Why Real Exchange Rate?

How does one determine whether a currency is fundamentally undervalued or overvalued? This question lies at core of international economics, many trade disputes, and the new IMF surveillance efforts.

NOMINAL EXCHANGE RATE V/S REAL EXCHANGE RATE

Nominal Exchange rate usually expressed as domestic price of foreign currency. for e.g.

1 euro = 1.36 dollar

And from euro holder perception

1 US dollar = 0.735 euro

But,the nominal exchange rate is not the whole story. The person or firm, who buys another currency is interested in what can be bought with it. Are they better off with dollars or euros? That's where Real Exchange rate(RER) comes in.

• If the real exchange rate is 1, A product in USA cost 1.36 and 1 euro in Germany


• In this one product world ( in which price equal the exchange rate), the purchasing power parity(PPP) of the dollar and euro is the same and RER is 1 (see underexplained example)

What is Real Exchange Rate?

The RER between two currencies is the product of the nominal exchange rate(the dollar cost of euro, for example) and the ratio of prices between the two countries.The core equation is

RER = e*p^/p, where e is the nominal dollar euro exchange rate , p^ is the average price of a good in the euro area, and p is the average price of the good in the USA

In our example, e=1.36.If the german price is 2.5 euros and the US price is $3.40, then 1.36*2.5/3.40 yields an RER of 1. But if the german price were 3 euros and the US price $3.40, then RER would be 1.36*3/3.40=1.2

• Suppose a product sells for 1.2 euros in Germany, suggesting that the euro is 20 per cent overvalued relative to the dollar


• Therefore, there will be pressure on nominal exchange rate to adjust, because the same good can be purchased more cheaply in one country than the other


• It would make economic sense to buy dollars,use them to buy a product in USA at the equivalent of 1 euro and sell them in Germany for 1.2 euros. Taking advantage of such price differentials is called arbitrage.


• As arbitrageurs buy dollars to purchase a product to sell in Germany, demand for dollars will rise, as will its nominal exchange rate, until the price in Germany and US is the same-the RER returns to 1.

Source:'Finance & Development'

Difference between Global Fund and International Fund:

In the English language, “Global” and “International” tend to be used interchangeably – hence the confusion takes place. In investing world global and international funds are having completely different goals and providing different kind of investment opportunities to the investors.

Global Funds:

Global funds consist of securities in all parts of the world, including the country in which you reside.

Global funds are for those investors who wish to diversify against country-specific risk without excluding their own country.

Benefits of Global Funds:

An investor may already have a lower than desired concentration of domestic investments may get the perfect portfolio.

An investor may not want to take on the high level of risk involved in making foreign investments.

International Funds:

International funds consist of securities from all countries except the investor’s home country.

International funds are for those investors who want diversification outside of the investor’s domestic investments.

Benefits of International Fund:

If an investor currently holds a portfolio consisting mainly of domestic investments, he or she may choose to diversify against country – specific risk and purchase an international fund.

A speculator may invest in an international fund because he anticipates a rise in a particular foreign market.

Business of cricket

Liquor king and airline baron Vijay Mallya,auto Major Hero Honda and leading telecom company Reliance communication have started negotiation with BCCI to buy rights over the teams who wil play in 20-20 format which was announced to counter subhash chandra's Indian cricketleauge.T whole idea is...

* Under Twenty20 Format the company is not a sponsor but the owner of the team

* BCCI is asking corporates to pay between $50 million and $60 million (Rs.200 crore to 240 crore) to own on IPL team for life time

* In turn, the BCCI will offer companies revenueshare from stadium advertising and gate money

* The team can be listed on the stock exchanges and buyer have right to re-sell the team at premium

* However,the team owner will not have any share in the revenue the BCCI earns through selling television rights

SOURCE: Business standard

FDI & Stock Market Boom:

For the week ended September 28, india’s forex reserves increased by almost $12 billion. This is more than the $10 billion that came into the country between April 2005 and March 2006.

Why FDI is coming in to our economy?

Many reasons. But primarily, it is because booming stock market, a robust economy and expectations of Indian corporates doing well. For all these reasons, foreign investors are thinking about India.

Because of this flow of FDI stock exchange is getting more money. And Sensex is going up. If the same trend is continued we will see Sensex at the sky !