ECON5103

Question 1
(a) Determinants of Exchange Rate movements:

Changes in consumer preferences/trends:

Eg. A product from country A, is heavily consumed in country B, which
imports the product. In the event of a fall in demand in country B for that
product, country A experiences reduced demand for its currency (It is
implied that the product is paid for in the currency of country A the
country of its origin).

Relative changes in income:

If there is a more significant increase in Purchasing Power Parity of country
A than that of country B in the previous example that is, the income of
country A grows at a faster pace than that of country B, there is an
increase in demand in country A of imported products. This leads to a
depreciation in the currency of country A.

Relative changes in price:

If the price of a product increases in country A relative to the price of the
same product in country B, consumers of country A will look to source
the product from country B, increasing demand for the currency of
country B. On the other hand, consumers in country B are unlikely to
purchase goods from country A, reducing supply of the currency of
country B. This simultaneous increase in demand for, and decrease in
supply of, the currency of country B, leads to a depreciation in the value
of currency of country A.

Relative interest rate changes:

If country A increases its interest rates, foreign investors and institutions
might find investing in country A more attractive than before, leading to
an increase in demand for its currency, as well as increase in supply of
foreign currencies. This leads to an appreciation in the value of the
currency of country A.

Speculation:
Anticipation of changes in factors such as economic growth, inflation rates
affect the demand, and consequently the supply, of currency. Suppose
that the market expects increased growth, increased inflation and interest
rate cuts in country A as compared to country B. This makes us believe
that the currency of country A will depreciate in the future, as explained
above, and that the currency of country B will appreciate. This would
lead to investors shorting the currency of country A and going long on
the currency of country B. If and when the expected exchange rate
changes occur, the investors buy currency of country A and cover their
position, and sell their holdings in the currency of country B, making a
profit on both trades.

Tariffs and barriers to trade:

Changes in trade policies and free trade agreements also cause exchange
rate movements. Assume a newly signed free trade agreement between
country A and country B. This leads to fewer trade restrictions, and
greater demand for products from each country that are (a) not available
in the consumers home country, and (b) cheaper to source from the
foreign country. If country A has a number of products that are in
demand in country B, the free trade agreement enables consumers in
country B to source the products with greater ease, driving up the
demand, and consequently, the value of the currency of country A.
On the other hand, increased tariffs in country A make the products more
expensive to source from country B, despite the lower base costs. This
decreases demand for the currency of country A, as consumers would
rather purchase the products locally.

Technology and Productivity:

Improvements in the technology and productivity of country A lead to
lower unit inputs for products and services produced domestically. This
allows local enterprises to sell these products and services at relatively
lower prices. This leads to a fall in demand for the currency of country B,
causing a depreciation in the value of the currency of country B.

(b)Movement in AUD against USD, EUR, JPY

(Please refer to the excel file attached in the email. The chart for the data
is in the sheet titled Chart) (Please note that AUD has been used as the
base rate and movements in other currencies against the AUD have been
depicted for convenience purposes).

Sources:
Peng, X. (2010). Financial theory.
Jackson, J., McIver, R. and Bajada, C. (2007). Economic principles. Sydney:
McGraw-Hill Australia.
http://www.rba.gov.au/statistics/tables/index.html#exchange_rates
http://www.rba.gov.au/chart-pack/exchange-rates.html