FIN3711 International Financial Management

Answers:

Task 4:

The spot rate of the Euro USD exchange rate is taken for the task which would be used in the forecasting of the exchange rate on 1^st July 2021. The exchange rate or the spot as on 21^st March 2021 is EURO 1.1899/USD (Kenen 2019). The interest rate which is currently prevailing in the US is 1% annually while the interest rate in the Euro Region is 1.79% annually. Thus, using the interest rate parity equation, the forward rate on 1^st July 2021 is calculated which is provided below (Lilley, Maggiori, Neiman and Schreger 2019).

As per the interest rate parity the forward rate is expected to be 1.19222 as on 1^st July 2021. The exchange rate is also calculated using the purchasing power parity which is used in the equation which is provided below. The inflation rate in the US is expected to be 0.41% while the inflation rate in the Euro region is expected to be 0.79%. Hence using the equation the forward rate is calculated and provided below (Barguellil, Ben-Salha, and Zmami 2018).

The exchange rate on 1^st July 2021 based on the purchasing power parity is 1.191024, which is near to the expectation as per the interest rate parity (Hofmann, Shim and Shin 2020).

The models which is being selected is the interest rate parity model and the purchasing power parity model and the reason for the selection is provided in the points below.

• The economy has been recovering in a V-Shape Trajectory globally which would affect the Euro/USD exchange rates.
• As the economy is recovering the inflation in the countries would increases which would affect the exchange rate.
• As the economy would be recovering it would lead to flow of capital from the Euro to the US which should lead to the depreciation of the Euro currency when compared to the US.
• Also, investors would tend to invest greater in developing economy which would lead to a depreciation of the exchange rates(Narayan 2020).

Hence, based on these factors and reasons the above models have been selected for the measuring of the Euro USD exchange rate on 21^st July 2021 (Zhang and Zhang 2018).

Task 5:

The following drawbacks and the factors which would affect the Euro USD exchange rate is provided in the points below.

• The bond yields is rising globally which would affect the exchange rate in the economy as the investors would invest the funds in the domestic bonds which would generate a higher return with lower risk.
• This effect might lead to the appreciation of the EURO/USD exchange rate and hence the prediction made by the model can be affected from this change.
• The other factor which can affect the exchange rate is the foreign trade policy of the countries and if the countries relax the policy further it would lead to significant appreciation of the exchange rate in both the regions(Delgado, Delgado and Saucedo 2018).

References:

Barguellil, A., Ben-Salha, O. and Zmami, M., 2018. Exchange rate volatility and economic growth. Journal of Economic Integration, 33(2), pp.1302-1336.

Delgado, N.A.B., Delgado, E.B. and Saucedo, E., 2018. The relationship between oil prices, the stock market and the exchange rate: evidence from Mexico. The North American Journal of Economics and Finance, 45, pp.266-275.

Hofmann, B., Shim, I. and Shin, H.S., 2020. Bond risk premia and the exchange rate. Journal of Money, Credit and Banking, 52(S2), pp.497-520.

Kenen, P.B., 2019. Trade, speculation, and the forward exchange rate. In Essays in International Economics (pp. 183-209). Princeton University Press.

Lilley, A., Maggiori, M., Neiman, B. and Schreger, J., 2019. Exchange rate reconnect. Review of Economics and Statistics, pp.1-28.

Narayan, P.K., 2020. Has COVID-19 changed exchange rate resistance to shocks. Asian Economics Letters, 1(1), p.17389.

Zhang, Y. and Zhang, S., 2018. The impacts of GDP, trade structure, exchange rate and FDI inflows on China's carbon emissions. Energy Policy, 120, pp.347-353.