Question

Explain the factors that are relevant in trying to explain how to determine exchange rates. Why do you feel it is so difficult to forecast interest rates?

Answer 1

Following factors are relevant in determination of exchange rates :

i) Rate of Inflation : The rate of Inflation impact the rate of exchange of currency of a country.It detetmines the growth rate and the country having low rate of Inflation in comparison to other country it's currency will always appreciate in comparison of other.

ii) Rate of Interest : Rate of interest and foreign currency exchange rate are directly correlated to each other.Higher the interest rate higher the rate of appreciation of foreign currency.

iii) Debt of government : Debt obtained by government is a national debt and it leads to higher Inflation as the amount of debt increases so it indirectly impact exchange rates with increase in government Debt.

It is very much difficult to forecast interest rate since it depends upon large number of factors which can impact it.Interest rate can not be determined by individual bank, it is determined by numerous investor trading in credit markets which impact interest rates. Any change in any such components like risk free rate can directly impact interest rates.