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Country’s Price Inflation

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There are three factors will determine the exchange rate. A country’s price inflation, a country’s interest rate and market psychology. In the PPP model, we assume that the spot rate of two countries equal to the inflation rate of two countries.

When a country raising its interest rate, the inflow of the foreign capital will be increasing the demand for its currency and the exchange rate will rising at the same time. On the contrary, lower interest rates may leads to capital outflows and the exchange rate decrease.

Inflation refers to the phenomenon of currency devaluation and price rise caused by the money supply exceeding the amount of money needed for commodity circulation. When a country experiencing inflation, its commodity cost will inevitably increase, the price of export commodities expressed in foreign currency will inevitably rise, the competitiveness of the commodity in the international market will be weakened, and the excessively high inflation rate will inevitably leads to a capital outflow, which will also affects the market's expectation of future prices and exchange rates.

People's optimism about a country's economic situation, balance of payments, inflation and interest rate will causes a large number of purchases of its currency, causing the exchange rate to rise. Conversely, bearish, the exchange rate will fall. This kind of psychological expectation is accompanied by various speculative factors, and even some rumors and the speech of a certain leader will cause speculative activities and may set off an uproar in the foreign exchange market, resulting in the fluctuation of the exchange rate.


When a country's currency is too strong, as in the United States. This will cause the country relying more on export. But if the country exports high-tech products or products which quality is far superior to that of any other country, then the exchange rate will not have a significant impact on the import and export. Because those products are irreplaceable, which means, no country, company or person can find a similar product to replace it. Technological innovation and technological progress can well enable these countries with strong currencies to make full use of their abundant resources to reduce the risks brought by foreign exchange rate.


International traders use the foreign exchange market by several reasons. First, they want to convert export receipts, income received from foreign investments, or income received from licensing agreements. Second, they want to pay a foreign company for products or services. Third, to invest spare cash for short terms in money markets. Fourth, they may want arbitrage from shifts in exchange rate. In conclusion, foreign exchange market is a good choice for investors to get into.

As the largest financial market in the world, the foreign exchange market is extremely liquid and can be traded 24 hours a day. Investors can buy or sell at will. Foreign exchange prices are influenced by macro international factors, such as politics, military affairs, economy, supply and demand, as well as interest rates set by local central Banks, stock markets, economic environment and data, policy decisions, various political factors and major events. These factors are not controlled by a single investor or group, and investors in foreign exchange trading are spread around the world. The investment environment is fair and transparent. The foreign exchange market is one of the largest financial markets in the world economy, with participants including Banks, commercial institutions, central Banks, investment Banks, hedge funds, governments, multinational organizations and retail investors. As a result, the foreign exchange market is extremely liquid, and investors do not have to bear the investment risk caused by the lack of trading opportunities.



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