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Financial Markets & Investments

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FINANCIAL MARKETS & INVESTMENTS

FINANCIAL MARKETS & INVESTMENTS [pic] Task: Write a brief essay (suggested length of 2–4 pages) in which you explain how foreign exchange markets facilitate international trade. In your essay: A. Differentiate between the nominal exchange rate and the real exchange rate. The nominal exchange rate is the rate at which a person can trade the currency of one country for the currency of another. For example: The dollar/yen exchange rate is the number of dollars you can get foe each yen. The real exchange rate is the level of the exchange rate factoring in inflation differences. It’s used to measure the price of foreign goods in price levels and not just in currency adjusted terms.

B. Explain the theory of purchasing power parity (PPP). The principle that a unit of currency will purchase the same basket of goods anywhere in the world (Cecchetti, 2011, p. 239). PPP is useful when the currency purchasing power of two countries varies drastically, when goods are available. For example: A box of cigarettes that sells for a $1.50 in Canada should cost a $1.00 in the U.S when the exchange rate between Canada and the U.S. is $1.50. As a result both boxes of cigarettes should cost a $1.00 in the U.S. PPP solves this by calculating the price of the box of cigarettes so the price is the same when calculated in the USD/CAD currency.

C. Identify at least three primary factors that influence the supply and demand for a country’s goods. 1. Discuss how each factor can affect exchange rates. The price that consumers will pay for imported goods and exports will be determined by the currency exchange rates between countries. When a countries currency is high exports are more expensive resulting in less expensive imports from foreign markets; a low currency results in less expensive exports and imports become more...

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