27. ForecastingExchangeRates
Forecasting future exchange rates is virtually a necessity for a multinational enterprise, inter-alia, to develop an international financial policy
It is particularly useful for an international firm if it intends to borrow from or invest abroad
It is also useful for framing a hedging policy
In short term
Three methods are used for the purpose:
Method of Advanced Indicators:
- the ratio of country’s reserves ( gold, foreign
currencies and SDRs) to its imports
- The ratio indicates the number of months (N)
imports, covered by the reserves (R)
N = R/I x12 N= (30/80) x 12 = 4.5 months
As a general rule, if reserves are than 3 moths’ value of imports, the currency is vulnerable and may face devaluation
2. Use of Forward Rate as Predictor of Future Spot Rate:
-Some authors believe in the efficiency of markets and consider that forward rates are likely to be an unbiased predictor of the future spot rate
-In other words, the rate of premium or discount should be an unbiased predictor of the rate of appreciation or depreciation of a currency
Graphical Methods:
-Rate-time Curve, -Bar Chart, -Curve of Resistance, -Curve of Support
The charts or graphs are prepared to gain insight into the trend of fluctuations and forecast the moment when the trend is likely to reverse
In Medium and Long-term
Economic Approach:Structure of the balance of payments,Reserves in gold or in foreign exchange, Interest rates, Inflation rates, Employment level
2. Sociological and Political Approach
Open-Economy Macroeconomics: Basic Concepts
Open and Closed Economies
-A closed economy is one that does not interact with other economies in the world.
-There are no exports, no imports, and no capital flows.
-An open economy is one that interacts freely with other economies around the world.
An Open Economy
-An open economy interacts with other countries in two ways.
1It buys and sells goods and services in world product markets.
2It buys and sells capital assets in world financial markets.
29.The Flow of Goods: Exports, Imports, Net Exports
An Open Economy
-The United States is a very large and open economy—it imports and exports huge quantities of goods and services.
-Over the past four decades, international trade and finance have become increasingly important.
Exports are goods and services that are produced domestically and sold abroad.
Imports are goods and services that are produced abroad and sold domestically.
Net exports (NX) are the value of a nation’s exports minus the value of its imports.
Net exports are also called the trade balance.
A trade deficit is a situation in which net exports (NX) are negative.
Imports > Exports
A trade surplus is a situation in which net exports (NX) are positive.
Exports > Imports
Balanced trade refers to when net exports are zero—exports and imports are exactly equal.
30.The Flow of Financial Resources: Net Capital Outflow, Saving, Investment, and Their Relationship to the International Flows
Net capital outflow refers to the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners.
A U.S. resident buys stock in the Toyota corporation and a Mexican buys stock in the Ford Motor corporation.
When a U.S. resident buys stock in Telmex, the Mexican phone company, the purchase raises U.S. net capital outflow.
When a Japanese residents buys a bond issued by the U.S. government, the purchase reduces the U.S. net capital outflow. Variables that Influence Net Capital Outflow
The real interest rates being paid on foreign assets.
The real interest rates being paid on domestic assets.
The perceived economic and political risks of holding assets abroad.
The government policies that affect foreign ownership of domestic assets.
-Net exports (NX) and net capital outflow (NCO) are closely linked.
-For an economy as a whole, NX and NCO must balance each other so that:
NCO = NX
-This holds true because every transaction that affects one side must also affect the other side by the same amount.
31.Mundell–Fleming model
The Mundell-Fleming model is an economic model first set forth by Robert Mundell and Marcus Fleming. The model is an extension of the IS-LM model. Whereas the traditional IS-LM Model deals with economy under autarky (or a closed economy), the Mundell-Fleming model tries to describe an open economy.
Typically, the Mundell-Fleming model portrays the relationship between the nominal exchange rate and an economy's output (unlike the relationship between interest rate and the output in the IS-LM model) in the short run.
The Mundell-Fleming model has been used to argue that an economy cannot simultaneously maintain a fixed exchange rate, free capital movement, and an independent monetary policy. This principle is frequently called "the Unholy Trinity," the "Irreconcilable Trinity," the "Inconsistent trinity" or the Mundell-Fleming "trilemma."
