Forecasting Exchange Rates and Risks Associated with Transaction and Translation Exposure

Question 1

Normally, the big Max Index is an informal way of measuring Purchasing Power Parity (PPP) which concerns two currencies. It also provides a test of the degree to which the market exchange rates leads to goods sharing the same price in different countries(Clements, 2013).

Precisely, the bigmax index supports the theory of PPP in that, when we divide the price of a big mac in a particular country (using its currency) by the price of another country (using its currency), we get the big mac PPP exchange rate. The value then gets contrasted with actual exchange rates and if it’s lower, then it is undervalued and visa vis.

While following this explanation, it is rational to argue out that a country with high-interest rates tends to have a high inflation rate too. In this manner, the international Fisher Effect (IFE) gets related and reflected by different prices on the big mac index(Clements, 2013).

Inflation gets related to athe price index and the prices in turn get related to personal incomes. Usually, high inflation reflects sharp increases in prices of commodities traded globally. The increase in prices of goods only occurs in response to inflation of the money supply. Therefore, purchasing power is weakened, and personal income seems inadequate.

Question 2.

When it comes to international business, Translation exposure is considered as the difference between exposed assets ans exposed liabilities. Translation exposure, on the other hand, refers to the amount of foreign currency dominated transactionsalreadyentered to. Therefore, when we consider inflation and interest rates, losses and gains can be obtained on settlements, depending on the currency in which a company invoices its sales, the one it buys and currency domination of borrowing. For an enterprise to mitigate the degree of transaction exposure, the particular company can invest, borrow and invoice both purchases and sales in the local currency(Carbaugh, 2013).

Question 3

Highly inflated countries have weak home currencies. It isparticularlybecause inflation leads to high prices which in turn leads to a weakening purchasing power of the specific currency. The money ends up weakening as long as inflation prevails.

Weak currency countries possess poor economic fundamental and these may include chronic current account, high rate of infalstion, budget deficits and sluggish economic growth. These countries usually have a higher level of imports compared to exports which results to more supply than demand. Therefore, there is no pricing advantage for exporters from such nations.

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