There are several methods in which foreign exchange rates can potentially be predicted which are based upon parity conditions, balance of payments, and the asset market. After an evaluation of each of these methods, an assessment will be provided suggesting the best approach for financial managers to utilize as they attempt to forecast exchange rates.
The law of one price suggests that identical goods sell for a single price regardless of the location of the market or the currency in which the good is denominated (Eiteman, Stonehill, & Moffett, 2010). When the prices across markets differ, arbitrage opportunities exist and arbitrageurs will buy and sell goods to return the market price to equilibrium (Bodie, Kane, & Marcus, 2011). Out of these arbitrage activities, various international parity conditions arise connecting exchange rates, interest rates, and price levels (Eiteman et al., 2010).
The purchasing power parity (PPP) theory suggests that, given the law of one price, the exchange rate can be determined based on an “individual set of prices” (Eiteman et al., 2010, p. 165). It relates the pricing of goods to the movement in inflation rates between countries (Eiteman et al., ...
... middle of paper ...
...s. (9th ed.). New York, NY: McGraw-Hill/Irwin.
Eiteman, D. K., Stonehill, A. I., & Moffett, M. H. (2010). Multinational Business Finance. (12th ed.). Boston, MA: Pearson Education, Inc.
Gharleghi, B., Shaari, A. H., & Shafighi, N. (2014). Predicting exchange rates using a novel “cointegration based neuro-fuzzy system.” International Economics, 137. http://dx.doi.org/10.1016/j.inteco.2013.12.001
Rogoff, K. (2009). Exchange rates in the modern floating era: What do we really know? Review of World Economics, 145(1), 1-12. http://dx.doi.org/10.1007/s10290-009-0006-5
Solnik, B. B. (1978). International parity conditions and exchange risk. Journal of Banking & Finance, 2(3), 281-293. http://dx.doi.org/10.1016/0378-4266(78)90017-1
Taylor, M. P. (1995). The Economics of Exchange Rates. Journal of Economic Literature, 33(1), 13-47. Retrieved from http://www.AEAweb.org
Need Writing Help?
Get feedback on grammar, clarity, concision and logic instantly.Check your paper »
- Introduction Currency exchange rate is one of the important factor which affect external and internal balances of a country. Devaluation of a local currency makes its goods relatively cheaper. So its capacity of exports is likely to increase with devaluation if it has got enhanced productive capability and favorable trade-related elasticity. With the increase in demand for country’s goods and services, its currency appreciates and reverse is the case if its volume of exports falls. So Cristine (1981) describes the foreign exchange risk is the possibility of changes in the value of the company which arises from the potential for changes in foreign exchange rate.... [tags: Economics ]
1025 words (2.9 pages)
- 3.1 Determinants of Exchange Rate Foreign exchange rate is the price of a unit of foreign currency in terms of the domestic currency . In a floating exchange rate mechanism, foreign exchange rate is determined in the same way like the price of any other commodity in a free market economy. Thus, change in the value of the domestic currency relies on factors like foreign exchange reserves, money supply in the economy, the central bank’s policies and differences in the interest yield on dated securities of the concerned economies.... [tags: capital, inflation, interest]
1033 words (3 pages)
- Discuss the concepts of internal and external balances and what floating exchange rates can do to a country's economy Review of the subject When referring to the internal balance these are the goals of economics relating to full employment or a case of normal production and low inflation, that is, the prices are stabilized. In the situation of over-employment the prices of materials increase while in the case of under-employment the prices will decrease. When unexpected inflation occurs, the country finds it difficult to plan for the future and there is a case of income redistribution between traders and investors.... [tags: inflation, countries, economy]
479 words (1.4 pages)
- 1. Introduction Exchange rates are the price of a country’s currency in terms of another country’s currency. For example, the Japanese yen is pegged to the United States dollar which is known as the USD/JPY exchange rate. This in turn, means that exchange rates have two components, the domestic currency and a foreign currency, which can be quoted either directly or indirectly. A direct quotation is the price of a unit of foreign currency expressed in terms of a domestic currency, whereas, an indirect quotation is the price of 1 unit of domestic currency expressed in terms of a foreign currency.... [tags: currency, GDP, money]
2259 words (6.5 pages)
- Factors influencing the exchange rate There are a several factors which can influence the exchange rate of a given country such as interest rate of a country, inflation rate and money supply. In some reason non-theoretical or non-economical factors can influence the exchange rate to appreciate or depreciate against the other currencies. 1. Inflation rate How price and inflation rate can affect the exchange rate can be explained by Purchasing Power Parity (PPP) theory. In other words, PPP theory suggests that, in a long-term domestic inflation can influence the exchange rate.... [tags: foreign currency, ppp, trade]
582 words (1.7 pages)
- Exchange Rates Missing Two Graphs “For many years it has been believed that if countries import more than they export and so have a deficit on the current account of the balance of payments then their currencies will tend to fall in value. Yet over the last two years the dollar has been a strong currency even though USA has had a record current account deficit. How can this fact be explained. What does it tell us about the factors, which determine exchange rates. What policy decisions with regard to exchange rates do you think USA and other governments should take in response to these developments?” Exchange rates Exchange Rate, in relation to foreign exchange of money, is the... [tags: Economics]
2357 words (6.7 pages)
- Introduction The foreign exchange market is a worldwide decentralized over-the-counter financial market for the trading of currencies. It determines the relative values of different currencies. A local currency is a currency not backed by a national government, and intended to trade only in a small area. Currency is used as a medium of exchange in goods and services. It has vital role in the economy. Because devaluation of a local currency makes its goods relatively cheaper; it increases the capacity of exports.... [tags: Economics]
2697 words (7.7 pages)
- Introduction Currency exchange rate is one of the important factor which affect internal and external balances of a country. Devaluation of a local currency makes its goods relatively cheaper. So its capacity of exports is likely to increase with devaluation of local currency. With the increase in demand for local country’s goods and services, its local currency appreciates and reverse is the case if its volume of exports falls. So foreign exchange risk is described by (Christine, 1985) that this is the change in the value of the firm occur due to the potential changes in currency exchange rate.... [tags: Economics]
3342 words (9.5 pages)
- Methodology Data The purpose of this research is to examine the foreign exchange risk exposure of listed companies on the Karachi Stock Exchange (KSE) over the period January 2005 to December 2009. The research uses different exchange rate measures namely; the rupee to US dollar, the rupee to UK pound sterling, and the rupee to the euro to determine the degree of exposure. The data for this study involved 40 listed firms on the Karachi Stock Exchange. Monthly share price information for the period January 2005 to December 2009 required for the study were obtained from the Karachi Stock Exchange (KSE).... [tags: Economics ]
2251 words (6.4 pages)
- Foreign Exchange Paper A country's currency is a gauge of how well that country's economy is doing. "Currently the United States has a 3% real rate of return. The short-term interest rate is 5.25% and the inflation rate is 2.25% based on the core-rate from the GDP numbers" (Kordell, 2008). If one compares our real rate of return with other countries; Canada +2.50, Britain +2.50, Euro FX +0.25, and Japan +1.15 one can see that money tended to flow towards the U.S. over the past several years ever since the monetary policy was changed and interest rates in the U.S.... [tags: Economics Finance]
1415 words (4 pages)