Rates of Exchange
In the rates of exchange for all bills other than bills at sight, there is no element of value so constant and as effective as the rate of interest in the country on which the bill is drawn. The fluctuations in bills at sight are limited, to a certain extent, by what we have called the specie point: they can exceed the specie limit either upwards or downwards for a time; but, be it remarked only when the two countries are at a considerable distance from each other, so that specie cannot rapidly become a matter of importance; in fact, only under very extraordinary circumstances.
The fluctuations in long bills, on the other hand, are unlimited, because they are co-extensive with the fluctuations in the value of money in accepting country and co-extensive, too, with the apprehensions which may be felt as to the solvency of the names on the bills. The effect of the value of money or other of every variation in the prevailing rates of discount, upon the foreign exchanges, is a matter of the highest importance and will have to be considered with some minuteness later on.
On the other hand, the extent to which the solvency and credit of the drawer, as well as of the acceptor, of a bill, affects the value of that bill and consequently the rate of exchange at which it will sell, does not require much elucidation. Firms of first rate standing are said, in technical language, to make the best exchanges. The price which is paid to a merchant of undoubted position for sixty days sight bill on a foreign country will be higher than that which is granted for a second rate bill on the same place. The purchasers of bills must be induced, by a concession in price, to take an article of inferior security. They must be indemnified for the greater risk. Credit is a very important element to be considered in the rate of exchange and so notorious is this amongst those engaged in international trade that the price, at which exporting houses can sell their foreign bills, is looked upon as an unerring test of the credit which they enjoy among their neighbors. Thus credit causes a difference in the value even of such foreign bills as are drawn on the same day, rendering it difficult to give any exact or definite quotation of the price of long dated paper and further it operates on exchanges generally in times of commercial panic or excitement and causes the prices of all bills to fall. In case of America, to which allusion has been made, doubtless purchasers of bills felt bound to indemnify themselves by a large discount for the risks which they thought they ran; either the bills might not be accepted at all, in consequence of an enormous fall in the value of the goods against which they were drawn, and the drawers whom the purchaser would then have to call upon to refund the amount, might have failed in the interim or the bills might have been accepted but not be paid at maturity, owing to the difficulties in which it was expected that all connected with America would be involved.
II. THE FOREIGN EXCHANGE MARKET
The foreign exchange market is the largest of all markets. It is also a market in which options and other currency derivatives are widely used and traded, both in organized exchanges and over the counter. Therefore, it is natural to think that the currency option markets may contain useful information on the behavior of the exchange rate, an issue that is essential to international economists, financial economists, market analysts as well as monetary and regulatory authorities all over the world. Nevertheless, it was only recently that researchers had started exploring the information contents of currency option markets. This volume is an attempt to bring together, in a self-contained manner, some of the recent developments in this field.
III. CURRENCY OPTION MARKETS
Currency option markets offers a lot of information that is potentially useful to different people. Here we focus on the information that is of common interest to academics and practitioners. This focus is motivated by the following observations most students of financial economics focus on the mathematical tools of the option pricing models with little emphasis on the economics of exchange rate determination, while traditional macro-international economists tend to shy away from the technically of the currency derivative, despite its obvious importance in practice. This gap in academic research and training has created difficulties for practitioners. As we know, financial analysts need both a precise option in exchange rates and their derivatives and monetary and regulatory authorities need to understand the option markets in order to better implement their policies.
The information variables include the expected exchange rate volatility and its future path, currency risk premium, he markets assessment of the exchange rate distributions and the probability of future exchange rate that jumps amongst others. They are used to test the efficiency of the market and the rationality of market expectations, to predict future exchange rate changes and to estimate the markets expectations. Needless to say, the studies in this field contribute also to the academic developments of both finance and international economics literature.
IV. FUNDAMENTAL ANALYSIS
Fundamental analysis involves a detailed study of macro-economic indicators that interact to determine the performance of individual economies, and a fundamentalist is generally defined as a trader or forecaster who relies primarily on the analysis and forecasts of economic fundamentals to predict exchange rate trends. The global economy has functioned under a floating exchange rate system in which currency values primarily reflect market forces, resulting from external balance adjustments subject to occasional governmental intervention. Exchange rate volatility has characterized the floating exchange rate system and attempts to explain currency fluctuations, typically involve a detailed analysis of the fundamental macroeconomic variables, determining the relative performances of global economies. Over the long run, currency movements are primarily influenced by underlying economic factors such as inflation and trade flows, however, in the short run, economic fundamentals are often swamped by speculative capital flows, political events or technical considerations.
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