International Financial Management Project - Example

Title: International Financial Management Project

I am handing in a report as indicated in the Project Notes in the manual of tests of a specific research question.

Yes

I have placed my appendices and references at the end of this project. The appendices just contain backup data only with brief explanations. All the results of my tests are in the main text

Yes

The LECTURE NOTES, support material and textbooks have been my MAIN source of reference.

Yes

Any sequence of more than FOUR (4) words from another source has been referenced using the Harvard system FOR EXAMPLE “words from another source” (Keynes V. B., 2005). You MUST use inverted commas (“….”) for words that are NOT your own.

No

This paper was to be referenced according to APA style.

My similarity score is below 15%. AND I have allowed 24 hours for Blackboard to work out my similarity score

Yes

ALL the material for my project is contained in my Word file submission. I understand that NO other source will be marked

Yes

Data from Excel and other sources have been cut and pasted into my Word file submission as appropriate (EITHER through direct “copy and paste” OR the printscreen key (PrtScn) and then cropped to the relevant area). Large databases have been shortened by giving the first 10 and last 10 entries.

No

All my computations have been performed in word file using a scientific calculator (FX-115ESPLUS)

ALL tables, graphs etc have a clear title AND in the bottom left hand corner “source:……” for example Source: ESDS and own analysis

Yes

I have constructed ALL the tables and graphs in my submission MYSELF

Yes

I have followed the write up format given in the Project Notes in my manual and the Assignment section of the Blackboard site

Yes

My data includes the latest data available

Yes

Introduction

Balance of payment (BOP) is a statement which gives a summary of all transactions relating to a county’s economy with other countries over a specific period of time. Moreover it gives a report on the nature of transactions involving goods, services and income for both resident and nonresidents. BOP account is classified into two accounts to include the capital account and the current account that records acquisitions or the disposal of fixed assets needed for production and the inflow and outflow of goods and services into a country respectively. The summation of goods and services gives as a balance of trade (BOT) which determines whether there is a deficit or a surplus (Afonso & Lagos, 2015, 263-313). Essentially, BOP account is expected to balance however this may not be the case due to several reasons which entails fluctuations in the exchange rates that changes the value of money hence causes a discrepancy in the BOP account. On the other hand, for a trading economy like the United Kingdom, exchange rate is used to denote the cost incurred by a firm in terms of commission paid when one currency exchanges with another. These exchange rates impacts on the price of exports and imports which forms the aggregate demand (AG) hence a change in the BOP (Cesaratto, 2015, 3). This project aims to establish the relationship between balance of payment and the exchange rate by testing the null hypothesis that there is no significance difference between balance of payment and exchange rates. The significant of this test is designed to give a country a position to devalue its currency in the financial markets so that its BOP becomes stable over time. Devaluing a domestic currency over a foreign currency has an effect of making domestic exports cheaper and imports expensive for the locals in order to eliminate the BOP imbalance.

Test design

If the project research answers the hypothesis or the problem of study, then it is a success. In this case, an appropriate qualitative or quantitative tool should be utilized so that we can have strong basis of either accepting or rejecting the hypothesis. This project will employ Marshall- Lerner Condition tool to establish the correlation between BOP and the exchange rate (Thirlwall, 2014, 128). Marshall- Lerner conditions states that devaluation or depreciation of a currency will lead to an improvement in the current account balance if the elasticity of demand for exports plus elasticity of demand for imports is greater than 1.

PED of Exports + PED of Imports > 1

= % ∆Qx + % ∆QI >1

% ∆Px % ∆PI

Note that the % ∆P is the currency real or nominal rate.

Real exchange rate is the relative price of foreign goods in relation to the domestic price of domestic goods. In order for the balance of payment to improve, the value of the domestic currency has to go up more than the devaluation rate (Gabaix & Maggiori, (2014). In this case, the price elasticity of exports must be greater than one to satisfy the equation. For the test condition to remain true the following assumption has to hold: the commencing point must come from a balance of trade position to summarize the total value of a country’s exports and imports over a given period of time. On the other hand, the price elasticity of supplies must be infinite and remain constant throughout the test period. Moreover, the rate of inflation as depicted by the consumer price index (CPI) will remain constant (Jones et.al, 2014). In his argument, Marshall states that there will be an increase in the balance of payment given a depreciation in the domestic currency. This statement however, will hold if the summation of the price elasticity of demand of exports and imports is greater than 1. Nevertheless, there are some draw backs involved with this condition as a test statistic given that it lacks the equilibrium condition and considers only two types of markets which relate to the exports and imports of a country indicating that they are independent of each other. This is disputed since in an ideal budget constraint, markets cannot be independently of each other (Starr, 2014). This paragraph has clearly reviewed the designed that will be used in the project to establish the relationship between the balance of payment and exchange rates.

Test of the statistic

In this section we shall use a case study to explain whether there is a significant difference in the two variables of the project. Consider the transactions between UK and US which relates to the imports and exports volume.

Original Exchange rate

£ 1= $ 1.80

New exchange are will be:

£ 1= $ 1.60

Exports of PCs from UK

Imports of DVDs from US

UK price £

350

US price $

450

US price $

630

UK price £

250

Demand

40,000

Demand

60,000

Export Revenue

14,000,000

Export Revenue

15,000,000

New exchange:

UK price £

350

US price $

450

US price $

60

UK price £

281.25

Demand

46,220

Demand

56,670

Export Revenue

16.177,00

Export Revenue

15,938,438

Table I: Exports and Imports with change in exchange rate (2011-2015)

Source: UK trade NS

The table above depicts the trade between the two countries and the changes in the overall current account when currency is altered. Using the Marshall model, we can establish the relationship between the changes in the current account balance given the fluctuations in the rate. It should be noted that the PED of Exports+ PED of Imports >1. If the result is a figure greater than 1, the null hypothesis is rejected (Gelman et.al, 2014). However, if the result does not satisfies the equation, you accept the null hypothesis. Using the information from the above, Marshall Lerner condition can be used:

= % ∆Qx + % ∆QI >1

% ∆Px % ∆PI

=% ∆QX=46,220-40,000/40,000*100=15.55%

= % ∆Px = 1.80-1.60/1.80*100= 11.11%

=% ∆QI=56,670-60,000/56,670*100= 5.87%

= % ∆PI = 1.80-1.60/1.80*100= 11.11%

PED X=15.55/11.11=1.39

PED I= -5.87/11.11= 0.52

Hence, elasticity= 1.39+0.52=1.91

From the result, the PED X+PED I>1 therefore reject the null hypothesis which states that there is a significant difference between the balance of payment and the fluctuations in exchange rates (Farnham, 2015).

Reflection on the results and further tests

From the results it is clear that the changes in the exchange rate has a big impact in the current account. This effect is that an increase in the rate causes the home currency to depreciate against the foreign currency. The impact is that home currency making the imports expensive for the locals and exports cheaper. When a country exports more that it imports, then it means there is a surplus in the balance of trade which improves the BOP of a country. On the other hand, it can be stated with high degree of confidence that a strong relationship exist between the BOP and exchanges rates as shown in the stock market exchange. Furthermore, the research can utilized correlation analysis tools as further tests to establish this relationship (DeFusco et.al, 2015). If correlation is used as a test statistic, then the researcher will be keen to identify the sign of the value r which represents the coefficient of correlation. If the computations show a negative figure, then little strength exists between the variables as opposed to when the figure is positive. The rule is, values above zero (0) have a strong relationship. Similarly, the study could also use linear regression line by plotting a scatter diagram and drawing the line of best fit passing through most of the points (Harrell, 2015). Using the trend and the regression equation, it is possible to determine a series of changes in the BOP if exchange rates fluctuate. Future predictions can be determined by this method if accuracy in the derivation of equation was adhered. Moreover, changes taking place in the current account may also be impacted by other factors apart from the exchange rates. For instance a decrease in the disposable income of households may lower the BOP since the levels of production will become low hence a decrease in the exports. To gain normalcy, the government may come hand in hand to offer subsidies in the production sectors to encourage more production to take place. With increase in production and more exports, the balance of trade will improve so does the BOP.

Conclusion

When conducting a project or research study, the researcher is keen to ensure that he finds the best solution to his problem. This will only be possible depending on the choice of the statistical tools used to test for the level of significance which will form a basis for decision making. The most tools used in research include regression analysis, correlation among other depending on the type of project. However, whichever the method used, a correct solution should be reached that will answer the research problem. In this project, the sole aim was to determine the association between the BOP and the exchange rates which has been established based on the results showing a strong associations. Adverse changes in the exchange rates has an impact on the BOP which can only be addressed by the government of a given nation in conjunction with the central bank.