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International Bond and Currency Markets - Essay Example

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International Bond and Currency Markets Table of Contents Introduction 3 Challenges in Forecasting Exchange Rate in Short Run 4 Challenges in Forecasting Exchange Rate in Long Run 6 Conclusion 8 References 10 Introduction Effective and accurate forecasting of the exchange rate fluctuations is an important and fundamental problem in international financial decisions…
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International Bond and Currency Markets
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International Bond and Currency Markets

In precise, it also helps in pre-determining the fluctuation of the currency appreciation or depreciation in respect to countries and influenced cross border trade prospects by a substantial extent. It is noteworthy that the volatility of exchange rate, in the short run and also in the long run depends on multiple factors such as the demand and supply prospects in the financial market. Arguably, forecasting in the long run and short run is considered as quite difficult, which can be explained with reference to the Theory of Speculation in the market and the collective belief of the investors about the future prospects (Andreou & Zombanakis, 2006). Based on these underpinnings about the importance of forecasting exchange rate fluctuations, this essay will aim at emphasising the challenges commonly witnessed by analysts when obtaining the intended forecasting results in the short run as well as in the long run performance of the exchange rate. Challenges in Forecasting Exchange Rate in Short Run Arguably, in the short run, the forecasting of exchange rate is nearly impossible. Forecasts, which are delivered by the macroeconomic factors, are generally less accurate than the results obtained through Random Walk theory application. In general, the Random Walk Theory presumes that market changes, in terms of stock-prices changes, are unpredictable. Even though in the long run forecasting, the theory has been considered by many financial investors and analysts, the short run implications of Random Walk theory remains under considerable scrutiny. It is in this context that no claims to substantiate a perfect Random Walk model in the short-run stock price fluctuation were firmly made. On the contrary, arguments centralised on the theory that forecasting stock-prices changes in the short run is challenging owing to the fact that in the short run, the volatility of the exchange rate is less but the speed of convergence based on Purchasing Power Parity (PPP) is slower than that recorded in the long run (Babazadeh & Farrokhnejad, 2012). Correspondingly, it has been argued that the level of exchange rate in the short run is not very predictable, but is also not entirely unpredictable, as the volatility of the currency and the correlation between them vary with time and hence, forecasting becomes challenging (Mitra, 2008). The current account balances, real income of the people, interest rates, the preferences of the consumers regarding the domestic or foreign products, are all signified as market fundamentals influence the stock-prices in the short run, as per the conceptual framework of PPP. As explained by Taylor & Taylor (2004: 135), “PPP is a disarmingly simple theory that holds that the nominal exchange rate between two currencies should be equal to the ratio of aggregate price levels between the two countries, so that a unit of currency of one country will have the same purchasing power in a foreign country”. Subsequently, it is the monetary policies, the fiscal policies and the market speculations affect the forecasting decisions in the short run. These factors are important when considering the financial transfers with regards to the ... Read More
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