International finance essay question
Introduction
In 2016, Britain shocked the world by voting to exit the EU, China, and other growing markets remained uncertain, with the cost of products still in fall. However, the U.S economy seemed bright by comparison (Laura, & Rafael, 2016). Although, the U.S Federal Reserve kept postponing plans to increase interest rates in spite of the unemployment number falling to 4.9%.
Why forwards is an unbiased predictor of future spot rates?
As growth prospects are analyzed for the global economy, keeping insight the duty of the U.S current account deficit, it becomes difficult to predict the future spot rates. Moreover, the U.S. commercial counterparts on current account deficits continued with a capital inflow from foreigners (Laura, & Rafael, 2016). As the inflows accumulated, the variation between the U.S Holdings of assets in abroad as well as the U.S foreign holdings assist considerably went down.
More importantly, in exchange markets, forward exchange rates are believed to be good predictors of the future spot rates. According to Dooley, and others (2004), the unpredictability of the future spot is influenced by the U.S account deficit. Forward rates are depicted to be useful predictors of the future spot rates mainly when the rate of the next spot is measured on the rate of forwarding levels (Laura, & Rafael, 2016). Similarly, forward rates are established not to be perfect predictors of the future spot rates especially when the exchange level depreciation is measured on the forward payment. The repayment becomes the log parity of the spot level, and the forward payment is the record parity between the forward level and the present spot rate.
(b) How the party relationships allow one to predict future spot rates
Some the U.S policymakers had ignored the risks associated with the current account deficits as well as the current global position (Laura, & Rafael, 2016). These policymakers argued that the deficit just reflected the prettiness of the U.S economy as a destination for international investment.
The parity relationships allow one to predict future spot rates by predicting foreign exchange rates. Businesses require enclosing foreign exchange risk because of uncertainty over future currency rates. Also, through parity relationship, firms can understand the reason why exchange rates vary (Laura, & Rafael, 2016). Hence, the transformations in exchange rates lead from alterations in the demand and supply of currencies. These changes can happen for several reasons. First, because of the coins are needed to finance global trade, the variations in the trade lead to transformations in exchange rates. Also, in his view, Bernanke, (2005), believes that the stability of the U.S account will help strengthen the certainty of future spots. Therefore, a nation with an existing account deficit with imports exceed the exports can expect to observe its transfer levels depreciate because the supply of currency would exceed the need for the currency.
2 (a) Identify and explain the type of exchange rate exposure the university has
The university has a short-term exchange rate exposure, in this short exchange rate exposure, when a firm it has contractual monetary flows such as receivables and payables whereby values are a subject to the unanticipated changes in exchange rates because of a contract is being denominated in a foreign currency. The university exchange rate was affected by the deficit in the U.S account (Dooley, et al. 2004). To realize the national significance of its foreign denominated monetary flows, the university is expected to exchange the exchange for the domestic currency (Laura, & Rafael, 2016). Notably, as businesses discuss contracts with the set prices as well as the delivery dates within the face of unstable foreign trade market with the exchange rates continually fluctuating, the industry face a threat of transformations within the transaction levels between the foreign as well as the domestic currency.
b. Explain the methods the university could take to mitigate its exposure
Notably, most firms desist from the effective administration of their exchange exposure, although, they appreciate that the exchange rate fluctuations may affect their value and earnings. One of the methods the University could take to mitigate its exposure is by using risk management instruments, such as the forwards, options, and futures, as provisional. On his part, Bernanke, (2005), acknowledges that the U.s account has experienced enormous challenges in the market. This problem has affected different areas in the global markets. Also, they may say that such financial manipulations stay outside the business’ field of expertise. Additionally, the university may claim that the exposure is immeasurable. The currency exposure remains involved and may seldom be measured with precision. Third, the university may hedge the business. Hence, every transaction including imports or exports should be covered.
3. In a freely floating exchange rate system, if the current account is running a deficit, explain the consequences for the capital and financial accounts and the overall balance of payments.
As the U.S dollar increases in value, other items being equivalent, U.S. products and services remain relatively expensive within the foreign currency terms, whereas foreign goods and services remain relatively less costly within the dollar terms. Thus, the outcome is a little surplus or rather a larger deficit placed on the current account (Laura, & Rafael, 2016). As a matter of fact, exchange rates compare currency supplies plus demands. Such exchange rates fail to determine the allotment of the money flows between the trade flows and the capital flows. This observation of the exchange rates forecasts that there is not a cheap relation between trade levels and the existing account balance (Laura, & Rafael, 2016). Importantly, trade deficits do not lead to the currency depreciation; neither does money reduction by itself facilitate a reduction trade deficit.
(b) Explain why the balance of payment information is importance to firms
Most analysts contend that the current account can continue to be financed at a higher rate. Additionally, it was noted that larger rates of indebting cause the U.S financial system vulnerable in such manner that it lost the confidence that would induce a sudden end to cash inflows.
Notably, the balance of payment of a country recommends to everyone whether it can save enough funds to pay for the imports (Laura, & Rafael, 2016). Therefore, it establishes if a country produces sufficient economic production to pay for the growth. A balance of payments shortage implies that the nation imports much more products, services, as well as the capital than it exports. It should borrow from new countries to pay for imports. Also, the firm's economic growth will be fueled in a short term basis while in the long term the company becomes a net consumer and not the producer of the world’s economic productivity.
In conclusion, the stability of the U.S dollar will help boost the efficiency of foreign exchange markets. Also, nations are expected to increase their productivity and balance their imports and exports to achieve economic growth and stability. Therefore, the balance of payments is used to describe world's transactions.
References
Bernanke, B. S. (2005). The global saving glut and the US current account deficit (No. 77).
Dooley, M. P., Folkerts-Landau, D., & Garber, P. M. (2004). The US current account deficit and economic development: collateral for a total return swap (No. w10727). National Bureau of Economic Research. Retrieved from: http://www.nber.org/papers/w10727
Laura A. & Rafael D.( 2016). The U.S Current Account Deficit. Harvard Business School.
Retrieved from: http://www.federalreserve.gov/boarddocs/speeches/2005/200503102/default.htm
