...Critical Thinking, (Spot Exchange Rate) The interest rate on South Korean government securities with one-year maturity is 4%, and the expected inflation rate for the coming year is 2 %. The interest rate on U.S. government securities with one-year maturity is 7%, and the expected rate of inflation is 5%.The current spot exchange rate for Korean Won (W) is $1 = W1,200. Forecast the spot exchange rate one year from today (Hall, p. 318). The forecast spot exchange rate one year from now will be W1,166.35. Explain the logic of this answer? The logic for the above answer begins by understanding the meaning and relationship between Spot, Exchange Rate, Interest Rate Parity, and Fisher Effect. 1. Spot Exchange Rates The interaction between supply and demand influences the exchange spot rate. The spot exchange rate is the daily rate which one currency is converted into another. 2. The Fisher Effect In foreign currency transactions between two countries, the spot exchange rate changes in equal amounts as it moves the opposite direction to the difference in nominal interest rates between two countries. According to the Fisher effect, only the interest rate and not the inflation rate are used for calculating the spot interest rate. 3. Interest Rate Parity The differences in currency values pertain to short-term interest rate differences between two countries. The real int. rate in the United States is 2% (7-% maturity – 5% expected inflation). The real interest for...
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...Exchange Rate Exposure Dominique and Tesar 2006 – Journal of International Economics 68 Summary by Paolo De Angelis As any introduction, the first part of the article describes and conjects about the main thesis: a possible relationship within exchange rate exposure and firm value. The Authors talk about their work and how they builded such strong hypothesis to demonstrate which is the connection and doing that they explain two objectives: understand how much these firms are exposed to exchange rate fluctuation and investigate why some firms are exposed and some not. Then there is an explanation about tools used to do the research and statistic technique used to test different ideas about correlation among main features characterizing these frims. A very important inference is about the firms involved and not; talking about Ford Motor Company the Authors explain how not only international operating firms are influenced by exchange rate but also local ones, infact exchange rate does influence sales competition in the country where local firms operate. As a resume it explain the third hypothesis about firms exposed due to the level of trade that they do; but, instead of the two previous hypothesis, using proxies because of data lacking. All of this using two diffused indexes: a mark-up index and the Herfindhal Hirschman Index, that is very suitable because of his power to evaluate firms not only relating to market share but squaring it to avoid both arithmetical...
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...than the debit. It means that this country is using its saving for investing. In Singapore, the government is heavily managed the country’s economy. It promotes high levels of savings. Also, the Monetary Authority of Singapore focuses on accumulating foreign reserves. Consequently, Singapore became a net creditor to other countries. It has a large current account surplus and saving accumulation in excess of domestic investment demand, which lead to produce a long-term real appreciation of the SGD. 2. What is a real exchange rate? What determines real exchange rates in the long-run? Real Exchange Rate = Nominal Exchange Rate - Inflation It’s the ratio at which any country’s own currency is equivalent to other currencies in terms of purchasing power. It discounts inflation from the nominal interest rate. It also provides a better measurement of countries exchange rates. The Monetary Authority of Singapore focused mainly on inflation and didn’t use exchange rate as a competitive tool. Therefore, Singaporean companies had to find its way in competing with foreign producers without having...
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...understanding on the forces driving exchange rate changes as these would affect investment and financing opportunities. This report analyzes the movements of three currencies, Australian Dollar (AUD), Icelandic Krona (ISK), and Indian Rupee (INR) against US dollar, and suggests events that may cause the violations of three chosen currencies. Analysis shows that factors including but not limited to inflation rates, interest rate differences, foreign investment as well as demand and supply of domestic currency are highly correlated with exchange rate changes in chosen currencies. Based on the analysis, Purchasing Power Parity is used to forecast spot exchange rates of those chosen currencies in one-year and three-year time. Rationales and limitations of PPP are also given to analyze the forecasts of three currencies. Table of Content 1.0 Introduction 1 2.0 Question 1 1 2.1 AUD/USD 1 3.0 Question 2 4 3.1 ISK/USD 4 3.2 INR/USD 6 3.3 Common Events that May Have Influenced the Exchange Rate Changes 8 4.0 Question 3 9 4.1 Forecast of Currencies 9 4.2 Forecast of AUD 10 4.3 Forecast of ISK 11 4.3 Forecast of INR 11 4.3 Comments on the Forecasts 12 References 13 Figures & Tables Figure 1 Exchange Rate of AUD/USD Over Five Years 1 Figure 2 Percentage Change of AUD/USD Exchange Rate 2 Figure 3 Trends of AUD/USD and Gold Price 2 Figure 4 AUD/USD Exchange Rate and Interest Rate over Five Years 3 Figure 5 Exchange Rate (ISK/USD) 4 Figure 6 Percentage...
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...Determinants of Exchange Rates * The Purchasing Power Parity or PPP happens to be one of the most significant approaches to determine exchange rate. PPP is primarily based on the “Law of One Price”. However, this law is based on the assumption that identical goods are sold at equal prices. It is a flow model of the balance of payment. This law lays down that exchange rate of currencies have to compensate for the differences in prices of goods. The Relative PPP approach continues to be applied till date. This approach lays down the fact the exchange rate has to compensate for the difference in inflation rate. PPP is not a very reliable determinant since changes in technology, commercial policies, labor force and tastes change the national productivity, which in turn changes the real exchange rate. * The Balance of Payment Approach depends on the assumption that there exists an exchange rate and there exists internal and external equilibrium. The internal equilibrium is based on the assumption that there is full employment. The external equilibrium is the equilibrium in the balance of payments. This theory is more dependable as it can explain permanent deviations in PPP. This approach offers guidance on short term ups and downs. There are certain disadvantages of this approach. The model does not inform about the exact rate of unemployment. Next, the exchange rate does not maintain its consistency in accordance with the external accounts. * Monetary and Portfolio Approach...
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...-21 (revised) OFFICE OF INDUSTRIES WORKING PAPER U.S. INTERNATIONAL TRADE COMMISSION How Do Exchange Rates Affect Import Prices? Recent Economic Literature and Data Analysis Cathy L. Jabara Office of Industries U.S. International Trade Commission Revised, October 2009 Cathy Jabara is a Senior Economist with the Office of Industries of the U.S. International Trade Commission. Office of Industries working papers are the result of the ongoing professional research of USITC Staff and are solely meant to represent the opinions and professional research of individual authors. These papers are not meant to represent in any way the views of the U.S. International Trade Commission or any of its individual Commissioners. Working papers are circulated to promote the active exchange of ideas between USITC Staff and recognized experts outside the USITC, and to promote professional development of Office staff by encouraging outside professional critique of staff research. This paper is a revised version of Working Paper No. 21 dated May 2009. The paper has been updated to include 4 lags in the exchange rate estimation, instead of 3, and a new equation for Latin America is included. JEL codes: F10, F12 Key words: Exchange rates, pass-through, U.S. imports Address correspondence to: Office of Industries U.S. International Trade Commission Washington, DC 20436 How Do Exchange Rates Affect Import Prices? Recent Economic Literature and Data Analysis Cathy L. Jabara U.S. International...
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...1 Explain how foreign exchange rates are determined. How do changes in interest rates, inflation, productivity, and income affect exchange rates? What are the advantages and disadvantages of a weak versus a strong dollar for imports, exports, international and domestic markets? Explain how foreign exchange rates are determined? Foreign exchange rates exist because banks buy and sell foreign currencies from other countries in large quantities. Exchange rates exist in the U.S. dollar, Europe euros, Japanese yen, British pounds, Canadian dollars, Australian dollars, and much more. There are currently two main systems that are used to determine a currencies exchange rate. The floating currency sort of works like the supply demand method. This system is normally used for countries that are in a stable economy. These exchanges are considered more efficient because the market will correct the rate to reflect inflation and other economic forces automatically. The downfall of this system is that it can discourage investment. The other system is a pegged or also known as a fixed system. This is the system that is used when an exchange rate is set and artificially maintained by the government. The rate will be pegged to other countries dollar and does not fluctuate from day to day. How do changes in interest rates, inflation, productivity, and income affect exchange rates? Exchange rates affect different areas in the economy such as interest rates, inflation, productivity...
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...Friday, May 3, 13 Principles of Macroeconomics Exchange Rates People, firms and nation exchange products for money and use the money to buy other products to pay for the use of resources. Within an economy, prices are stated in the domestic currency, such as US dollars to European euros. Buyers use their currency to purchase goods. International markets are different. Producers in other countries who export goods want to be paid in their own currencies so they can carry out transactions. As a result, a foreign exchange market develops where national currencies can be exchanged. Such markets serve the need of all international buyers and sellers. The equilibrium prices in these markets are called exchange rates. An exchange rate is the rate at which the currency of one nation is exchanged for the currency of another. The foreign exchange market is the financial relationship between countries that makes it possible for international trade to be accomplished more efficiently than barter. Because each nation uses its own monetary unit, people in one country who want to purchase something in another country must exchange their own currency for the other to accommodate the transaction. Many travelers will research foreign exchange rates before purchasing cheap airline tickets or other means of travel to other countries. Depending on the destination, some travelers can benefit greatly from exchanging currencies .The foreign exchange market is where one nation's currency is traded...
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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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...What is exchange rate? In finance, exchange rate is the value of one country currency in terms of another country currency. In other words, it is the rate that will be exchanged by one country currency in order to obtain another country currency. For example: When Vivian ,a Malaysian wants to travel to America, she will need to change Malaysia ringgit into US Dollar in order to consume any kind of facility or shelter provided in America. Exchange rate is needed because one nation’s currency is not always accepted in another. Besides that, exchange rates changes every day and when exchange rate changes, it affect different stakeholders in different ways depending on the direction of change. Exchange rates are determined in the foreign exchange market and are open to a wide range of different type of buyers and sellers across different country. Currency trading is continuous from 20:15GMT Sunday to 22:00 GMT Friday. Furthermore, when others say a statement such as an interbank exchange rate of 80 Japanese yen(¥80) to the United Stated dollar (US $) give the meaning of US$ 1 will be exchanged for each ¥80 or ¥80 will be exchange for each US$1. In other words, an individual must give up US$1 to get ¥80. However, if the exchange rate in one country is higher than another, this means that the value of money of that country is worth more than a country with a lower exchange rate. Also, exchange rates are market clearing price that equilibrate supplies and demand in the foreign exchange...
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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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...exchange rate determination “Having endeavored to forecast exchange rates for more than half a century, I have understandably developed significant humility about my ability in this area…”[1] - Alan Greenspan Figure 1: Exchange Rate Determination [pic] Source: Exchange Rate Determination I. Short-Run Forecasting Tools Short-term changes in exchange rates are the most difficult to predict and are often determined based on bandwagon effects, overreaction to news, speculation, and technical analysis.[2] Trend-Following Behavior is the tendency for the market to follow a trend. In other words an increase in the exchange rate is more likely to be followed by another increase. Investor Sentiment is based on the consensus of the market. For example if the market is bullish on the dollar, then the dollar is likely to strengthen versus other currencies. The FX market is quite different from the world equity markets in one important aspect: transparency. In equity markets, rules ensure that volume and price data are readily available to all parties… this is NOT the case in FX markets. In fact large FX dealers are able to observe factors such as: shifts in risk appetite, liquidity needs, hedging demands, and institutional rebalancing.[3] Order Flow - there is evidence of a positive correlation between spot exchange rate movements and order flows in the inter-dealer market[4] and with movements in customer order flows.[5] Three explanations for the cause...
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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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...Nicole Soto 02/15/15 Exchange Rates With regard to currencies, exchange rates, as well as any other price, are determined by supply and demand. The supply and demand of currencies depends on many factors which can be grouped as follows: * the monetary system, which places the political structure in relation to exchange rates; * economic data as the trade balance, inflation and the national product. Fundamental analysis is based on the observation and evaluation of these economic data, as has been proved in the past, has influenced exchange rates. Taking into account these correlations optimal analysis can be done to give an indication of the long-term trend of exchange rates; * technical factors. historical rate fluctuations and volumes are examined and analyzed. Some models, which are expected to repeat themselves over time, can be used as a predictive criterion for short-term trends (technical analysis); * expectations. activities of financial operators are not the only based on known economic data, but also on their expectations of future trends; * political events / psychological factors, such as elections, political tensions, etc. Fundamental analysis is based on the study of the economy. It is based on the assumption that the supply and demand of currencies is the result of economic processes that can be observed in practice and can be predictable. Fundamental analysis studies the relationship between the evolution of exchange rates and economic indicators...
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...BACK TO BASICS Why Exchange Rates? Luis A.V. Catão OW does one determine whether a currency is fundamentally undervalued or overvalued? this question lies at the core of international economics, many trade disputes, and the new IMF surveillance effort. George Soros had the answer once—in 1992—when he successfully bet $1 billion against the pound sterling, in what turned out to be the beginning of a new era in large-scale currency speculation. Under assault by Soros and other speculators, who believed that the pound was overvalued, the British currency crashed, in turn forcing the United Kingdom’s dramatic exit from the european exchange Rate Mechanism (eRM), the precursor to the common european currency, the euro, to which it never returned. But in the ensuing years, neither Soros nor fellow speculators have repeated the feat consistently, and the economics profession itself lacks a foolproof method of establishing when a currency is properly valued. this failure is striking given that the exchange rate is a central price in economics and that there is a measure potentially capable of delivering the answer and for which plenty of data exist: the real exchange rate (ReR). Real h What things really cost Most people are familiar with the nominal exchange rate, the price of one currency in terms of another. It’s usually expressed as the domestic price of the foreign currency. So if it costs a U.S. dollar holder $1.36 to buy one euro, from a euro holder’s perspective...
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