The Mexican peso in this case appreciates in relative to the US dollar, is of great benefit to the Mexican production industries. This is because the cost of exports will raise thus increase in profits for the Mexican industries. Mexican products too will be competitive in the international market as the production cost does not exceed the sale value of the product. US investment in Mexico will increase due to certainty of the value the peso and the higher inflation rate of Mexico than that of US. Foreign exchange risk is minimized as investors are able to eliminate all doubts when they evaluate all likely risks. The fact that there is lack of perfect information concerning markets means that investors have to operate on market signals, but this will be sufficient to make vigilant investors act on first sight of an opportunity.
When nominal interests rise and the real interest falls, the euro depreciates in value. This denotes an increase in expected inflation which results in an expected depreciation of the euro that is greater than the rise in domestic interest rate. This leads to fall in euro assets and as a result, the general exchange rate of the euro. The movement demonstrated above has been the key driver of the global markets.
A country whose domestic currency devalues is not most likely to be in bad shape. Even though a weak currency has its negative impacts, the advantages mostly outweigh the disadvantages. Advantages of a weak currency are; cheap domestic goods and services, which lowers imports thus promoting local industries, increased demand for locally produced goods and services encourages more local production, increase in demand for exports. Locally produced goods are cheaper and of good quality, their demand in foreign countries increases. This in turn increases employment opportunities that are of great benefit to the country’s economy. A weak currency also promotes tourism; people from other countries find it cheaper to travel to the countries with weak currency as they are likely to spend less. Tourism is a major income earner for any country in terms of foreign exchange. A weak currency has its negative effects on the economy, for instance purchase of foreign goods that are not available locally is expensive and so is traveling abroad. Although a weak currency makes locally produced goods competitive in international market, foreign trade is restrained due to high cost of imports. Purchase of raw materials and other unfinished goods becomes too expensive increasing the prices of goods. The alteration between import and export volumes ,all attached to price will determine the long term economic health of a state, hence from this stand point, sober decisions needs to be undertaken so as to guard the long-term financial outlook of an economy.
The central bank is the chief custodian of a country’s money. Through this, central banks will keep unfavorable economic conditions in check, like inflation, which is as a result of printing excess currency .During the fixed exchange rate regime where the Indonesia’s par exchange rate is undervalued, its central bank has to intervene. This is done through the sale of the domestic currency and purchase of foreign assets in the exchange market by Indonesia’s central bank. By doing so, it would see Indonesia’s international reserves and money supply increase. This process is otherwise referred to as unsterilized foreign exchange intervention. Whereby, the central bank of Indonesia makes an unsterilized sale of foreign assets, and then the domestic money supply will increase resulting in appreciation of the Indonesia’s currency. From the above analysis, the role of central banks is very crucial and cannot be underestimated for the sake of economic prosperity.
A large scale balance of payments surplus may force a country to fund the surplus by sale of its domestic currency in the foreign market. This, as a result will boost its international reserves thus avoiding further depreciation of its currency. To achieve this, the country’s central bank, distributes more domestic currency into the country’s economy, increasing supply to the public. By doing this, it increases the country’s monetary base. Due to increased supply of money to the public, prices of commodities and services shoot up leading to increased inflation rate.
Exchange rate pass through is defined as the percentage change in domestic currency, of imported goods prices realized as a result of change in exchange rate by one percent between the two trading countries. A purchasing power parity major implication on exchange rate pass through, is that as a result of various adjustments costs, lays a big barrier in which nominal exchange rates can adjust without causing change in relative domestic goods’ prices. From an economic perspective, a country which exports more than it imports will have an impressive long term financial outlook than one which imports more than it exports. This is as a result of increased commitment of funds to imports hindering other forms of development.
Unbiased predictor is defined as the assumption that the prevailing market price of a physical commodity will be the exact same price to that of its predicted price in future in relation to the market’s forward rate. It is referred to as unbiased because it is supposed to give the actual price as predicted without error. Only when the future spot rates are reverted, on the future rates have they shown to be good predictors. Conclusions made have suggested that in reference to the two tests carried out to prove its efficiency, forward rate is not a good predictor of the future spot rate. Its continued use might have repercussions in the long term as it might end up misguiding the financial analysts.
Relevancies between foreign currency options and foreign currency futures are almost similar to each other as both are used for a common purpose, speculation. Foreign currency futures is a very instrumental tool used in management of business objectives, speculation and offsetting potential losses and gains otherwise referred to as hedging. They are used by financial managers to determine the business financial position, while; expecting profit, speculating and sometimes in reducing substantial losses or gains, incurred by either a business or an organization. They are considered more useful compared to forward contracts in speculation. Foreign currency options is a contract that allows, but not fully entitles the buyer, to purchase or sell a pre-determined amount of foreign exchange at a given fixed price per unit over a stipulated period of time. A buyer can only lose the much they paid in purchase and not more.
A the theory of purchasing power parity which states that the exchange rate between two different currencies, will change to show the resulting changes in the price levels of the two countries. In this case the option owner has the choice to not sell, leaving it to expire. He is entitled to either unlimited profit or a loss not exceeding the initial premiums paid. As a potential buyer the information provided means the initial quoted rate is 1.460, which the seller could choose to sell. Additional information provided is that of the maturity rate of 3.67, if the seller chooses to not sell until then. This means the seller could make profit if he chooses to sell or a loss if he opts for expiry. The owner reserves the right to only exercise the option only when it’s profitable or choose to abandon it altogether.
