International Trade Operations in US - Essay Example

?International Trade Operations Part Introduction Going in international trade demands a lot of knowledge over a number of issues including the interpretation, trends and implications associated with exchange rate. This is because as far as international trading is concerned, the likelihood of having to use foreign currency to trade and trade off is very high. With a very good knowledge on exchange rate therefore, it puts one at a very good position to having fair trade and also giving off fair trade to clients. Risks and benefits of pricing goods in U.S. dollars or pricing goods in local currency when selling in a foreign market First regarding the pricing in US Dollar, the demerits include the fact that international buyers who do not have US dollars as their local currency would have to go through the cumbersome process of having to convert their currencies to US dollars whenever they want to do business with you. The excesses in the procedure may just be one reason that someone may prefer other competitors to you. Again, the differences in exchange rate between the local currencies of international buyers and the US dollars will cause price flatuations. It is very likely that the price of good for each particular day will have to change because of changes in exchange rate. This, according to Gibbons (2012) creates currency swing, where by the customer may have to build in a 10-15% "adverse currency swing" factor. Conversely, quoting the US dollars may be very desirable when dealing with buyers who already deal in US dollars. It is common k knowledge that a lot of buyers around the world today are into the use of the US dollars. This is because it ensures uniformity in quantum price of goods and products. Again, quoting in US dollars very advisable for smaller companies with limited human resource as Gibbons (2012), notes that “you may not have the ability to assume the currency risk, the currency exchange costs and the effort needed to run pricing in local currency.” Regarding quotation of prices in local currencies, once prices are quoted in local currencies and not in US dollars for international buyers, whose local currencies are not the US dollars would not have to create any price hedge to cater for the prices of goods. This is a major advantage for dealing with international buyers. This is because the duty of having to convert prices into US dollars and also having to go through the exchange processes, which sometimes attracts extra cost from banks would all be avoided. In would be observed that because pricing in US dollars creates price fluctuations, local buyers are often forced to hedge for the price of goods so that they will not have to be changing their expenditures so often. The converse demerit with pricing in local currency is that there would have to be a different price of same goods when they move from one country to the other. In this case, it is likely that by the time all sales are completed and the seller converts his earnings back to a common currency, there may be some little price falls because of the differences in US dollar rates in different countries (Colacito and Croce, 2011). Rate parity theory and how it is used to predict future exchange rates According to Forex Karma (2010), “Interest Rate Parity (IPR) theory is used to analyze the relationship between at the spot rate and a corresponding forward (future) rate of currencies.” The theory operates on a number of principles that makes it possible to predict future exchange rates. First, Picardo (2012) writes that “the basic premise of interest rate parity is that hedged returns from investing in different currencies should be the same, regardless of the level of their interest rates.” This means that future predictions of exchange rate can be made if returns on rate hedging remain constant. This is because in such as situation, both the exchange rate and interest rate do not have any influence on one another. The second has to do with the quote rates of interest rate and currency rates. This is because “a currency with lower interest rates will trade at a forward premium in relation to a currency with a higher interest rate” (Picardo, 2012). The implication is that it is possible to predict the future exchange rate by using the level of interest rate whereby countries that have lower interest will experience forward premium when it comes to their exchange rate. Forward premium refers to a case where the difference between the forward or future rate and the current rate of spot rate is positive. Calculation of the current Forward Exchange Rate for the United States and Egypt Given the US dollar rate to the Egyptian Currency as 1USD = 6.03153EGP Interest rate of US at 3.15% and that of Egypt as 9.3 The forward exchange rate shall be calculated as follows 1 USD = 6.03153 X (1 + 9.3%) = 1.14012 EGP (1 + 3.15%) Relationship between monetary policy, interest rates, and exchange rates From the layman’s point of view and in reality, importers and sellers make buyers and by extension consumers their last point of shedding cost. Indeed no one goes into trading to make loss due to price pegging. What this simply means is that sellers will make consumers pay for prices they (sellers) incur. It is again true that most importers and international business owners like Mr. Swanson wants to be depend a lot on banks and other financial institutions for funding. The most common form of fund they receive is loans. Ultimately, the loans come with interest. Once interest rates on the loans are high, they will make the price of their exported goods high. This ultimately affects exchange rate as exchange rates may go up in this situation because of higher demand for foreign currency (Sanchez, 2005). The relationship between interest rates and exchange rate therefore is that higher interest rates lead to higher exchange rate in order to cater for expenditure cost. All two – interest rate and exchange would in turn have effect on the monetary policy of a country because government and central bank would want to structure the supply of money and availability of money in such a way that the strength of the currency is not excessively weakened by the interest rate and exchange rate surges. Briefly introduce other factors that influence exchange rate fluctuations. Address whether any of these are a factor when looking at the future exchange rate between the United States and Egypt. First, it will be noted that there is an increased purchasing power for countries with low inflationary rates when they are trading with other currencies. This means inflation is a major determining factor in the exchange rate fluctuations of a country. Current account deficit has also been identified as another factor that influences exchange rate fluctuations. This is because when deficits occur with the country’s current account, the implication it gives is that “the country is spending more on foreign trade than it is earning, and that it is borrowing capital from foreign sources to make up the deficit” (Bergen, 2012). Public debt of a country, terms of trade used by a country and political stability are all other minor factors that affect the fluctuations that may be experienced in the exchange rate of a given country. Particularly with Egypt, political stability and inflation ought to be checked critically. This is because political decisions have the tendency of putting the country at a point where economic mismanagement may lead to unfair international trading activities thereby causing the value of the country’s currency to loss strength against other major currencies. REFERENCE LIST Bergen J. V (2012). Six Factors that Influences Exchange Rate. Retrieved February 29, 2012 from http://www.investopedia.com/articles/basics/04/050704.asp#axzz1nsuptv8j Colacito R and Croce M. M. (2011). International Asset Pricing with Risk-Sensitive Agents. Retrieved March 1, 2012 from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1547248 Forex Karma (2010). Interest Rate Parity (IRP) Theory. Retrieved February 28, 2012 from http://www.forexkarma.com/interest-rate-parity.html Gibbons N. (2012). International Pricing: Dollar or Local Currency? Retrieved March 1, 2012 from http://ezinearticles.com/?International-Pricing---Dollars-Or-Local-Currency?&id=4062370 Picardo E (2012). Using Interest Rate Parity To Trade Forex. Investopedia. Retrieved March 1, 2012 from http://www.investopedia.com/articles/forex/08/interes-rate-parity.asp#axzz1nsuptv8j Sanchez M. (2005). The link between Interest rates and Exchange rates do contractionary Depreciations make a difference? European Central Bank. Retrieved March 1, 2012 from http://www.ecb.int/pub/pdf/scpwps/ecbwp548.pdf Part 2 Central bankers are responsible for taking monetary and fiscal policy decision that transforms the entire economies of given nations. Given the fact that the world just suffered global economic meltdown, it took central bank gurus from European Central Bank, U.S Federal Reserve and Bank of Japan to ensure that their countries and by extension the world economy did not suffer total collapse. Through the 1977 amendment to the Federal Reserve Act, the monetary policy of the Fed has affected the US economy over the last ten years in two basic ways and these are “to promote "maximum" sustainable output and employment and to promote "stable" prices” (Federal Reserve Bank of San Francisco, 2012). It is reported that during the periods of September 2007 to December 2008, “the Federal Reserve lowered its short-term interest rate target, known as the federal funds rate target, from 5? percent to effectively zero, where it stands today” (Pianalto, 2011). This move was important in giving more support to finance market and the economy as a whole. Because the finance market was cushioned by this move, it was still position to keep interest rates at lower levels than it would have naturally suffered in the heat of the recession. The same is true for the exchange rate. As part of finance market base, banks and businesses were positively affected because they were cushioned against external shocks that came from countries whose economies where totally collapsing. This in turn promoted international trade positively, making the US keep a lot of her international trade partners. Since the monetary policy by the US Federal Reserve has proved over the years to be competent to handle its affairs independently without governmental interferences, it is suggested that the Keynesianism economics should be followed to take govern hands further away from monetary policy control. REFERENCE LIST Federal Reserve Bank of San Francisco (2012). U.S. Monetary Policy: An Introduction. Retrieved February 28, 2012 from http://www.frbsf.org/publications/federalreserve/monetary/index.html Pianalto S (2011). Current Issues in U.S. Monetary Policy. Federal Reserve Bank of Cleveland. Retrieved March 1, 2012 from http://www.clevelandfed.org/for_the_public/news_and_media/speeches/2011/pianalto_20110407.cfm Read More