Inividual 4 Essay Example | Topics and Well Written Essays - 1000 words

Inividual 4 - Essay Example Predicting the performance of different currencies in the market can help both individuals and investors in making sound business decision to minimize risk and maximize returns on investment (Oberlechner, 64). This paper focuses on a case studies related to exchange rate forecasting. A leader in a certain firm who has had keen interest on the exchange market and studied it predicts that in the next 12 months the exchange rate between the dollar and the Euro will be $1.41 to Euro. The company seeks to invest $ 500 000 in the forward, spot or options market. Using the current performance in the market, the forward rate is $1.37o5 to the Euro and the spot rate is $1.3435. This article discusses why the firm leader predicts that there will an increase in the exchange rate, seeks to calculate the profits that can be earned from the investment and gives recommendations on investments based on speculations. How to make Prediction on Future performance of the currencies in the exchange rate market One of the ways that can be used to predict future performance is by the use of Purchasing Power Parity (PPP). This is the most commonly used method and is based on the theory of one price where the prices of a identical commodities are assumed to have the same price in different countries. This means that if the rate of inflation in one country if higher than the rate of inflation in another country is lower, then the value of the currency with a higher rate of inflation will reduce in relation to the currency of the country with lower inflation. For instance, in this case study, the increase in value of euro could be as a result of increase in the rate of inflation in America in relation to inflation in the euro zone. For instance, if the predicted increase in inflation in America for the next 12 months is 5% and the expected increase in rate of inflation in the euro zone is 2% then the difference in inflation rates is the level of depreciation the American dollar currency suffers in relation to the dollar (Yu et al 245). 5%-2%= 3% difference in inflation rates. If currently the value of the euro is $1.5 then the new exchange rate will be: $1.5 ? 103%= $ 1.545 1 euro will exchange for $ 1.545. Another way the leader could have predicted an increase in the value of euro in relation to the dollar could be through the prediction of the relative economic growth rate. The value of a nation’s currency is expected to appreciate if the country has a good economic growth outlook with likelihood of greater domestic and foreign investment. American just experienced a government shutdown which is a phenomenon that is expected to influence investment negatively. Both foreign and domestic investors may not be willing to make huge investment under the unsure circumstances and this is expected to stunt economic growth rate (Yu et al 243). The euro zone is not experience anything like this and their economies are expected to continue growing. It is thus possibl e that the value of the euro will increase in relation to that of the dollar. Calculation of the Expected profits The spot rate is $ 1.3435 Forward rate $ 1.3705 $1.3705-$1.3435= $0.027 Percentage increase in rate: 0.027?1.3435? 100= 2.01% Expected profit $500 000? 2.01%=$ 10050 Recommendation on Investment Making investments in the speculative market brings about a lot of income within short period of time. It is also less involving as it does not require labor but being able to predict the market