Foreign exchange market
Foreign exchange market is the biggest market in the world with over one trillion sterling pounds being traded in a single day. The world market has widely embraced flexible exchange rate system – in an attempt to promote world trade – where the value of a country’s currency in the market is determined by the demand and supply of that currency in the market or simply left to appreciate and depreciate in value own its own with minimum regulations from the domestic country. (Forexyard, n. d. ).
This has led to volatility in the market due to deregulation and other factors that affect international trade such as productivity and level of development in an economy, business environment political factors, factor endowment and geographical disparities. (Campbell et al, 2005). This paper is an evaluation of the effect of price fluctuations in the exchange market at the micro level by looking at its effect at the individual transaction level and at the macro level by highlighting the factors that affects exchange rate fluctuation in the market in and attempt to analyse and explain the exchange rate market
Effect of depreciation and appreciation in the exchange market. Theoretically, the exchange rate between two countries currency is determined by the purchasing power parity, To simply explain the purchase power parity theory, if a unit of country A’s currency can purchase what 3 units of country B’s currency can, then the exchange rate will be 1 of A for 3 of B (Hoontrakul, 1999). Exchange rate fluctuation can lead to appreciation of the countries currency which means that the domestic currency has gained value relative to another countries currency.
In case of appreciation, then the amount of domestic currency used to buy one unit of other counties currency will be reduce for instance if one used AUD 2 to get GBP 1 and it appreciates to AUD 1 to GBP 1 then the AUD has appreciated in value over the GBP. (Bergen, n. d. & Hoontrakul, 1999). Exchange rate market is predominantly affects the revenue earned by exporters and importers. To an exporter, appreciation of the domestic countries currency relative to other countries currencies leads to loss of revenue while depreciation of domestic currency leads to increased of revenue due to exchange rate changes (Bergen, n.
d. ). Illustration [a (i) and (ii) clearly show the effect of exchange rate fluctuation to individuals trading in the exchange market. In illustration [a(i), assuming that the payment to the Australian exporter was based on March 1st exchange rate, then the amount of revenue in AUD is 3850 equivalent to [0. 42*3850] GBP 1617. However, given that the exporter receives payment on July 1st when the exchange rate has appreciated to exchange at AUD 1 = GBP 0. 45, then the amount that the exporter receives in terms of the domestic currency is [1617*0. 45] AUD 3593.
3 which is less AUD 256. 7. Therefore, the movement in the exchange rate between March and July led to a loss of approximately AUD 257 due to appreciation of the AUD against the GBP. In illustration (ii), the depreciation of the AUD against NZD from AUD 1= NZD 1. 10 in July 1st to AUD 1= NZD 1. 05 in August 1st will lead to a loss. To obtain the same amount of NZD in August needed to cover the family reunion, one has to spend more AUD since due to depreciation of AUD against NZD then she will be forced to use more Australian dollars to get the same amount of NZD.
I. e. On July 1st when the exchange rate was AUD 1 = NZD 1. 10 then to get NZD 5400 the cost in AUD would be [5400/1. 1] 4909. Given that she is travelling on August then the cost of obtaining NZD 5400 in AUD would be [5400/1. 05] 5142 which is approximately AUD 234 more than it would have been had aunt bought NZD in July. Therefore I would have to pay AUD 234 to cover the depreciation of AUD against NZD.