International Fiance

International Finance

Exchange rate fluctuations - Causes , effects and remedies

Introduction

The increasing trend towards globalization and liberalization has brought to the fore the issues related to exchange rate variations Several attempts by the international community to find a lasting solution to the problem of reducing the volatility of exchange rates and to evolve a perfect standard for measuring the relative values of various currencies , have failed to yield satisfactory results . The near collapse of various currencies towards the end of the last century and the beginning of this century , and

the recent downslide in the value of the US Dollar , have added to the problems of various countries , and has affected international trade in a significant manner , making the subject of international finance a highly relevant matter for analysis and understanding . This examines the causes for fluctuations in exchange rates between currencies , the impact that such fluctuations have on trade in general and individual company profitability in particular , and the remedies available to corporates and individuals to protect themselves against adverse effects of such variations

Exchange Rate Fluctuations - Causes

Exchange rate is the rate at which a particular currency is traded or exchanged against another currency . For example , one Euro was traded on February 12 , 2008 against the US Dollar for 1 .4534 (Yahoo ! Finance 2008 . This is a continuously changing rate that is determined by various factors . One of the most significant factors that affect the exchange rate between currencies is the exchange rate system adopted by a country

Exchange Rate Systems

Broadly speaking , there are two types of exchange rate systems - floating and fixed . Floating exchange rate systems allow the markets to determine the exchange rate between the currency of a country and various foreign currencies . This causes the exchange rates to continually change , and the payments are made depending on the spot exchange rates quoted on a particular day and time . There are several factors that affect this market-determined value , and some of these are discussed in greater detail in the following sections . The exchange rates systems adopted by most industrialized nations are the floating rate system

Managed Floating Exchange Rate Systems

Managed floating exchange rate systems represent a variation in floating exchange rate systems , and are characterized by limited governmental intervention . The exchange rate is allowed to be freely determined by market forces under normal circumstances , but when the fluctuations go beyond certain limits , the government , or the central bank of the country , intervene through market operations to restore the balance Managed floating exchange rate systems are , in principle , less volatile than free floating systems . In general fixed systems are more stable than floating systems (Dreyer , Haberler and Willett , 1978 , 10 . However as we shall see later , this is true only in the short term , and long-term adjustments need to be made even under fixed exchange rate systems

Fixed Exchange Rate systems

In contrast to the above , under the fixed exchange rate systems , it is the government of the concerned country that determines the rate...