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Khawaja 1

Saad Khawaja
McMennamy
Capstone - 5
20 September 2016
Timed Writing #1 Final
Currency value is something that fluctuates very often and for a variety of reasons. When
investing in something as diverse as a currency stock individuals must look into how these
fluctuations occur so that they can make the best investment. The volatility of a currency value
can be predicted by examining how crashes occur, looking at economic status of the country, and
also looking at old and new financial data.
In order to invest in a currency with the idea of making profits one must understand how
currency crashes occur so that one can avoid poor investments. This is important because if an
individual can understand how to avoid a crash then he or she will be able to make stronger
investment choices. First it is crucial to understand the meaning of a currency crash which is a
large change of the nominal exchange rate that is also a substantial increase in the rate of change
of nominal depreciation(Frankel and Rose). This essentially means that the value of the
currency has declined to the rate that it is no longer worth what it used to be. Highly educated
economist state that crashes tend to occur when: output growth is low; the growth of domestic
credit is high; and the level of foreign interest rates are high(Frankel and Rose). When these
factors happen investors tend to develop specific investor scopes and those scopes only make the
crisis increase even rapidly. Scopes in this context means a set value of what investors believe
the price of a currency will increase or fall to. So it is important to understand that a mental
investor crisis in turn can also create physical currency crisis. This is largely due to something

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called investor paranoia where the investors anxiety about the currency leads them to make bad
investment choices which in turn affect the whole currency market. Frankel also explains that
a low ratio of FDI to debt is consistently associated with a high likelihood of a crash(Frankel
and Rose). In order for currency to be at a healthy level the ratio of foreign direct investment to a
country's debt should be relatively high. So to predict the depreciation of a currency one must
also look at the foreign direct investment to debt ratio levels and ensure that FDI is higher.
The economic and political status of the country strongly affects the currency value. It is
vital to know that the variability of the exchange rates between the currencies circulating in
those areas is largely explicable in terms of OCA(optimum currency areas) theory(Bayoumi and
Eichengreen). The OCA theory is basically a region that maximizes economic efficiency to have
the whole area share a single currency and states that a country could join a monetary union if
the benefits are greater than the overall cost. Additionally market pressures depend upon an
economys financial structure, in particular the level of capital controls and the depth of financial
markets(Bayoumi and Eichengreen). A positive financial status of the country usually
correlates with a stable currency amount. Bayomi discusses the exchange rate regime in a
framework that allows us to consider systemic as well as country-specific factors. These factors
include governments policies which can directly control the economy. These policies usually
help positive economic areas during a positive trend and attempt to fix the losses if the economy
is not great at the time.
Financial data both past and present aid greatly in predicting the volatility of a currency
stock. Financial data, especially when calculating projection values for the future are very
valuable and can help lead to a better return on investment. Using this data in formulas is the
most effective form of predicting. Things such statistical timeseries models can greatly aid in

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the prediction of a currency price (Jorion). The independent variable in the time series model is
time and it says that the variables influenced in the past will continue to follow that trend in the
future. Another more effective method is using the ISD formula. It is widely believed to be the
best available forecast of volatility of returns over the remaining contract life(Jorion). The
implied standards deviations formula which is SN(d1)- Ke -tt N(d2) is a specific formula that
uses values from previous financial data. But it is very important to understand that
measurement errors and statistical problems can substantially distort inferences(Jorion). Any
malfunction or error in calculating the projection can be a huge obstacle into getting the correct
values so it is vital to calculate efficiently.
The majority of stocks in the currency market are fast moving and volatile stocks. It is
important to understand the market crashes, be aware of the economic status, and look at
financial data to reach maximum investment potential. Looking at these factors is an individual's
best bet to see the future of a currency stock.

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Works Cited

Bayoumi, Tamim, and Barry Eichengreen. "Exchange rate volatility and intervention:
implications of the theory of optimum currency areas." Journal of International
Economics 45.2 (1998): 191-209.
Frankel, Jeffrey A., and Andrew K. Rose. "Currency crashes in emerging markets: An
Empirical treatment." Journal of international Economics 41.3 (1996): 351-366.
Jorion, Philippe. "Predicting volatility in the foreign exchange market." The Journal of
Finance 50.2 (1995): 507-528.
Kaminsky, Graciela, Saul Lizondo, and Carmen M. Reinhart. "Leading indicators of
currency crises." Federal Reserve Staff Papers 45.1 (1998): 1-48.

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