International Financial Management - Essay Example

Australian Dollar US Dollar Over the past few years, Australian dollar’s strength has been a of extensive discussion among economists. Despite of having rising foreign debt and high current account deficits, the real exchange rate of Australian dollar has appreciated significantly. This essay seeks to find out the relationship of Australian dollar with U.S dollar and possible causes of appreciation and decline in Australian dollar. Australian Dollar/ US Dollar Exchange Rate Movements - 5 Years The purpose of exchange rate is to reflect the purchasing power of one currency with respect to another currency. Strengthening of Australian dollar with respect to US dollar means that less Australian dollar are required to buy one US dollar. This section analyses the trend of exchange rate of AUD/USD for the past 5 years. The trend line below in the graph shows the trend of exchange rate of AUD/USD over the past 5 years. At first glance, it is quite evident that Australian dollar has increasing trend against US dollar and some fluctuations exist. Although the graph shows strong increased trends in this 5 year period, yet there are some noticeable points need to be paid consideration to. The first substantially fluctuating period is in January 2009, where Australian dollar touched the lowest of past 5 years. It is the recession of Australian currency. This is the post-recession period after the financial crisis of 2008. Australian currency hit its lowest point in January 2009 and reached an exchange rate of 0.64. After the recession of 2009, Australian dollar continued to strengthen against US dollar until 2013. The AUD/USD exchange reached 1.04 on January 2013. The Australian dollar has only stayed at lowest point for a short period, which is due to recession. Apart from that, no significant fluctuations can be seen in Australian dollar for the past 5 year. Australian dollar/ US dollar Exchange Rate Movement Over the Last Year The exchange rate between Australian Dollar and US Dollar for the past 1 year commencing from March 1, 2012 and ending on February 28, 2013 can be observed in the chart presented above. Australian Dollar experienced a significant decline especially in the beginning quarter of this period such that kit deflated from USD1.08 to USD0.97 in nearly 3 months. The percentage decrease in the value of Australian Dollar against US Dollar in these 3 months was around 10.18% which was a very major slump. After that Australian Dollar bounced back in a more stable position such that it reached at a point of USD1.05 in the month of August. Since then it kept fluctuating within the band of USD1.02 and USD1.06 till the end of this 1 year period. Australian Dollar was its peak on the first day of this period with the value of USD1.08 and completed the period with the value of USD1.02. It experienced a net decline of USD0.04 which is around 3.7%. Highest point of the year was USD1.08 whereas the lowest point of the year was USD0.96. The average value of Australian Dollar for the whole year remained at around USD1.025. Overall, it can be concluded that Australian Dollar did not experience deep declines in the last year except of the first quarter which resulted in a decline of around 10.18% in just three months’ time. The performance of Australian Dollar remained quite satisfactory as the currency did not undergo deep fluctuations but remained stable throughout the year. Factors Affecting the Fluctuations in Australian Dollar There are various factors which have significant effects upon the movements and fluctuations of Australian Dollar with respect to US Dollar such as higher interest rates, slow growth in developing countries like China and India, instability in Eurozone etc. (Gaylican, 2012). The following section highlights each of these factors in a more detailed manner. Interest Rate Pacific region is considered as the quite unique region in terms of interest rates such as Japan in the one which has very low interest rates whereas Australia is the one which has the highest rates (Investopedia, 2011). One of the major factors associated with exchange rate is the interest rate. In the last year, Australian Dollar slipped massively especially in the first half of the year mainly due to the higher interest rates promulgated by Reserve Bank of Australia. Higher interest rates in the economy curtail the money supply so does exchange rate. Later on, RBA started to ease out the interest rates in the economy which also caused an increase in the exchange rate. Slow Economic Growth in China Australia is one of the leading countries that exports agricultural and mining products to all over the world especially the developing countries such as China and India. In the beginning 6-month period, there was a significant slow growth felt especially in China which is the leading importer of Australian products. This caused a significant reduction in the production of Australia and caused fewer remittances in Australia. Due to low remittance, Australian Dollar got weakened against all major currencies including US Dollars. After improvements in the economic situation of China, the production and exports achieved their previous levels and thus injected more remittances into Australian economy causing a stable and healthy exchange rate in the end. Instability in Eurozone The situation around the Eurozone was a significant worrying sign for all the developed countries and not only Australia. Australia was considered a safe haven especially for USD assets (Teckchandani, 2011). However with the increasing fears over the Eurozone situation has also made the Australian economic factors quite vulnerable. With the overall increase in the Dollar Index against all the major currencies, Aussie also suffered from the weakened position due to rising uncertainty in Eurozone. Australian economy is not directly connected with European economy, however, as a ripple effect in the major currencies also wobbled Aussie especially in the last year. In the later phase of the year, when ECB with the support of Germany started to back up the Eurozone instable economies, global currency including Euro, Yuan, Yen etc. started getting improved and thus reshaped Aussie to its equilibrium level. Coal Industry and Currency Risk Exposure The export activity of Australia mainly depends upon the two types of products which are agricultural products and mining products (Kohler, 2012). Among the mining products, coal contributes the largest. According to the reports issued by Australias Bureau of Agricultural and Resource Economics and Sciences (ABARES), the projected production of coal is likely to grow by 1.8% in the next two decades whereas the local consumption of coal may remain a bit sluggish with the negative growth of around 0.8% in the same period. However, the coal exports are likely to increase by some 2.4% as the demand for coal in developing countries like China and India is constantly increasing. In this way, the hard coal industry is likely to reap the advantages due to such global increase in demand for its coal. The exchange rate of Aussie is also positively correlated with the production of coal such that if there is an increase of 1 million coal exports, this would result in an increase of 0.00245 US Dollars (Ali and Rahman, 2012). In this way, it can be noted coal exports have a dominating influence upon the currency movements and thus poses significant currency risks. Following are some of the measures which Australian exporters can take in order to save themselves from adverse movement of exchange rate. Forward/Future Hedging With the forward/future hedging, the exchange rate can be fixed. This measure can eliminate the risk of adverse currency movements but its major disadvantage is that the exporters cannot enjoy the favorable currency movements as the contract is binding and has to be enforced. Option Hedging Options provide an opportunity to the investors of enjoying the favourable currency movements as the option can be exercised only when there is adverse currency movements. However, the biggest disadvantage of this hedging technique is the increased amount of premium cost which has to be paid irrespective of exercising the options. Currency Swap This option can be exercised when an exporter of the same amount can be found in the developing countries. Thus the Australian exporter can take its money in Aussie with the Australian importer whereas the developing country’s exporter can receive his remittances from the importer of the same country thus effectively eliminating the currency risk exposure. The biggest disadvantage of this technique is the search of the exporter in other countries with the same amount and same need. Future Prospects of Australian Dollar It is a popular assumption that appreciation of real exchange rates typically has positive impacts on the Australian economy; however the effects are both extensive and diverse. In long term, the primary trigger behind the appreciation of exchange rate is the operational change in Australian economy (Pettinger, 2008). Strong Australian dollar is a sign of more expensive Australian exports however in the global markets export industries will become less competitive effectively. Other than farming, mining, tourism and manufacturing, majority export industries are likely to be influenced by this. Those that will not be able to compete under greater exchange rates will diminish. In gray, AUD per 1 USD are shown. The forecast for the target year and month is shown in green. It is predicted that in March 2014, Australian dollar will be at around 1.00. The gray line in chart falling left to right shows weakened US dollar as compared to other currencies. It causes goods produced in other countries to be more expensive for US purchasers. This situation will decrease imports of US. As the US dollar weakens, other currencies get strengthen against US dollar, causing goods produced in other countries to be less expensive for US buyers. It will increase imports of US (West, 2012). The above mentioned table shows 12 month forecast for Australian dollar. The chart reveals that the exchange rate for Australian dollar in 2014 will be around 1.01 AUS to USD. In February 2013, the Australian dollar exchange rate averaged 0.97 Australian dollars to US dollar. It is 1.7 basis points greater than 0.95 in January 2013. This rate is 3.6 basis points higher than the rate of 0.93 in February 2012. Increment in the exchange rate of AUD/USD indicates upward movement in the short term trend of AUD/USD. In other words, USD strengthens against Australian dollar in short term. The highest AUS/USD exchange rate over the last year was 1.00. The lowest rate was 0.95. The highest rate occurred in May, 2012. The market low was attained in March, 2012. Many market commentators believe that AUD at US$ 1.10 was overpriced. Despite of that, a UK based economist, Toscafunds Savvas Savouri states that Australian dollar is more likely to hit US$ 1.70 by 2014. It is forecasted that Australian economy will expand 3.75% in 2013. Savouri further states that “A rising Australian dollar is an endorsement of your economy and is not something to be feared.” Two broad forecasts are possible for Australian dollar in the next two years. Wither it will stay at its average rate or it will increase substantially as compared to past few years. In both cases, policy makers and investors can formulate relevant strategies in order to hedge against currency risk (ABC News, 2012). Works Cited ABC News. 2012. Economists react to falling dollar. Available: http://www.abc.net.au/news/2012-05-01/economists-react-to-falling-dollar/3984018. Last accessed 18 March 2013. Ali, L and Rahman, S. 2012. Influence Of Australian Coal Export On A$/US$ Exchange Rate: A Longitudinal Study. International Business & Economics Research Journal. 11 (4), 397-406. Gaylican, C. 2012. Australian Dollar Outlook - 05/17/2012. Available: http://au.ibtimes.com/articles/341979/20120517/australia-dollar-usd-aud-eur-commodities-europe.htm#.UUopnhf-EWk. Last accessed 18 March 2013. Investopedia. 2011. The Australian Dollar: What Every Forex Trader Needs To Know. Available: http://www.investopedia.com/articles/forex/11/aud-fx-traders-should-know.asp. Last accessed 18 March 2013. Kohler, A. 2012. Australia will be a casualty of the currency wars. Available: http://www.abc.net.au/news/2012-12-19/kohler-currency-wars/4435690. Last accessed 18 March 2013. Pettinger, T. 2008. Australian Dollar Appreciation. Available: http://www.economicshelp.org/blog/426/trade/australian-dollar-appreciation/. Last accessed 18 March 2013. Reserve Bank of Australia, n.d. International Market Operations. [online] Available at: Accessed at 18 March 2013. Teckchandani, V., 2011. Weak Australian dollar deserves better. [online] Available at: < http://www.investordaily.com.au/cps/rde/xchg/id/style/11686.htm?rdeCOQ=SID-0A3D9632-389E0454> Accessed at 18 March 2013. West, M., 2012. Dollars long rally far from done. [online] Available at: Accessed at 18 March 2013. 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