Int Finance

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1.0 Introduction Since early 80s, the new policy that opened China to the world had gained great impacts on this country’s economy. To have a further understanding about the China’s currency, we analyze the historical movements of the Yuan (CNY) towards its trading currency pair – the US Dollar (CNY/USD) in a 20-years period till now, argue the policies adopted and other factors that caused such movements of the Yuan in the past. In addition, how arbitragers buy and sell CNY using 2 point, 3 point and covered interest rate arbitrage to make profit in reality is also explained in this report.

2.0 Historical movements of the CNY/USD

A flexible exchange rate is a system, which allows exchange rates to be affected by the supply and demand of its currency. It is unstable due to the low elasticity of import and export, which may cause depreciation in the currency, which leads higher levels of inflation. As China is a country with an undiversified export producing industry, it is unlikely that it would adopt this system as when the exchange rates rises, exporters would find it in their favor as they would be able to sell their goods cheaply aboard. However, importers are unhappy with the undervalued CNY as the price they would have to pay for goods would be more expensive and would seek to decrease the exchange rates. This would cause uncertainty with regards to investments and trade. However, Mr Guan, a senior official from China foreign exchange state that if China were to continue the peg with USD, when the dollar is facing a depression and inflation risk, the peg might cause China to import those problems (Wall Street Journal 2010). With the dollar depreciating to compete in the trade market and the constant rise in unemployment in the USA, it risks falling into a depression. When the dollar depreciates too much to increase exports, it would cause an increase in…...

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