Name FIN 426 Exam
Name __________________________________________ FIN 426 EXAM 2 Please read instructions carefully
Please read the instructions carefully: The assignment refers to “your country” which stands for the country you have presented on. Please specify “your country” here _________________________ The assignment refers to “main currency” which is either US Dollar or Euro. If “your country” has a fixed exchange rate tied to USD, use Euro as “main currency”. Otherwise, use USD. Please specify “main currency” here ______________________ Go to Yahoo! Finance and find information on the exchange rate of the main currency/your country’s currency. Take a screenshot of the Summary tab (Fig. 1).
What is the bid-ask spread according to the above screenshot?
What is the bid-ask spread for the reciprocal quote (“Your country’s currency/Main Currency”)? You must show how you converted the values from the Summary tab to obtain the reciprocal quote.
Open daily exchange data in the Historical Data tab, and fill out the following table:
Table 1. Historical exchange rates for Main Currency/Your Country’s Currency
Date | Main Currency/Your Country’s Currency
—for example, 4/8/2016—
Using the values in Table 1, calculate the indirect exchange rate (Your Country’s Currency/Main Currency) for each date, showing your calculations.
Explain how each of the following conditions would be expected to affect Your Country’s Currency/Main Currency exchange rate:
a) Your country’s central bank substantially lowers interest rates
b) A deficit in your country’s Balance of Payments’ current account due to import/export imbalance
c) An increase in the US government debt
Table 2. Historic exchange rates for Russian Ruble/Main Currency
Date | Russian Ruble/Main Currency
—for example, 4/8/2016—
Using information in Table 1 and Table 2, find the cross-exchange rate between the Russian Ruble and Your Country’s currency for each date, showing your calculations.
Using daily historical data on exchange rates between Main Currency/Your Country’s Currency, fill out the table to calculate the average volatility of your country’s currency:
Date | High | Low | Difference
—for example, 4/8/2016—
Calculate the annual interest rate (CPI) data from the World Bank and supplement Table 1 with interest rates for your country and the main currency country, dated (e.g., 4/8/2016).
Analyze how well the relative Purchasing Power Parity (PPP) holds in this example and explain your reasoning.
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Paper For Above instruction
The evaluation of exchange rate behaviors and their implications for international business is an essential component of global economic analysis. This paper aims to systematically analyze real-world exchange rate data, including bid-ask spreads, reciprocal rates, historical fluctuations, and macroeconomic factors influencing currency values, for a specific country and its main currency—whether USD or Euro—and interpret these findings within the framework of theories such as Purchasing Power Parity (PPP). This comprehensive analysis will facilitate an understanding of whether PPP holds in practice and the potential impact of various macroeconomic policies and conditions on currency stability.
Selection of Country and Currency Context
For illustrative purposes, let us assume our country is Brazil, and the main currency selected is the US Dollar (USD). Brazil, a significant emerging market, has historically had a flexible exchange rate regime, although periods of fixed or managed rates have occurred. The choice of USD as the main currency aligns with a flexible exchange rate system, where supply and demand primarily determine the currency value.
Bid-Ask Spread Analysis
The bid-ask spread is a fundamental measure of market liquidity and transaction costs, calculated as the difference between the highest price buyers are willing to pay and the lowest price sellers are willing to accept. From the Yahoo! Finance summary, suppose the bid price is $5.1500 and the ask price is $5.1800 per Brazilian Real (BRL). The spread is calculated as:
\[
\text{Bid-Ask Spread} = \text{Ask} - \text{Bid} = 5.1800 - 5.1500 = 0.0300
\]
Expressed as a percentage of the bid:
\[
\frac{0.0300}{5.1500} \times 100 \approx 0.58\%
\]
For the reciprocal quote (BRL per USD), the prices invert to:
\[
\text{Reciprocal Bid} = \frac{1}{\text{Ask}} = \frac{1}{5.1800} \approx 0.1931 \quad \text{BRL per USD}
\]
\[
\text{Reciprocal Ask} = \frac{1}{\text{Bid}} = \frac{1}{5.1500} \approx 0.1942 \quad \text{BRL per USD}
\]
The spread for the reciprocal quote is:
\[
0.1942 - 0.1931 = 0.0011
\]
with a relative spread of:
\[
\frac{0.0011}{0.1931} \times 100 \approx 0.57\%
\]
This close parallel indicates market efficiency, with bid-ask spreads around 0.58-0.57%.
Historical Exchange Rate Data and Calculations
By examining historical data for the period of April 8-9, 2016, suppose the exchange rates (BRL per USD) are:
| Date | Rate (BRL/USD) |
|---------|--------------|
| 4/8/2016 | 3.2900 |
| 4/9/2016 | 3.3000 |
Calculating the indirect rate (USD per BRL):
\[
\text{USD/BRL} = \frac{1}{\text{BRL/USD}}
\]
For April 8:
\[
\frac{1}{3.2900} \approx 0.3042 \, \text{USD/BRL}
\]
For April 9:
\[
\frac{1}{3.3000} \approx 0.3030 \, \text{USD/BRL}
\]
The percentage change in the rate:
\[
\frac{0.3042 - 0.3030}{0.3042} \times 100 \approx 0.39\%
\]
This indicates minimal fluctuation, reflecting market stability over the period.
Impact of Macroeconomic Conditions on Currency Exchange
The future trajectory of the BRL/USD exchange rate can be influenced significantly by macroeconomic policies and conditions:
a) Lowering interest rates in Brazil:
A substantial reduction in Brazil’s interest rates typically results in decreased demand for the local currency as investors seek higher yields elsewhere (e.g., U.S. assets). This depreciation pressure would likely cause the BRL to weaken against the USD, increasing USD/BRL exchange rate. The reduced carry trade incentive diminishes capital inflow, further weakening the local currency.
b) Current Account Deficit:
A persistent deficit in the current account reflects higher imports than exports, leading to increased supply of BRL on the foreign exchange market to pay for imports. This excess supply depreciates the BRL, resulting in a higher USD/BRL rate. Over time, sustained deficits can erode currency value and destabilize exchange rates.
c) Increase in U.S. Government Debt:
An increase in U.S. debt can lead to concerns about U.S. fiscal sustainability, which may weaken the USD relative to other currencies, including BRL. Conversely, if investors see U.S. debt as a safe haven, the USD may strengthen temporarily. The overall effect depends on the global risk sentiment, but generally, rising U.S. debt could lead to USD depreciation if doubts about U.S. fiscal health grow, indirectly affecting the USD/BRL rate.
Cross-Exchange Rate Calculation
Using the historical exchange rates of the Russian Ruble against the USD, suppose the data is:
| Date | IRS/USD | BRL/USD | RUB/USD |
|---------|----------|---------|---------|
| 4/8/2016 | 0.0147 | 3.2900 | 0.0147 |
The cross rate RUB/BRL is derived as:
\[
\text{RUB/BRL} = \frac{\text{RUB/USD}}{\text{BRL/USD}} = \frac{0.0147}{3.2900} \approx 0.00447
\]
On April 8, 2016, 1 BRL equals approximately 0.00447 Russian Rubles, reflecting the relative strength and valuation between the currencies.
Volatility Analysis
Calculating the daily volatility involves determining the difference between the high and low exchange rates over specific days, then averaging these differences over the study period. For example, if the high for April 8 is 3.3100 BRL/USD and the low is 3.2700 BRL/USD, the difference is 0.0400. Repeating this across dates gives a dataset to evaluate the average volatility, which is crucial for risk assessment and forecasting.
Relative PPP Evaluation
The purchase power parity (PPP) theory suggests that exchange rates should adjust to equalize the price levels between countries over time. Empirical observations often reveal deviations from PPP, especially over short periods, due to factors like interest rate differentials, capital flows, and political stability. In this example, if inflation rates in Brazil are significantly higher than those in the U.S., the BRL should depreciate relative to the USD over time to maintain PPP equilibrium. Any persistent deviations point to market imperfections or structural frictions, indicating that PPP may hold only in the long run.
Conclusion
The comprehensive analysis of exchange rate data, bid-ask spreads, macroeconomic influences, and theoretical frameworks such as PPP reveals that currency relationships are complex and responsive to diverse economic factors. While theoretical models provide a baseline understanding, real-world data often demonstrate deviations caused by market sentiment, fiscal policies, and geopolitical developments. Understanding these dynamics is essential for firms engaged in international trade, investment, and risk management.
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