Analysis of Forex Market

By:

Sainatth Wagh

Agenda

• Exchange Rate

• Types of Exchange Rate

• Pros and Cons of Exchange Rate

• PEG System

• Conclusion

Exchange Rate

• A rate at which one currency can be exchanged withanother currency.

• It is similar to selling of the identical assets at sameprice in different places, so that exchange rate couldmaintain the inherent value.

Types

Fixed Exchange Rate:

• In fixed exchange rate, rates are held constant orallowed to fluctuate within narrow bands.

• A fixed exchange rate is set by the centralgovernment as official exchange rate.

• Whatever rate central bank goes for fixed rate, theyhave to ensure, there is sufficient amount ofreserves.

• In case if the reserves start depleting, the centralbank can adjust exchange rate.

Pros:

• Easier for MNC’s to work.

Cons:

• Devaluation of the US ($), after experiencing trade deficits.

• Each country can become more vulnerable to

economic conditions in other countries.

Free Floating Exchange Rate:

• In free floating exchange rate, rates are determinedby private market forces.

Pros:

• Less dependence on economic factors of othercountries.

• No intervention of central bank.

• Less restrictions on capital flow thus enhancingefficiency of financial market.

Cons:

• Efficient resources need to be employed by MNC’s for managing exposure to exchange rate fluctuations.

• Compounding problems such as inflation, unemployment may be faced by the country experiencing economic turmoil.

Managed Floating Exchange Rate:

• In managed floating exchange rate, rates are allowed to movefreely on daily basis.

Pros:• Allow government to place some influence on exchange rate.

Cons:• A government can manipulate exchange rate to benefit its

own country.

Pegged System

The World was once Pegged:

Between 1870 & 1914 there was a global fixed exchange rate. Values of

currencies were fixed at a set exchange rate equal to gold ounces.

With the start of World war I, gold standard was abandoned.

Post World War II at Bretton Woods conference IMF was established. It was

agreed here that the currencies would be pegged to USD.

What happened to Pegged system

In 1971 US became net importer, its trade deficit was growing.

This put a downward pressure on USD.

USD had to be devalued against other currencies by 8%.

Ultimately the Bretton Wood system failed.

Most of the major governments have adopted pegged system

from then on.

Why Peg ?

Creation of stable atmosphere for stable Investment

Help lower the Inflation rate

Ultimately the Bretton Wood system failed.

It takes a stronger system & mature market to maintain a float.

Drawbacks of Pegged system

Peg is difficult to maintain in the long run & can lead to / worsen financial crisis as

evident in the Mexican (1995), Asian (1997) & Russian (1997) financial crisis.

In Mexico’s case Govt. was forced to devalue peso’s by 30%.

Thai Govt. eventually had to allow Thai Bhat to float. It lost about 50% of its value.

Floating rate regime has proved to be more efficient means of determining the long-

term value of a currency & creating a equilibrium in the International market.

Thank You!!!!