Factors Affecting Relative Prices of Commodity - Report

Added on - 28 May 2020

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Running head: INTERNATIONAL FINANCEINTERNATIONAL FINANCEName of the StudentName of the UniversityAuthor’s Note
1INTERNATIONAL FINANCETable of contentsIntroduction.................................................................................................................................................3Discussion....................................................................................................................................................3Conclusion...................................................................................................................................................7References...................................................................................................................................................8
2INTERNATIONAL FINANCEIntroductionThe objective of this report is to provide an overview on the main factors affectingrelative prices of commodities. Fluctuations in prices are upward or downward swings incommodity prices in the economy. A significant part of the price differences between thecountries are the terms of trade of goods and services, fluctuations in exchange rate, wagecompression etc. The causes of price fluctuations between the nations focus on the factors thatimpact the prices of tradable products, mainly services, as the price divergence apt to beeroded in the traded industry of the nation (Frank, Bernanke and LUI 2015)An exchange raterefers to the price of the country’s currency with respect to another country’s currency.Exchange rates are mainly determined in foreign exchange market. Relative prices of productsand services are vital for determining changes in exchange rates over long periods. Purchasingpower parity (PPP) signifies that the exchange rate between currencies is equivalent to ratio ofcurrencies. It is determined in every nation based on their cost of living as well as inflationrates. This economic theory however compares various nations’ currencies through basket ofproduct approach. Terms of trade (TOT) indicates the prices of country’s exports relative totheir import prices. Fluctuation in terms of trade leads to changes in prices of exports andimport goods. Foreign exchange market refers to the market in which the participants of thenation have the ability to purchase, sell, speculate and exchange on the currencies (Frenkel andJohnson 2015). The operations of foreign exchange market mainly includes- transfer of fundsbetween two nations, providing short term credit to importers to increase the flow of productsbetween countries and hedging risk of foreign exchange. The central banks of the respectivenation plays vital role in this foreign exchange market. These banks control supply of money,inflation, and interest rates. They utilize foreign exchange reserves for stabilizing market. Thegovernment usually intervenes in the FX market in order to influence exchange rate level andstabilize it for improving the health of the nation.
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