Exchange Rate

Topics: Exchange rate, Foreign exchange market, International trade Pages: 22 (7437 words) Published: December 7, 2012
Table of Contents

1.0 Abstract2
2.0 Introduction3
3.0 Objective of the Study5
4.0 Literature Review5
5.0 Contents8
5.1 Factor That Effect Exchange Rates in Long Run8
5.2 Exchange rates in short run (A supply and demand Analysis)10
5.3 Factor that determinant exchange rate11
5.3.1 Shift the demand for domestic assets11
5.4 Other Factors that effects exchange rates and its volatility12
5.4.1 International financial crises12
5.4.2 Speculators effect12
5.4.3 Central bank intervention policy13
5.2 The effects of exchange rate and volatility14
5.2.1 International trade, export and import14
5.2.2 Foreign direct investment15
5.3 The Empirical model18
6.0 Conclusion20

1.0 Abstract

This paper prefers theoretical and empirical evidence that exchange rate has negative impact on international trade or export. In this paper, we focus on export of Australian country. We also, offer a simple model of domestic and foreign asset demand to determine the exchange rate of home country. From this model, we can see the result, either the exchange rate are appreciate or depreciate in value. We use annual data from world databank (2012) over the period 1980 to 2012 for this study. We also use Ordinary Least Square (OLS) to fine the relationship between real exchange rate and export trade. The result shows that export are negatively influence by exchange rate volatility. This result gives a significant result and supported by the theory. 2.0 Introduction

Since the breakdown of the Bretton Woods system of fixed exchange rates, both real and nominal exchange rates have fluctuated widely. Under this system, each country’s central bank was obligated to intervene in the foreign exchange market to keep the exchange rate in a narrow band around the previously agree rate. This Bretton Woods system will encourage more open trade, finance and investment and lead to a period of rapid economic growth after World War 2. This volatility has often been cited by the proponents of managed or fixed exchange rates as detrimental, since in their view exchange rate uncertainty will inevitably depress the volume of international trade by increasing the riskiness of trading activity. The price of one currency in terms of another is called exchange rate. As can see in figure 1, exchange rates are highly volatile. Exchange rate volatility refers to the tendency for foreign currencies to appreciate or depreciate in value that will affect the profitability of foreign exchange trades. The volatility is the measurement of the amount that these rates change and the frequency of those changes. Goldberg (2006) state that, exchange rates is define as the domestic currency price of a foreign currency, matter both in terms of their levels and their volatility. When a currency appreciate, meaning that its value will increase relative to the value of another currency. Exchange rates play an important role in linking a country to the global supply chains. For instance, Huchet-Bourdon and Korinek (2011) recognise exports generally include high import content and the impact of exchange rate appreciation or depreciation on any finished product is therefore complex. If exchange rate appreciation makes exports of final products “expensive,” it makes imported components “less expensive” for domestic producers. For example, at the beginning of 1999, when Euro was valued 1.18 dollar and this value was appreciate in year 2011 that is at $1.42 dollars. This value was appreciated by 20%. When the U.S dollar becomes more valuable relative to foreign currency, foreign goods became cheaper for American but foreign goods become more expansive. Firstly we can buy the product at 1.18 dollar per unit, but after U.S values appreciate in value, we must increase the number of money to get the same product. Although exchange rate hedging mechanisms are available, they are probably somewhat prohibitive for some particularly...

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