Answer to Question #111317 in Finance for Aliyu Musa Garba

Question

1.What is suggested by the international Fisher effect?
2. Defined transaction exposure
3.what is defined as effective exchange rate?
4.what is the balance of payments? specify its major categories

Answer 1

1.The Fisher International Effect is an exchange rate theory developed by economist Irving Fisher in the 1930s. The model is based on present and future nominal interest rates, and not on pure inflation, and is used to predict and understand the dynamics of the current and future exchange rates. In order for the theory to work in its purest form, it is assumed that the risk-free aspects of capital are freely traded between countries whose currencies make up the currency pair in question.

IFE is calculated as:

$E=\frac{i1-i2}{1+i2}$

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E - the percent change in the exchange rate

i₁ - country A’s interest rate

i₂ - country B’s interest rate

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2.Transaction exposure, defined as a type of foreign exchange risk faced by companies that engage in international trade, exists in any worldwide market. It is the risk that exchange rate fluctuations will change the value of a contract before it is settled. This can also called transaction risk.

3.Effective exchange rates compare a country’s currency to a basket of other countries’ currencies. The most common way to identify the basket of currencies is to consider a country’s major trade partners. In this case, the effective exchange rate is called the trade-weighted index because the weights attached to other countries’ currencies reflect the relevance of the home country’s trade with these countries.

The effective exchange rate measures the value of the domestic currency against the weighted value of a basket of foreign currencies, where the weights reflect the foreign countries’ share in the domestic country’s trade. Therefore, you use the effective exchange rate if you’re interested in the domestic currency’s performance compared to the country’s most important trade partners.

4.The balance of payments, also known as balance of international payments and abbreviated B.O.P. or BoP, of a country is the record of all economic transactions between the residents of the country and the rest of the world in a particular period of time (e.g., a quarter of a year). These transactions are made by individuals, firms and government bodies. Thus the balance of payments includes all external visible and non-visible transactions of a country. It is an important issue to be studied, especially in international financial management field, for a few reasons.

IMF balance of payments