Globalization and International Financial Management Research Paper

Globalization and International Financial Management - Research Paper Example Factors such as relative interest rate, real interest rate, relative income level and other government controls are few which affect the determination of exchange rate. Governments all across the globe vigilantly monitor their exchange rates and actively make the direct and indirect intervention for control purposes. Measuring the change in the exchange rate is easier as compared to evaluating the intricacy of the factors responsible for it. In order to analyze the cause and effect of a change in exchange rate, the concept of exchange rate equilibrium can be utilized. The concept is based on the basics of the law of demand and supply. Like a commodity, the foreign currency is also traded in markets where their exchange rates are determined based on the current demand and supply of that particular currency in the global economy. In order to grasp the concept, let us take two currencies into comparison: United States Dollar ($) and Euro (â‚ ¬). The exchange rate of Euro will be dete rmined by the conditions of demand and supply of the currency in Europe. In addition, the demand for Euro in the United States will also be a major factor in determining the exchange rate of the currency. ... Inflation rate holds significance in determining the spot exchange rate of a country. Inflation rate casts direct impacts on the trading activity of a country. Higher inflation in one country would cause its goods to become less desirable in other parts of the world and thus its exchange will deteriorate as the demand for the currency of that particular currency will decline. Interest rates are also one of the factors responsible for fluctuation in the exchange rate. Interest rate can categorize into relative interest rate and real interest rate in order to determine the effect of a change in the exchange rate as a result of its hike and decline. Considering the relative interest rate, it can be defined as the change in the interest rate of the country when compared with any ot her country. If the interest rate in country A rises while the one in country B remains constant, the investors in the country in A will deter from demanding the currency of country B as for them it is much more lucrative to invest in country A as it offers higher interest rates. Similarly, for investors in country B, it is much more desirable to invest in country A. The investors in country B will then resort to selling their currency in order to obtain the currency of country A. Result, the exchange rate of the country A will escalate when compared with that of country B. This can be more intricate when the effect of change in exchange rate is taken into consideration from a global perspective. The change in the exchange rate of a third can also cause the relative exchange rate between the country A and B although their relative interest rates remain the same.