Case C8: Going Down to the Wire in the Money Transfer Market (340)

Theme: Markets for Foreign Exchange (The Global Monetary Environment)

Review Chapter Learning Objectives
Thoroughly Review the chapter topics
Read the case writeup carefully

Summarize the case, addressing each issue clearly and separately

What is Exchange Rate?
Definition: Exchange rate is the price of one currency in terms of another currency.

Description: Exchange rates can be either fixed or floating. Fixed exchange rates are
decided by central banks of a country whereas floating exchange rates are decided by the
mechanism of market demand and supply.

https://economictimes.indiatimes.com/definition/exchange-rate

What factors affect Exchange rate? Include Fisher and International Fisher Effect

8 Key Factors that Affect Foreign Exchange

Rates
Foreign Exchange rate (ForEx rate) is one of the most important means through which a country’s
relative level of economic health is determined. A country's foreign exchange rate provides a window
to its economic stability, which is why it is constantly watched and analyzed. If you are thinking of
sending or receiving money from overseas, you need to keep a keen eye on the currency exchange
rates.

The exchange rate is defined as "the rate at which one country's currency may be converted into
another." It may fluctuate daily with the changing market forces of supply and demand of
currencies from one country to another. For these reasons; when sending or receiving money
internationally, it is important to understand what determines exchange rates.

This article examines some of the leading factors that influence the variations and fluctuations in
exchange rates and explains the reasons behind their volatility, helping you learn the best time to
send money abroad.
1. Inflation Rates
Changes in market inflation cause changes in currency exchange rates. A country with a lower
inflation rate than another's will see an appreciation in the value of its currency. The prices of goods
and services increase at a slower rate where the inflation is low. A country with a consistently
lower inflation rate exhibits a rising currency value while a country with higher inflation typically
sees depreciation in its currency and is usually accompanied by higher interest rates

2. Interest Rates
Changes in interest rate affect currency value and dollar exchange rate. Forex rates, interest rates,
and inflation are all correlated. Increases in interest rates cause a country's currency to appreciate
because higher interest rates provide higher rates to lenders, thereby attracting more foreign capital,
which causes a rise in exchange rates

3. Country’s Current Account / Balance of Payments

A country’s current account reflects balance of trade and earnings on foreign investment. It consists
of total number of transactions including its exports, imports, debt, etc. A deficit in current account
due to spending more of its currency on importing products than it is earning through sale of
exports causes depreciation. Balance of payments fluctuates exchange rate of its domestic currency.

4. Government Debt
Government debt is public debt or national debt owned by the central government. A country with
government debt is less likely to acquire foreign capital, leading to inflation. Foreign investors will
sell their bonds in the open market if the market predicts government debt within a certain country.
As a result, a decrease in the value of its exchange rate will follow.

5. Terms of Trade
Related to current accounts and balance of payments, the terms of trade is the ratio of export prices
to import prices. A country's terms of trade improves if its exports prices rise at a greater rate than
its imports prices. This results in higher revenue, which causes a higher demand for the country's
currency and an increase in its currency's value. This results in an appreciation of exchange rate.

6. Political Stability & Performance

A country's political state and economic performance can affect its currency strength. A country
with less risk for political turmoil is more attractive to foreign investors, as a result, drawing
investment away from other countries with more political and economic stability. Increase in
foreign capital, in turn, leads to an appreciation in the value of its domestic currency. A country
with sound financial and trade policy does not give any room for uncertainty in value of its
currency. But, a country prone to political confusions may see a depreciation in exchange rates.

7. Recession
When a country experiences a recession, its interest rates are likely to fall, decreasing its chances to
acquire foreign capital. As a result, its currency weakens in comparison to that of other countries,
therefore lowering the exchange rate.

8. Speculation
If a country's currency value is expected to rise, investors will demand more of that currency in
order to make a profit in the near future. As a result, the value of the currency will rise due to the
increase in demand. With this increase in currency value comes a rise in the exchange rate as well.

Conclusion:
All of these factors determine the foreign exchange rate fluctuations. If you send or receive money
frequently, being up-to-date on these factors will help you better evaluate the optimal time for
international money transfer. To avoid any potential falls in currency exchange rates, opt for a
locked-in exchange rate service, which will guarantee that your currency is exchanged at the same
rate despite any factors that influence an unfavorable fluctuation.

https://www.compareremit.com/money-transfer-guide/key-factors-affecting-currency
-exchange-rates/

Fisher Effect vs. International Fisher Effect

The Fisher effect describes the relationship between interest rates and the rate
of inflation. It proposes that the nominal interest rate in a country is equal to the
real interest rate plus the inflation rate, which means that the real interest rate is
equal to the nominal rate of interest minus the rate of inflation.

Therefore, any increase in the rate of inflation will result in a proportional

increase in the nominal interest rate, where the real interest rate is constant. For
example, assume that the real interest rate is 5.5% and the rate of inflation
changes of 2.5% to 3.5%.

https://corporatefinanceinstitute.com/resources/knowledge/economics/internationa
l-fisher-effect-ife/

How are futures forecast used to determine current spot rate?

What are the main recipient remittance countries? Immigrant countries? Why?
Remittances, usually understood as the money or goods that migrants send back to
families and friends in origin countries, are often the most direct and well-known link
between migration and development. Remittances exceed official development aid but are
private funds. Global estimates of financial transfers by migrants include transactions
beyond what are commonly assumed to be remittances, as the statistical definition used
for the collection of data on remittances is broader (see IMF, 2009). Also, such estimates
do not cover informal transfers. Remittances can also be of a social nature, such as the
ideas, behaviour, identities, social capital and knowledge that migrants acquire during
their residence in another part of the country or abroad, that can be transferred to
communities of origin (Levitt, 1998: 927).
What is the main problem faced by foreign workers? What are some solutions?
What are some initiatives to protect funds transfers?
What’s the role of exchange rate in global financial crises? What part did it play in the Asian
Financial Crisis?

Answer the questions

Conclusion: Assess the future of funds transfers and exchange rates

Lots of financial data is available:

IMF
World Bank
Federal Reserve bank
Financial Times
WSJ
Economist
Current textbooks on finance
Investopedia