International Trade
Institution Affiliation
Date
Explain with examples (at least 3) of arbitrage in exchange rates.
Arbitrage is said to occur when a security is bought in one market and simultaneously sold in another market at a higher amount. Arbitrage gives out a mechanism to ensure prices do not differ substantially from fair value for a wide span of time (Cui et al.., 2018). The first example involves buying and selling of the currency. For instance, a stock of company Y is trading $10 on the New York Stock Exchange while, at the same time, it trading at 10.5 on the other stock exchange. In this case, a trader can buy the stock from NYSE and later sell it the other stock exchange company and earn a profit of 5 cents for every one share.
The second example is referred to as the triangular arbitrage where banks with different exchange rates are used. In this strategy, trader goes through stages. The first stage is converting one currency to another at one financial institution. The second stage is converting the second currency to a different bank. Finally, the trader converts the third currency back to the initial at a third financial institution. The third example of arbitrage happens on the corporate scale, and it is commonly referred to as global labor arbitrage. This form of arbitrage involves a company moving its assets to another country to obtain cheap labor.
Explain how a country’s balances of payment directly affect the exchange rate
A change in the balance of payment of a country causes fluctuations in the exchange rate between foreign exchange and its currency. The reverse of the statement is also true in that a fluctuation in the exchange rate affects the balance of payments (Guzman, Ocampo, & Stiglitz, 2018). A balance of payment is defined as the statement of all transactions that are carried between a country with other nations. The relationship between foreign exchange and the balance of payments under the system of floating-rate exchange is influenced by the supply and demand for the currency of the country and all transactions carried out with other countries. Suppose a customer in America wants to buy goods from France. The company in France is not likely to accept dollars as payments. Therefore, the customer will be required to buy euros and then exchange it with a French product. In that case, as more euros are demanded to satisfy the needs of the foreign customer or investor, upward pressure is experienced on the price of the euros.
Explain the many reasons why companies locate outside of their home country.
There are many reasons why the company may opt to locate outside of their country. One of the main reasons that may cause this situation is to expand is to reduce the transport-related costs of finished products (Cuervo-Cazurra, Ramamurti, & Ang, 2018). This act enables the company to reduce its prices for the goods hence placing itself in a position to compete effectively with the local industries. The second reason may be that the transportation of imported raw materials is expensive than the importing finished goods. The third reason is that some countries tend to have low labor wages than others. In that case, the company may locate itself in those countries to reduce the production cost of a particular good. However, this is common for the labor intensive production (Cuervo-Cazurra et al., 2018). In addition, skilled labor is another factor that may cause the company to locate in foreign countries. Mostly, this happens when the home country has shortage or no skilled manpower related in the production of particular product or service.
Explain the relationship between interest rates and exchange rates
Generally, high interest rates indicate that the currency of the country has a high value. This implies that investing in the country has a high chances of making great profits. Thus, this occurrence will raise the demand for the currency of the country involved (Thornton & Vasilakis, 2019). The investors will automatically invest in that country to take the advantage of the high rates. In a situation when the currency goes up exceeding another that of another country, the currency of that country is said to appreciate. When this instance occurs, the exchange rate increases. The reverse of this is also true in that, the country’s currency is said to be of low value when its interest rates are low. This results to the currency depreciation and leads to weak exchanges rates.
References
Cuervo-Cazurra, A., Luo, Y., Ramamurti, R., & Ang, S. H. (2018). The impact of the home country on internationalization.
Cui, Z., Qian, W., Taylor, S. M., & Zhu, L. (2018). Detecting Arbitrage in the Foreign Exchange Market. Stevens Institute of Technology School of Business Research Paper.
Guzman, M., Ocampo, J. A., & Stiglitz, J. E. (2018). Real exchange rate policies for economic development. World Development, 110, 51-62.
Thornton, J., & Vasilakis, C. (2019). Negative policy interest rates and exchange rate behavior: Further results. Finance Research Letters, 29, 61-67.