Analyzing Foreign Exchange and Investment
An exchange trade fund is a type of fund that has the ownership of some underlying assets such as bonds, goods, commodities, stocks, foreign currencies and divides the ownership of these assets into shares. The value of an investment varies from one country to another depending on the strength of the currency in those countries. In countries where the cost of labor and other factors of production are considered to be low, they are classified as emerging markets. Other countries with high costs of production may, therefore, outsource for their labor and any factor of production in the process. This paper seeks to analyze foreign exchange and investment and the effect each nation has on another nation’s economy. In achieving this objective, the paper makes a five-year analysis against the dollar showing the trend of how these two currencies have exchanged for the last five years.
Choice of a currency
The Exchange Trade Fund is slowly taking over the stocks in foreign investment. When making an investment in a foreign nation in Europe where the Euro is the major currency, there is a currency risk aspect introduced in the investment. A person using the dollar needs to understand that Euro is the currency upon which the ETF will be priced and it exposes the value of the holding and investments in any nation chosen (Richards, 2007). This is because there are possibilities of the Euro falling or rising in respect to the dollar. If the investments are shares, which are valued in dollars and the value of the Euro rise against the dollar, it means the value of the investment shall have gone down. The economic activities of the European nation using the Euro as its underlying currency are affecting the investments in the United States made in dollars.
Foreign currency influences the trading merchandise in the economy. When the currency of an economy is weak against another economy, it affects the value of the exports and imports in the country. A weaker Euro, for example, implies that the imports will become more expensive while the exports become cheaper. The economic effect will be on the trade deficit that it will create on the economy when in international trade (Canino, n.d). The depreciation of the currency in another country can make the export business remain competitive across different international markets. A stronger currency reduces the competitiveness of the export business because the imports are cheaper. This can further lead to trade deficits and further weaken the currency.
The effect of the currency of one nation on the economy of the other nation can also be observed through the effect it has on capital flows. Capital always tends to move towards the nations with stronger government, improved international relations, economic dynamics and stronger currencies (Porter, 2011). The possibility of exchange losses caused by the depreciation of the currency may discourage the foreign investors into a nation. This is because there are two ways in which the capital flows may take shape. First, it can take the angle of foreign direct investment where these investors inject capital in the already existing companies. Alternatively, the investors can invest through foreign portfolio investments through the purchase and sale of overseas securities. Strong governments prefer the foreign direct investments since they are more permanent and long-term compared to the foreign portfolio investment.
Another macroeconomic effect of the Extended Trade Fund through foreign currency is inflation. A lower level of currency brings in imported inflation. When the value of a foreign currency is lower, it means the prices of the goods from the country will be increased by the traders to maintain their original level of profits. Additionally, the banks when setting their exchange rates level look at the level of currency so that they make it accommodative to the nation they seek to trade with. A strong economy with a strong currency will have a higher interest rate. High interest rates affect the trading activities in the country because foreign investors are scared away.
Comparison of the Euro and the US Dollar
The last five years have seen a mixed but relatively stable exchange rate between the dollar and the euro currencies. The dollar was high as of 2014 but fell drastically in the year 2015. The exchange rate has remained almost stable until 2018 where the dollar has gained against the euro.
In conclusion, when a foreign currency is made lower against another currency then it has a number of macroeconomic implications. Such economic effects include affecting the price of the trading merchandise such as the stocks. Additionally, it leads to possibilities of inflation because the foreign traders are in need of maintaining the profits. The prices are set higher which essentially leads to inflation. Furthermore, the exchange rates are also affected because the countries look to create favorable conditions for trading with other nations. The major way of doing that is to affect the strength of the currency against that of the nation. A nation with a lower currency which is seen to be an easy trading avenue due to the low costs of labor and other factors can be described as an emerging market.
Canino, K. (n.d.). How Trade Deficits Work (e-Book). New York: Rosen Digital.
Porter, M. E. (2011). Competitive advantage of nations: creating and sustaining superior performance (Vol. 2). Simon and Schuster
Richards, A. M. (2007). Understanding exchange-traded funds. New York: McGraw-Hill.