Chapter 4 Research Methodology

Transcription

1 Chapter 4 Research Methodology 4.1 Introduction An exchange rate (also known as a foreign-exchange rate, forex rate, FX rate or Agio) between two currencies is the rate at which one currency will be exchanged for another. The spot exchange rate refers to the current exchange rate. The forward exchange rate refers to an exchange rate that is quoted and traded today but for delivery and payment on a specific future date. There are several methods and techniques available through which exchange rate is a measure like, Purchasing power parity, interest rate parity, fisher effect, international fisher effects. Foreign exchange risk also exists when the foreign subsidiary of a firm maintains financial statements in a currency other than the reporting currency of the consolidated entity. The risk is that there may be an adverse movement in the exchange rate of the denomination currency in relation to the base currency before the date when the transaction is completed. Investors and businesses exporting or importing goods and services or making foreign investments have an exchange rate risk which can have severe financial consequences; but steps can be taken to manage (i.e., reduce) the risk. Firms may adopt alternative strategies to financial hedging for managing their economic or operating exposure, by carefully selecting production sites with a mind for lowering costs, using a policy of flexible sourcing in its supply chain management, diversifying its export market across a greater number of countries, or by implementing strong research and development activities and differentiating its products in pursuit of greater inelasticity and less foreign exchange risk exposure. 4.2 Research Methodology Exchange Rates are very important for any country as they determine the level of imports and exports. If a domestic currency appreciates with respect to a foreign currency, imported goods will be cheaper in the domestic market and local companies would find

2 that their foreign competitor's goods become more attractive to customers. If the country has a strong currency then its goods become more expensive in the international market, which results in lost competitiveness. This is the reason that China, despite much pressure from the United States, is not letting its Yuan appreciated. Exchange rates are extremely important for a trading economy such as the BRICS. There are several reasons for this, including: Exchange rates represent a cost to firms, which arises when commission is paid on the exchange of one currency for another. Exchange rate changes create a risk to those firms that hold assets in currencies other than Nation Currency. Exchange rates affect the price of export to form a significant part of aggregate demand, and the price of imports with that the balance of payments. Generally nation economy strength is determined on the basis of exchange rate valuation. If nation exchange rate likely appreciates, this nation has sound economy. That s why developed nation exchange rate is always appreciating compare to developing nation. There are lots of factors influence exchange rate like, demand and supply of exchange rate, inflation, interest rate, balance of payment, stock market, speculator, GDP, GNP etc. 4.3 Statement of the Problem An international exchange rate, also known as a foreign exchange (FX) rate, is the price of one country's currency in terms of another country's currency. Foreign exchange rates are relative and are expressed as the value of one currency compared to another. When selling products internationally, the exchange rate for the two trading countries' currencies is an important factor. Foreign exchange rates, in fact, are one of the most important determinants of a countries relative level of economic health, ranking just after interest rates and inflation. A number of factors influence exchange rates. These include all of the following: Relative rates of inflation Comparative interest rates

3 Growth of domestic money supply Size and trend of a country's balance of payments Dependency on outside energy sources Central bank intervention Economic growth (as measured by the gross national product) Exchange rate is most important factors for the trading countries and developing countries because their economies mostly depend on the foreign trade and transaction. That s why in research select BRICS countries because these countries are developing countries and their economy depend on the foreign trade, FDI (Foreign Direct Investment) and FII (Foreign Institutional Investments) and BOP (Balance of Payment). The BRIC [Brazil, Russia, India and China] idea was first conceived in 2001 by Goldman Sachs as part of an economic modeling exercise to forecast global economic trends over the next half century; On the bases of Common characteristics are large, fast-growing economies all developing or newly industrialized countries. BRIC Foreign Ministers at their meeting in New York on 21st September 2010 agreed that South Africa may be invited to join BRIC. Accordingly, South Africa was invited to attend the 3rd BRICS Summit in Sanya on 14 April These BRICS countries main focus on export import trade and promote industrialization. That s why exchange rate is a keep factors for BRICS country. 4.4 Objectives of Study Main objectives: To find out which factor influence exchange rate in BRICS country and How to manage exchange rate fluctuation in BRICS country? Sub objectives: To study which types of flexible exchange rate method apply in BRICS country?

4 On this objectives find out which flexible exchange rate method manage exchange rate in their own nation. Which types of the government intervention are generated in flexible exchange rate? To check validity of exchange rate parity theories in BRICS country. In advance 5 parity theories are find out and which said inflation and interest rate are major factor to decide the exchange rate movement. Through theses check validity of exchange rate parity theories in BRICS country. PPP (purchasing Power Parity) FE (Fisher Effect) IFE (International Fisher Effect) IRP (Interest rate Parity) In real life these theories are really worked or not. To measures exchange rate fluctuation and risk for Company and Country. Exchange rate risk measures in company on the bases of relationship between market value of share and exchange rate movements. For country, to find out relationship between exchange rate movement and change in FII and Balance of Payments. To manage exchange rate exposure for company and country. For management of MNC exchange rate exposure use hedging techniques. And exchange rate hedge through the Commodity market and currency derivatives market. In BRICS country, Government policy is used for hedging. 4.5 Significance of Study To assists the business in making the international decision, which involve transactions in multi-currency. It focuses on the condition of the market, and evaluates whether the economy is truly governed by market forces, or else there are some interventions hindering the free flow of transactions in the economy.

5 To know about triangular arbitrage. To helpful in future predicted exchange rate. To helpful for offsetting their assets It is useful to MNC firm which make multilateral trade on credit base, because in which several exchange rate risk is associated. Investor also gets idea how to hedge and protects his investments in another country. 4.6 Sample Design Research design is the plan and structure of investigation so as to obtain the answer to research questions. The plan is the overall program of the research. It includes an outline of what the investigation will do from writing the problems and their implication to final analysis of data. Earlier part of my project is exploratory research design as the topic demands exploration the various terminologies in the exchange rate. While exploration I will come to know about the various concepts associated with exchange rate determination. Even collection of data also demands exploration through various books and websites. Then descriptive research method is adopted to find out the degree of causal relationship between the dependent variable and independent variable in respective parity condition model. Lastly again the reason to the functioning and none functioning were explored. Try to create one model through which easily predict exchange rate and minimize exchange rate risk with the help of contractual hedge. 4.7 Sample Size Selection for Nation There are 196 countries in world, among them population researcher has select only 5 countries (Brazil, Russia, China, India and South Africa). BRICS countries are developing countries and this idea was first conceived in 2001 by Goldman Sachs as part of an economic modeling exercise to forecast global economic trends over the next half

6 century; the acronym BRIC was first used in 2001 by Goldman Sachs in their Global. On the bases of Common characteristics are large, fast-growing economies all developing or newly industrialized countries. The four original BRIC countries comprise more than 2.8 billion people or 40 percent of the world s population, cover more than a quarter of the world s land area over three continents, and account for more than 25 percent of global GDP. In 2010 South Africa was added in BRIC countries because it has lots of natural resources and faster growth rate. Selection of Time Period Time duration after 1991, in 1991 liberalization policy was introduced in India. After the introduction of the liberalization policy MNCs were promoted, and increase global trade. As per all those changes exchange rate play a vital role in economy. Therefore time duration for data collection is after January 2005 to August Sample Selection Techniques Non probability judgmental sampling technique is used, because BRICS countries selections also depend on as per convenience and data collection period after January 2005 to August Data Collection Tools Secondary data: It is a second user data and reused data from various source of data. (Newspaper, Magazine, Journals, Research Report and Books) and electronic media (Websites, e-journals and data bases). The details are given as references at the end of the thesis Sources of Data and Form of Data Secondary data collection method is used. Time duration: Monthly January 2005 to August 2015

7 Types of data Characteristics of data Source of data Nominal Interest rate Treasury bill Country s central bank Exchange rate European Currency Quotation International Monetary Fund Nominal inflation rate CPI World Bank and International Monetary Fund GDP Future Rate European currency Quotation Trading Economy and country economy NSE Currency Future MCX Currency Future Monthly exchange rates between the US Dollar against Brazil Real, Russia Rable, Indian Rapee, China Yuan (Renminbi) And South Africa rand between the years January 2005 to august The data collected material has been revised by calculating the percentage nominal interest differential and the percentage exchange rate change for different quarters and country pair, where the US is the home country. The nominal interest differential has been computed by taking the US nominal interest rate minus foreign nominal interest rate divided by one plus the foreign nominal interest rate. Exchange rate has been computed by taking the exchange rate at time t+1 minus the exchange rate at time t, divided by the exchange rate at time t Statistical Tools Applied For effective data analysis and to derive the needed results the following financial and statistical tools were applied in this study: Trend analysis, Summary Statistics (Mean & Standard Deviation), Co - efficient of Variance, Multiple Regression analysis, Pearson s Correlation analysis, Adjusted R 2, intercept, beta valuation and Paired t- test.

8 Trend analysis is an important tool of horizontal financial analysis. This method determines the direction upwards or downwards and involves the computation of the percentage relationship. Measures of Summary statistics had been applied to measure mean and Standard Deviation between the time series data used for analyzing the exchange rate in BRICS countries. Karl Person s Correlation has been applied to analyze the correlation between the exchange rate and interest rate and inflation variable, also find out the exchange rate movement and stock price movement in BRICS countries and India s FII s and BOP are variated due to exchange rate change. With the support of Multiple Regression Analysis, a research model has been framed to measure the prime determinants of exchange rate movement in Brazil, Russia, India, China and South Africa. A line in a two dimensional or two-variable space is defined by the equation Y=a+b*X; in full text: the Y variable can be expressed in terms of a constant (a) and a slope (b) times the X variable. The constant is also referred to as the intercept, and the slope as the regression coefficient or B coefficient. Determinants of exchange rate parity theory: Where, α is constant and β is coefficients to estimate, and e is the error term Purchasing Power Parity Theory An economic theory that estimates the amount of adjustment needed on the exchange rate between countries in order for the exchange to be equivalent to each currency's purchasing power. Equation of Purchasing Power Parity (St+1 St)= (i.h,t i.f,t) St (1+ i.f,t) i.h,t = Inflation Rate Of Home Country USA, at time t i.f,t = Inflation Rate Of Foreign Country,at time t St = Spot Exchange rate At Time t

9 Fisher Effect Fisher effect says that currencies with high rates of inflation should bear higher rate than currencies with lower rate of inflation. (Shapiro 2002, 161) Equation of Fisher Effect (1 + r h,t) = ( 1+ E(I h,t)) (1+ r f,t) (1+ E(I f,t)) International Fisher Effect International Fisher Effect is the counter part of the fisher effect. It can be seen as a combination of the generalized version of the fisher effect and relative version of the PPP. (St+1 St) = (i.h,t i.f,t) and (1 + r h,t) = ( 1+ E(I h,t)) St (1+ i.f,t) (1+ r f,t) (1+ E(I f,t)) By the combination of two equations we get international fisher relation (St+1 St) = (r.h,t r.f,t) St (1+ r f,t) The international fisher effect shows the relationship between the percentage change in the spot exchange rate over time and differential between comparable interest rate in different nominal capital market (MadhuVij 2003, 214) Interest Rate Parity Interest rate parity say the currency of the country with lower interest rate should be at a forward premium in term of the currency of the country with the higher rate. The interest differential should be equal to the forward differential when this condition is fulfill that time create a interest rate parity. (Shapiro, 2002, 50) According to IRP F/S = (1+ rd) / (1+r f) Investor speculating on the future spot rate interested in making a profit would move capital from countries with low interest rate to countries with high interest rates.

10 4.12 Hypothesis for the Test The null hypotheses- thus hypotheses states that there is no association between the variable being tested. The alternative hypotheses this hypothesis states that there is significant association between the variable that are being tested and that the results obtained did not occur by chance. Following hypotheses and sub hypotheses were tested for the study purpose: H0: α = 0, β = 1 will be rejected at 5% confidence interval if p-value is less than P- Value are shows acceptance level. Hypothesis will be rejected at 5% confidence interval if the p-value is less than The null hypothesis is rejected H1: Inflation is significant and negatively related with exchange rate H2: Inflation is significant and positively related with interest rate. H3: Interest rate is significant and positively related with future exchange rate. H4: Cost of transaction is not increase due to exchange rate fluctuation Limitation of Study Monthly data are used, may be the parity condition would work for more time period. Bid- Ask spread is ignored Brokerage charge and other transaction costs are ignored. Sometime particular strategies are not works under certain circumstances. Hedging strategies are also expensive.

11 4.14 Future Scope With the help of this research, researcher can find out other variable factors (political, economic, internal war and any specific events) through which exchange rate fluctuated. To introduce one common currency for BRICS country, with the help of this currency promote international trade between members and other member s countries. Company also calculates operating and translation exposure due to exchange rate change, and maintain their assets and liabilities ratio.