Institute of Chartered Financial Analysts of India (ICFAI) University 2006 Certification Finance International and Trade – II - Question Paper

Caselet 2

learn the caselet carefully and ans the subsequent questions:

8. explain the different factors which influence the exchange rate of US dollar.

(7 marks) < ans >

9. Do you think dollar can depreciate sharply against other major currencies? explain.

(6 marks) < ans >

10. How falling dollar is affecting the Asian countries? How they can combat the situation?

(5 marks) < ans >

A gigantic current-account deficit ought to be bad news for a currency. For the dollar, reality seems at last to be coming into line with the textbooks. In the past month or so the greenback has lost 6% against the euro, 7% against the yen and 3% on a broad trade-weighted basis. This week it dipped beneath 8 yuan for the 1st time since China abandoned its fixed rate of 8.28 to the dollar last July. Even before the markets' latest upset, caused largely by inflation worries, there was cause to believe that the dollar was on the prolonged slide that economic logic suggests is overdue.

Before anybody begins talking about a turning point it is worth considering 2 caveats. First, the dollar has defied gravity less dramatically than many people think—especially once you cast your gaze beyond the euro, the yen and the yuan. The dollar's broad trade-weighted index has fallen by 18% since February 2002. Last year, notes Jim O'Neill, of Goldman Sachs, the greenback lost against the Canadian dollar (which has a weight almost as big as the euro's) and a few important emerging-market currencies such as the South Korean won (which counts for about the identical as the pound sterling).

The 2nd caveat is that once you look at the euro and the yen, the dollar has been here before, and not that long ago. At the begin of 2005, the greenback was weaker against both the euro and the yen than it is now, but gained against both currencies in the course of the year. Asian central banks, which have helped sustain both the current-account deficit and the dollar by buying Treasury bonds in startlingly large quantities, have little interest in a weaker greenback. Oil-exporting countries are also thought to have been putting at lowest a few of their extra revenues into dollar-denominated assets, including treasuries. Neither source of current-account funding looks likely to dry up just yet.

Against these caveats there are a number of reasons to argue that something fundamental may just have shifted against the dollar. The 1st is the removal of a temporary prop. Last year American companies were allowed a lower tax rate on profits repatriated from abroad. Now, that support for the external deficit and the dollar has been taken away.

Earning:   Approval pending.