CUD FIN 330: International Finance Project on Currency Exchange

This project undertakes an in-depth analysis of currency exchange rates, focusing on the determinants and economic indicators that influence them. The project begins with an economic context and literature review, exploring the characteristics of a chosen currency pair and the existing research on exchange rate determinants. Data collection involves gathering relevant economic data, such as GDP growth, balance of payments, and interest rates, over a specified period. The analysis phase includes calculating descriptive statistics like mean and median, creating illustrative graphs, and running regressions to identify the key determinants of the exchange rate. The project culminates in a conclusion that summarizes the findings and discusses the implications of the analysis. This assignment provides a comprehensive understanding of international finance and currency dynamics.

Running head: INTERNATIONAL FINANCE
INTERNATIONAL FINANCE
Name of Student:
Name of University:
Author Note:

1
INTERNATIONAL FINANCE
Executive Summary
The paper deals in the study of currency exchange rates and its determinants. This is studied by
analyzing the factors that can change the exchange rates and the importance of exchange rates in
an economy. The theory has been analyzed by finding the mean and median to find skewness of
data series.

2
INTERNATIONAL FINANCE
Table of Contents
1. Economic Context and Literature Review...................................................................................4
Effectiveness of currency exchange rate.....................................................................................5
Determinants of foreign exchange rate........................................................................................5
Literature review on the determinants of exchange rates............................................................6
2. Data collection.............................................................................................................................7
3. Analysis.......................................................................................................................................8
4. Conclusion.................................................................................................................................10
Reference List................................................................................................................................11

3
INTERNATIONAL FINANCE
1. Economic Context and Literature Review
Currency denotes the system of money in an economy which has three primary functions
such as store of value, unit of account and medium of exchange for goods and services in the
economy. A high value of currency of an economy makes the import of the country less
expensive with respect to exports in the international markets. This is effectively used to change
the value of goods and services with respect to adequate changes in market based statistics and
parameters. The role is to denote the value of goods as per significant changes in aggregate
demand, supply and the growth of GDP (Gross domestic Product). The money value or currency
is based on the demand for goods and services with respect to changes in the level of
international trade and exchange activities in an economy.
A strong value of the currency is effective for the tourists or travel people who moves
from one place to another and gets added advantage of low currency in other economies. It is
advantageous for the people who likes to use imported goods as imported goods will be cheaper
when the currency value is stronger. However, it is disadvantageous for the domestic companies
to operate and extract huge profits when the currency value is significantly stronger as it makes
way for import and export of goods relatively falls.
A weaker currency can also provide other befits such as increased job opportunities and
cheap imports of capital and technology that can improve the production of goods. This can
change the value of goods as per effective changes in market based strategies and outcomes. US
dollar has been one of the strongest due to its high standard of living and change in effective
market conditions. It is an important parameter to denote the well-being of an economy as it can
estimate the heath of the economy in comparison to other economies. This value indicates the

4
INTERNATIONAL FINANCE
demand for goods and services in the global market with respect to the level of imports and
exports. The role is to change the level of investment with a significant rise in foreign direct
investment that can help to move the economy out of such weak position and boost the economic
growth.
Effectiveness of currency exchange rate
The value of currency can be related to exchange rate which denotes the currency value
of one country with respect to the currency value of another country. It represents how many
units of foreign currency can be bought with the home currency. This can adequately change the
value of goods and services with respect to value of goods in other country. International trade is
effectively dependent on the value of exchange rates which denotes whether export is profitable
or not. Moreover, foreign exchange rates are always fluctuating because of a constant change in
the global economy as measured from consumer demand for goods. Exchange has a significant
impact on the rate of inflation as it as it denotes the demand and flow of goods between two
economies A lower exchange rate ensures a rise in demand for domestic products that effectively
evaluates the value of US currency as per effective changes in market based statistics and
outcomes.
Determinants of foreign exchange rate
Foreign exchange rate can be determined from several factors such as balance of
payments model, asset market model, international parity conditions and the value of economic
indicators.
International parity conditions is detrimental to the value of exchange rates as absolute power
parity is estimated by holding the price level in another country times the exchange rates
between the two countries (Ilzetzki, Reinhart & Rogoff, 2019). This is done to ensure that the

5
INTERNATIONAL FINANCE
purchasing power is same for the two economies such that exchange rate is used as a parity to
adjust the economic difference between two economies.
Changes in balance of payments can lead to fluctuations in exchange rates with respect to
its own and foreign currency respectively. If the exchange rate has a fixed system then it is
unaffected by balance of payments as it is systematically adjusted by the central banks in order to
offset international exchange of funds. However, US dollar has a floating exchange rate and the
value of currency changes according to the way currency trades in foreign markets. US has a
currency value that makes imports attractive and increases trade deficit (Investing.com, 2020).
Thus BOP value changes on a daily basis as per the level of international trade that changes the
exchange rates.
Asset market model is another determinant of exchange rates that uses currency as an
asset for the construction of investment portfolios (De Grauwe & Grimaldi, 2018). The price of
assets are denoted by the willingness of the people to hold the quantities of assets as per the
future expectation on asset prices. If people holds more assets then exchange rate will become
stronger.
Literature review on the determinants of exchange rates
Exchanges can be estimated from other economic indicators such as inflation, interest
rate, rate of growth of GDP and economic status. This is because a lower interest rate, enhances
the customer demand for goods and investor demand for investments which lowers the exchange
rate. However, this low rate of interest can make the value of goods extremely unattractive for
foreign investment in other countries as it increases the cost of operating goods and services
(Verdelhan, 2018). The growth rate of GDP also workers as an efficient determinant because it
denotes the aggregate value of goods and services in the entire economy such that a higher rate

6
INTERNATIONAL FINANCE
growth rate lowers the exchange rate. Therefore, it is important to estimate how the value of
determinants can affect the currency exchange rate of US (Li & Wang, 2017).
The country has a strong currency value that make imports cheaper and exports
expensive. US is referred to as a strong economy with largest per capita GDP and standard of
living. The stronger value of currency exchange rate attracts huge level of imports that creates
huge trade deficit. Even though the level of imports is huge, US still manages to be one of the
strongest economies. This makes it important to estimate how the determinants of exchange rate
affect its performance. This is done to establish a relationship with each other as per effective
changes in market based strategies and outcomes (De Grauwe & Grimaldi, 2018). It makes it
contradictory to the above literature which states how the parameters affect the exchange rate.
Moreover, it is important to carry out an effective analysis that will enable to understand how the
economy of US is so strong even though it faces constant currency fluctuations.
2. Data collection
The data that is collected is secondary data taken from authentic sources. The secondary
data collected for the paper has already been created by other researchers or statisticians that can
be effectively used to denote the effectiveness of exchange rate in US. The analysis is done with
respect to value of determinants to understand the change in value of goods as per significant
changes in market based statistics and outcomes (Papers.ssrn.com., 2020). Nine year data has
been taken for GDP, BOP, inflation, interest rates and the reserves used in BOP with respect to
change in rate of exchange for the last month of every year to denote the strengths of the
variables. The data of inflation rates and exchange rates are also taken for consideration.

7
INTERNATIONAL FINANCE
The values of determinants are taken to estimate the effectiveness of exchange rate in US.
This is done by finding the mean and median (Gabaix, & Maggiori, 2015). These two parameters
are used to estimate the central value of a data set. The middle value in the list is known as
median which is estimated after arranging the data set in an ascending order. The value of mean
is used to summarize a large amount of data into a single value in order to indicate the variability
of the single value data within the original data. The analysis is significantly based on the
outcomes on exchange rates as per the effectiveness of consumer behavior (Farhi & Gabaix,
2016). The goal of the paper is to change the values of variables due to change in effective
parameters and outcomes. The time period considered for the data is nine years which from 2011
till 2019 that will provide effective results and comparing data of US with UAE to understand it
efficiency.
3. Analysis
Mean and median is used to determine the skewness of the distribution. When the value
of mean exceeds the value of median, the data is said to be positively skewed. Whereas, if value
of mean is lesser than value of median, it distribution of the data is said to be negatively skewed.
If the two values are equal, then the slope of the curve will be symmetrical in nature.

8
INTERNATIONAL FINANCE
Reserves in UAE and US respectively
Table 2: Descriptive statistics of exchange rate in US (balance of payments)
Source: (as created by the author)
Table 1, shows that the value of mean for reverses used in BOP is more than the value of
mean which is 463.8057 and 449.907 respectively in US. For UAE, the skewness is negative as
mean is less than median with values70.87 and 78.424 respectively. This signifies that the values

9
INTERNATIONAL FINANCE
are positively skewed with each other which indicates that the data values are more spread out
(Cud.ac.ae, 2020). The mean and median is similar for exchange rate, denoting the fact that the
curve is flatter. This does not show much variance among the data series such that exchange rate
have not changed much.
The value of median is greater than value of mean for the change in value of exchange
rate in US which shows that the data sets are negative skewed (Data.worldbank.org, 2020). The
median value is a better representation of the data sets as it differentiates the higher value values
with the lower values when set in a proper and systematic manner as shown in Table 2.

10
INTERNATIONAL FINANCE
Table 3: Change in the value of GDP growth
Source: (as created by author)
The data sets are negatively skewed for the nine year data of the growth rate of UAE as
shown in Table 3. This is because the mean value is lower than the value of median. However,
there is a slight positive difference in skewness of US showing that US has better GDP growth
than UAE. These differences in the data sets shows that reserves in the US are effective, while
the other parameters are not effective as the skewness is negative or flat.

11
INTERNATIONAL FINANCE
Table 4: Trend in BOP of US
Source: (As created by author)
Similarly, a high value of median for BOP shows that values are positively skewed although
BOP is negative which shows that the parameter is ineffective as evident from Table 4.
Figure 1: Trend in Balance of trade