India's economy grew at an annual rate of approximately 7 percent since 2000 and proved relatively resilient to the 2008 global financial crisis. India was the 10th largest economy in the world in 2011, as measured by nominal gross domestic product (GDP). In the International Energy Outlook 2011, EIA projects India and China to account for the biggest share of Asian energy demand growth through 2035. India is heavily dependent on crude oil imported from the Middle East and imports more than 70% of its domestic demand. Due to a stagnation of domestic production, the import of crude has gone up from 11.68 million tons (mt) in 1970–1971 to 196 mt in 2007–2008. Oil import bill for India in 2007–2008 was $144.93 billion. With the high demand of oil and other petroleum, and their fluctuating price in the global markets, we are at a very high risk of foreign exchange risk. With so much purchase of energy imports, it might lead to exchange rate movements. And the volatility in the exchange rates (caused by the oil price volatility) may have severe effects on the economy, especially on infrastructural projects...
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...Foreign Exchange Market International Business Thesis By Mark Hansen 290587-1563 & Nina Johansen 140988-1838 Advisor Niels Blomgren-Hansen 17.05.2010 Executive summary In this thesis a financial transaction tax in the form of the Tobin Tax is examined as a means to reduce volatility on the foreign exchange market. James Tobin original proposal is presented followed by his 1995 paper and Frankel’s contribution to the discussion. Frankel gives merit to Tobin’s line of reasoning on reducing stability by dividing investors into short-term speculators and long-term fundamentalists and defines the former’s activities as destabilizing and the latter as stabilizing. However, we find this segmentation problematic since it is not possible to divide the market participants into these categories in the foreign exchange market. Many of the short-term investors do not necessarily speculate or disregard fundamentals, but rather try to avoid risk. Accordingly, many of the short term market movements are instead stabilizing. Therefore, the Tobin Tax would not only deter the destabilizing transactions, but also the stabilizing ones. If the foreign exchange market is in fact excessively volatile as Tobin argues then the tax could possibly have a positive effect by throwing sand in the wheels and thereby slowing short-term reactions. Our findings suggest that the foreign exchange market is in fact highly volatile, but we find no convincing evidence concluding this volatility to be...
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...Income Statement thereby reducing cash flow volatility. Revenue is generated & receivables are collected at budgeted rates Maintaining margins on long term projects as these projects are priced & bid with an exchange rate assumption, which needs to be protected to ensure desired margins Managing the translation risks in case of multiple geographies & overseas entities Best Practices A good risk management and hedging policy should be debated, understood & approved at the highest level (Board) The policy should indentify risks entity is exposed to, ways to measure these risks & suggest methods to mitigate these risks Should specify clear identification of responsibilities, authorities & limitations on its implementation Should state the purpose of hedging clearly - profit, protection, reducing volatility. Should suggest appropriate risk management tools like Sensitivity Analysis, VAR to contain risks Should be reviewed periodically by board in view of changing risks, market dynamics. Enctheirage use of natural hedges to reduce hedging costs METHODS OF HEDGING Methods of hedging can be classified as a. Internal methods b. External methods 1. Internal methods: Internal methods include: i. Invoicing: In invoicing the corporate shifts the entire exchange risk to the other party by insisting that all...
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...MANAGING F OREIGN E XCHANGE R ISK WITH DERIVATIVES by Gregory W. Brown* The University of North Carolina at Chapel Hill May, 2000 Version 3.4 Abstract This study investigates the foreign exchange risk management program of HDG Inc. (pseudonym), an industry leading manufacturer of durable equipment with sales in more than 50 countries. The analysis relies primarily on a three month field study in the treasury of HDG. Precise examination of factors affecting why and how the firm manages its foreign exchange exposure are explored through the use of internal firm documents, discussions with managers, and data on 3110 foreign-exchange derivative transactions over a three and a half year period. Results indicate that several commonly cited reasons for corporate hedging are probably not the primary motivation for why HDG undertakes a risk management program. Instead, informational asymmetries, facilitation of internal contracting, and competitive pricing concerns seem to motivate hedging. How HDG hedges depends on accounting treatment, derivative market liquidity, foreign exchange volatility, exposure volatility, technical factors, and recent hedging outcomes. * Department of Finance, Kenan-Flagler Business School, The University of North Carolina at Chapel Hill, CB 3490 – McColl Building, Chapel Hill, NC 27599-3490. Voice: (919) 962-9250, Fax: (919) 962-2068, Email: gregwbrown@unc.edu. A more recent version of this document may be available from my web page: http://itr.bschool...
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...Definition Illustration of Operating Exposure Determinants of Operating Exposure Managing Operating Exposure Selecting Low-Cost Production Sites International Finance in Practice: The Strong Yen and Toyota’s Choice Flexible Sourcing Policy Diversification of the Market R&D Efforts and Product Differentiation Financial Hedging International Finance in Practice: Porsche Powers Profit with Currency Plays CASE APPLICATION: Exchange Risk Management at Merck Summary MINI CASE: Economic Exposure of Albion Computers PLC How to Measure Economic Exposure 1. Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange rate a) Can have a significant economic consequences for U.S. firms. b) Can have a significant economic consequences for Japanese firms. c) Can have a significant economic consequences for both U.S. and Japanese firms. d) None of the above Answer: c) 2. Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange rate a) Will tend to weaken the competitive position of import-competing U.S. car makers. b) Will tend to strengthen the competitive position of import-competing U.S. car makers. c) Will tend to strengthen the competitive position of Japanese car makers at the expense of U.S. makers. d) None of the above Answer: b) 3. When the Mexican peso collapsed in 1994, declining by 37 percent, a) U.S. firms that exported to Mexico and...
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...Chapter Exchange Rate Determination and Forecasting QUESTIONS 1. What is the difference between the ex ante and the ex post real interest rate? 10 Answer: The ex post interest rate corrects the nominal interest rate with the realized or ex post rate of inflation; whereas the ex-ante (or expected) real interest rate corrects the nominal interest rate for expected inflation. As a lender, you care about the real return on your investment, which is the return that measures your increase in purchasing power between two periods of time. If you invest $1, you sacrifice $1 1+i real goods now, where P(t) is the price level. In 1 year, you get back , where i is the P(t) P(t+1) nominal rate of interest. We calculate the real return by dividing the real amount you get back by the real amount that you invest. Thus, if rep is the ex post real rate of return and ex post real interest rate, we have 1 + r ep ⎛ 1+i ⎞ ⎜ P(t+1) ⎟ ⎠ = (1 + i ) = ⎝ ⎛ 1 ⎞ ⎛ P(t+1) ⎞ ⎜ P(t) ⎟ ⎜ P(t) ⎟ ⎝ ⎠ ⎝ ⎠ Notice that the real rate of interest depends on the realization of the rate of inflation because P(t + 1)/P(t) = 1 + π(t + 1), where π(t + 1) is the rate of inflation between time t and t + 1. For simplicity, we drop the time notation and simply write 1 + r ep = If we subtract 1 from each side, we have (1 + i) (1 + π) r ep = which is often approximated as (1 + i) (1 + π) i-π = (1 + π) (1 + π) (1 + π) rep = i – π The approximation involves ignoring the term (1 + π) in the denominator...
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...debt crisis on the foreign exchange market 1. Introduction In 2010, the debt crisis caused the euro to go down 10% in a three-month period. Some largest hedge funds in America discovered this opportunity and short euro in groups to an enormous scale. Later on, the British pound is being infected. It continuously dropped for six days, which wrote the longest dropping period record. In this paper, the objective is to critically analyse how the European sovereign debt crisis affects foreign exchange markets. The theme focuses on the contagion on the markets. The contagion phenomenon exists between foreign exchange spot and derivative markets. One of the channels is the investor sentiment, which makes large scale of influences on both markets and volatility dynamics (Corredor, P., Ferrer, E., Santamaria, R., 2015). It makes sense on aspects like trading volume, effective transaction costs and so on. This paper has two main parts. The first part is to evaluate impacts on foreign exchange spot market through analysing the political channel, bank channel and financial markert channel. The second part is to investigate impacts on foreign exchange derivatives, especially on the foreign exchange swap. 2. Contagious impact on the foreign exchange market 2-1 Impacts on foreign exchange spot (impacts on euro) In this part, we explain how the debt crisis makes impacts on the foreign exchange spot market, especially, we focus on the exchange rate of euro against dollar. In...
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... b. If goods market arbitrage enforces broad parity in prices across a sufficient range of individual goods, (The law of one price) there should also be a high correlation in aggregate price levels. 2. Consensus Facts PPP c. Real exchange rates tend toward purchasing power parity in the long run (Nominal adjusted for difference in national price levels) d. Convergence Speed for PPP is very slow, deviations of roughly 15% per year. e. Short run deviations from PPP are large and volatile, one month conditional volatility of real exchange rates is of the same order of magnitude as the conditional volatility of nominal exchange rates. Price differential volatility is surprisingly large even when one confines attention so similar classes of highly traded goods. 3. PPP and Its Puzzle: How can we reconcile the enormous short term volatility of real exchange rates with the slow rate at which shocks appear to damp out. (Half life of three to five years) * 1. Creation a. Set in place as a means of setting relative gold parities. 2. Variants of PPP b. The Law of One Price (LOP) i. Domestic currency price of good I is equal to foreign currency price times the exchange rate. ii. Lop states that once converted, goods should sell at the same price in different countries. However it does not take into account extra costs like tariffs and transportation costs. iii. Commodities where the deviations...
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...BRAC University Journal, vol. V, no. 2, 2008, pp. 81-91 FOREIGN EXCHANGE RISK MANAGEMENT PRACTICES - A STUDY IN INDIAN SCENARIO Sathya Swaroop Debasish Department of Business Management Fakir Mohan University Vyasa Vihar, Balasore - 756019 Orissa, INDIA ABSTRACT Indian economy in the post-liberalisation era has witnessed increasing awareness of the need for introduction of various risk management products to enable hedging against market risk in a cost effective way. This industry-wide, cross-sectional study concentrates on recent foreign exchange risk management practices and derivatives product usage by large non-banking Indian-based firms. The study is exploratory in nature and aims at an understanding the risk appetite and FERM (Foreign Exchange Risk Management) practices of Indian corporate enterprises. This study focusses on the activity of end-users of financial derivatives and is confined to 501 non-banking corporate enterprises. A combination of simple random and judgement sampling was used for selecting the corporate enterprises and the major statistical tools used were Correlation and Factor analysis. The study finds wide usage of derivative products for risk management and the prime reason of hedging is reduction in volatility of cash flows. VAR (Value-at-Risk) technique was found to be the preferred method of risk evaluation by maximum number of Indian corporate. Further, in terms of the external techniques for risk hedging, the preference...
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...Economics 2 (2006) 129-146 EXCHANGE RATE RISK MEASUREMENT AND MANAGEMENT: ISSUES AND APPROACHES FOR FIRMS MICHAEL G. PAPAIOANNOU, Ph.D. International Monetary Fund Abstract Measuring and managing exchange rate risk exposure is important for reducing a firm’s vulnerabilities from major exchange rate movements, which could adversely affect profit margins and the value of assets. This paper reviews the traditional types of exchange rate risk faced by firms, namely transaction, translation and economic risks, presents the VaR approach as the currently predominant method of measuring a firm’s exchange rate risk exposure, and examines the main advantages and disadvantages of various exchange rate risk management strategies, including tactical vs. strategical and passive vs. active hedging. In addition, it outlines a set of widely-accepted best practices in managing currency risk and presents some of the main hedging instruments in the OTC and exchange-traded markets. The paper also provides some data on the use of financial derivatives instruments, and hedging practices by US firms. JEL Classification: F31, G13, G15, G32, M21 Keywords: Financial Risk, Financial Management, Foreign Exchange Hedging, Corporate Hedging Practices Corresponding address: 700 19th Street, N.W. Washington, DC 20431 e-mail: mpapaioannou@imf.org This paper draws heavily on various presentations on risk management while the author was the Director of Foreign Exchange Service of the WEFA Group...
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...Foreign Exchange Author Info Elena Andreou Maria Matsi Andreas Savvides Registered author(s): Andreas Savvides Abstract This paper investigates bi-directional linkages between the stock and foreign exchange markets of a number of emerging economies. A quarto-variate VAR-GARCH model with the BEKK representation is estimated for each of twelve emerging economies to test for spillovers, both in terms of return and volatility, between the emerging stock market, foreign exchange market and global and regional stock markets. We find significant bi-directional spillovers between stock and foreign exchange markets. We also examine the effects of a country’s choice of exchange rate regime, on the one hand, and the Asian financial crisis, on the other, on the volatility spillover mechanism. GLOBAL LINKAGE OF FOREIGN EXCHANGE MARKETS 6 Introduction The foreign exchange market is the biggest financial market in the world. Every day, transactions worth about 3.98 trillion dollars are carried out within the market. The major aim of introducing the foreign exchange market is to facilitate international trade by enabling businesses to perform transactions outside their local currency. The market operates round the clock from Monday through Friday. Foreign Exchange is the simultaneous Buying of one currency and paying for it with another at an agreed price (exchange rate) for settlement on an agreed date. FOREX is an acronym for FOReign Exchange. In the...
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...US dollars and 1 million Swiss Francs. The closing exchange rates yesterday were AU$1.5/US$ and AU$1/SWF. The historical average value of daily exchange rate return is zero for both AU$/US$ and AU$/SWF. The standard deviations of daily exchange rate return for AU$/US$ and AU$/SWF are 50 basis points and 100 basis points respectively. The historical correlation between the two exchange rate returns is 0.5. a) If the daily exchange rate returns for both AU$/US$ and AU$/SWF follow a normal distribution and independent across dates (i.e., the serial correlation in daily exchange rate returns is zero), what is 10-day VaR for the bank’s aggregate holdings of two currencies? b) Assume for this question that the daily exchange rate returns for AU$/SWF do not follow a normal distribution and not independent across dates either. Based on the historical data, there is typically 5% of chance that SWF will depreciate by more than 150 basis points relative to AU$ in 10 days, and there is also 5% of chance that SWF will appreciate by more than 100 basis points relative to AU$ in 10 days. What is 10-day VaR for the bank’s SWF position? 2. Foreign exchange risk a) OZ Bank issues a one-year Australian certificate of deposit to finance a US$1 million investment in one-year fixed rate U.S. bonds. The interest rate of AU$ CD is 5% per annum. and the yield to maturity of the US bond is 10% per annum. Currently, spot exchange rates are...
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...Exchange rate determination model as discussed by Alan C. Stockman A. Stockman did propose an alternative equilibrium explanation of ex- change rate behavior. The explanation is based on a model of the simultaneous determination of exchange rates and relative prices of different goods in international trade in an intertemporal framework with uncertainty and rational expectations. The model emphasizes the role of relative price changes, caused by real disturbances, in determining the behavior of exchange rates and integrates the important issues discussed by the traditional "elasticity theorists" into a general equilibrium framework. 2. In the model developed in his paper, explains exchange rates may be volatile and can exhibit auto correlated deviations from purchasing power parity, even though prices freely adjust to clear markets. Ex- change rate changes may appear to cause relative price changes and generate additional uncertainty even when all markets are in equilibrium. Nevertheless ,the relationship between the exchange rate and the terms of trade cannot be exploited by government exchange rate policies.-' 3. The model shows how a change in the terms of trade caused by relative supply or demand shifts is divided between nominal price changes in each country and an exchange rate change, creating a correlation between the exchange rate and the terms of trade. The greater the changes in the terms of the trade and the larger the role of changes in the exchange rate in...
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