Fixed Exchange Rates Increase Corporate Currency Risk in Emerging Markets because the markets usually in the Global Risk affect the currencies because a higher risk among market participants leads to inflows of capital into emerging markets, which results in an appreciation of their exchange rates (Chan, 2015). The unique position of the US dollar in the international monetary system also plays an important role. Some abrupt swings in emerging market exchange rates are typically linked to capital outflows, tighter financing conditions, and heightened financial instability. Financial instability can be the cause the various
The drivers in these movements, however, will be determined by the relative strengths of these currencies. This box presents a methodology in which are held to separating these currencies (Nakamura, 2016). The drivers of emerging market exchange rate swings; spillovers from interest rate effects and idiosyncratic domestic shocks. It uses the methodology to analyze the factors behind the sharp depreciation and subsequent recovery of emerging market rate exchange rate swings. As well as the alterations in which the exchange rates represent for the interest rates and the corporate currency will be at risk of default or not meet the standards of the company in their respective emerging markets.
As well as the increase in Corporate Currency Risk in emerging markets does have effects when it is regarded in the sense of the Fixed Exchange Rates Increases in currency risk. It creates a vital sense of how correlations since they’re fixed interest rates, cannot be changed (Helísek, 2019). This could cause corporate currency risk in emerging markets as the fixed rates must be fluctuated and be adjusted to meet specific needs and criteria for corporations and their emerging markets. With adjusting the interest rates in several countries there will be a greater result on the basis of the corporate currency risk which in emerging markets will fluctuate and the interest rates need to fluctuate accordingly (Nakamura, 2016).
Chan, M. S. (2015). REAL EXCHANGE RATE ADJUSTMENTS TO FOREIGN EXCHANGE INFLOWS IN A FIXED EXCHANGE RATE SYSTEM. Journal of Economics and Economic Education Research, 16(2), 61-89. https://prx-
Eiteman, D. K., Stonehill, A. I., & Moffett, M. H. (2021). Multinational Business Finance. Pearson Education Limited.
Helísek, M. (2019). Exchange Rate Mechanism II and the risk of currency crisis – empiricism and theory. Journal of International
Nakamura, C. (2016). Exchange rate risks in a small open economy. Journal of Financial Economic Policy, 8(3), 348-363.
2-According to many economics and monetary policy advisors in East Asia, multinational corporations preferred to have fluctuating exchange rate to minimizes their risks exposure. MNE do not agree with fixed exchange rates since the foreign exchange (forex) market fluctuates a lot day to day. For example, between 2011 and 2013, some Southeast Asia nations-such as Malaysia, the Philippines, Singapore, and Thailand-appeared to have adopted exchange rates regimes to keep their currencies relatively stable with respect to China’s renminbi (Martin, 2018). Moreover, East Asia countries adopted different types of exchange rates to benefit FDI. For example, free float policy helps a country increase their exchange rates. However, there is one option to peg their exchange rate to another currency to have advantages on U.S dollars reserves. For instance, Hong Kong’s three designated currency-issuing banks-The Bank of China, HSBC, and Standard Chartered Bank-must deposit with the Hong Kong Monetary Authority sufficient U.S.-dollar-denominated reserves to cover their issuance of Hong Kong dollars at the designated exchange rate of HKD 7.80 = USD 1.00 (Martin, 2018).
On the other hand, lets talk about purchasing power parity theory. The main idea is that MNE can buy more goods and services at better exchange rates than a fixed exchange rate. For example, a Chinese wants to purchase planes from an American plane manufacturer and then one day the U.S government decides to put a fixed exchange rate on the Chinese (Yuan) compared to the U.S dollar. The MNE will not buy planes from the U.S manufacturer because this can represent on a disadvantage from the Chinese buyer. Just like an American trying to buy goods and services from any other country where they have the advantages to buy more products when the U.S dollar appreciates more than the foreign currency.
Further, Edwards stated that in the 90s Milton Friedman printed an article comparing two countries Chile and Israel experiences. First, Chile fixed the exchange rate with respect to the US dollar in 1979. The dollar strengthened in global markets, and the terms of trade turned against Chile. On the other hand, when Israel fixed the value of the shekel in 1985, external shocks were promising when the price of oil dropped and a weakening of the U.S. dollar. An important difference between the two cases was that Israel undervalued the shekel by 20% before fixing it relative to the dollar. By doing this, it built a ‘cushion’ for real appreciation to take place without generating overvaluation. Chile instead fixed the exchange rate rigidly at a time when the peso was already overvalued (in 1979). Further, while Israel instituted income policies that included a temporary wages and prices freeze, Chile put in place a backward-looking wage indexation system that, with declining inflation, resulted in automatic increases in real wages (Edwards, 2020).
Edwards, S. (2020, November 10). Exchange rate regimes in emerging countries. VOX, CEPR Policy Portal. Retrieved September 22, 2021, from https://voxeu.org/article/exchange-rate-regimes-emerging-countries.
Martin, M. F. (2018). EAST ASIA’S FOREIGN EXCHANGE RATE POLICIES *. Current Politics and Economics of South, Southeastern, and Central Asia, 27(1), 31-47. https://prx-keiser.lirn.net/login?url=https://www….
3-A fixed exchange rate is an exchange rate where the currency of one country is connected to the currency of another country or a frequently traded commodity like gold or oil so the two countries can trade freely and smoothly with each other (Carrieri et al., 2006). The major concern with fixed exchange rate is that it put limitations to a central bank’s possibility to adjust interest rates to impact a country’s growth rate. In addition, a fixed exchange rate can be maintained if the two countries collaborate with strict capital controls (Sullivan et al., 2006).
Foreign exchange risk is recognized besides market segmentation, as one of the most important factors of foreign investments and an international asset pricing (Sullivan et al., 2006). Therefore, the existence of currency risk is part of the major concerns faced by international investors because exchange rate volatility may reduce the benefits of international diversification (Sullivan et al., 2006). Moreover, investments in emerging capital markets are an important and growing source of funds for financing projects which contribute to the rapid pace of growth in emerging markets (Sullivan et al., 2006).
In emerging markets, there is not enough movement in the exchange rate adjustment term. Capital outflows from emerging markets are a result of both higher global risk and intensifying country fundamentals lead to larger interest rate differentials (Carrieri et al., 2006). Even though, there is an expected and actual depreciation as a result of such outflows, these are not enough to offset the interest rate differentials as the role played by the currency risk is more important (Carrieri et al., 2006).
Carrieri, F., & Majerbi, B. (2006, May). The pricing of exchange risk in emerging stocks markets. Journal of International Business Studies. 37(3). 372-391. https://www.jstor.org/stable/3875265
Sullivan, M, A., & Dandapani, K. (2006). Currency risks in emerging markets. Journal of Managerial Finance. 22(2). 54-62. https://doi.org/10.1108/eb018598
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