3. Use of lead and lag options This refers to the hastening of payments or delay of receipts in response to changes in to interest rates movements within the capital market. Where interest rates on ABC limited’s bank borrowing is rising, and the operating cash flows are substantial enough to repay the debt without affecting its liquidity ratios, the firm may decide on to patch up off its liability before its
Activity I: a. the bank 's specific cash market risk is dependent on the increase in the interest rate because the interest rate in the futures market is a function of the interest rate in the cash market. It is calculated as follows: Cash Market Risk = 10000000 * 0.0461*(90/365) = $113,671.23 To hedge against the borrowing costs, the bank should sell Eurodollar futures because the futures interest rate is up trending. By doing so, any increase in the cash market interest rate would be matched in the futures market interest rate to offset any gain or loss on the scheduled issue of Eurodollar futures b. The best futures contract for the bank to use is June 2009 because it has the higher interest rate of 5.38%. The profit on the futures trade is calculated as follows: Profit =
The government of a country doesn’t let exchange rate change in response due supply and demand for the currency this known as a fixed exchange rate. The government will buy or sell its currency to keep the exchange rate at a particular point or near a particular point. Fixing exchange rates has a lot of problems. If a country cannot successfully fix the exchange rate at the point it wishes, then it must chose another (lower) exchange rate. The lowering of the exchange rate is called devaluation of the currency (this is done by increasing the money supply).
The most basic application of the Lucas model is to price equity in an economy with i.i.d. consumption growth and a representative infinitely lived and intertemporally maximizing consumer with time-separable utility. Over the past decades, numerous studies have investigated the effects of relaxing various assumptions of this model to explain financial market phenomena such as the remarkable variation in asset prices and expected stock returns, the development and bursting of bubbles, and the puzzling high equity premium. Mehra and Sah  suggested that elasticity offers a simple but powerful representation of the influence of fluctuations in the denominator variable on the volatility of the numerator variable. More importantly, elasticity is unit-free, and thus can be considered a convenient measurement that captures sentiment induced fluctuations in financial markets.
Fisher hypothesized that there should be a long-run relationship in the adjustment of the nominal interest rate corresponding to changes in expected inflation. He postulated that the nominal interest rate consists of an expected“real” rate plus an expected inflation rate. The real rate of interest is determined largely by the time preference of economic agents and the return on the real investment. These factors are believed to be roughly constant over time, and therefore, a fully perceived change in the purchasing power of money should be accompanied by a one-for-one change in the nominal interest rate. (anonymous, long-run relation between interest rates and inflation,
The reason why we choose this time period can be explained by these reasons: 1.These are the more recent data we can collect from the reliable database 2. 2011 was a year when U.S recovered it economy from the Financial Crisis so that we can avoid the huge influence of the financial crisis on the U.S economy and the China capital market. 3. 2015 was a year when a lot of policies were undertook, and the performance of China capital market experienced ups and downs abnormally due to the sensitivity to the change of policies so that we want to avoid this effect. 4.
Macro fundamentals are believed by the economists to determine forex rates such that a nation’s currency directly affects economic growth rate, trade balance, inflation rate fall, and interest rate. He suggested two theories that can come up with a model for determining the forex rate. The first theory is the quantity theory of money. This theory states that an increase in money supply tends to increase the domestic price level and it can come up with a model for the long-run equilibrium of forex rate. However, this theory cannot take into account the fluctuations of forex rate.
An expansionary approach fabricates the total supply of trade out the economy rapidly or reduces the financing cost. Right when the national bank needs to finish an expansionary monetary approach, it goes to the security market to buy government securities with money, accordingly extending the money stock or the trade accessible for use out the economy. Expansionary approach is for the most part used to fight unemployment in a subsidence. A contractionary approach of course decreases the total money supply or grows it just step by step, or raises the financing cost. Right when the central bank needs to complete a contractionary money related course of action, it goes to the security market to offer government securities for trade out this way decreasing the money stock or the trade accessible for use out the economy.
The absolute PPP is based on a strict interpretation of the law of one price and the relative PPP is based on a weaker one. According to Pilbeam (2013:126), absolute version of PPP holds that if one takes a bundle of goods in one country and compare the price of that bundle with an identical bundle of goods sold in a foreign country, converted by the exchange rate into a common currency of measurement, then the prices will be equal. This means a rise in the price level relative to the foreign price level will lead to proportion depreciation of the home currency against the foreign
CHAPTER TWO 2.0 LITERATURE REVIEW 2.1 Theoretical Literature 2.1.1 The Quantity Theory of money The monetary policy is based on the several monetary theories. The supply of money which is a monetary policy is based on one of the quantity theory of money. One of these is Irving Fisher’s quantity theory of money, which states that the quantity of money is the main determinant of the price level or the value of money. As the quantity of money in circulation increases, the price level also increase in direct proportion. If the quantity of money is doubled, the price level will be doubled also.