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Econ 910 Exchange Rate Determination of Australian Dollar in Relation to Us Dollar in the Foreign Trade Market

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RESEARCH REPORT

ECON 910

Submitted By:

SANJU THAPA MAGAR

Student No. 6010556

Class: 1

 (Sydney Business School,

University of Wollongong)

Submitted To:

Dr. KHORSHED CHOWDHURY

Submission Date: 24 March, 2018

Abstract

This report presents an information about the exchange rate determination of Australian dollar in relation to US dollar in the foreign trade market. The report illustrates the factors that manipulate the fluctuations of the exchange rate of AUD/USD using demand and supply model as well as it scrutinizes the flow of Australian dollar in comparative to US dollar. Nominal exchange rate data and trade weighted index data were attained from the website of Reserve Bank of Australia by the use of which the behaviour of Australian dollar was detected. Furthermore, the report reveals the impact of government intrusion in Australian dollar and Australian economy.

Keywords: Australian dollar, US dollar, forex market, Reserve Bank of Australia, exchange rate, intervention, depreciation, appreciation.

Introduction

This report gives information obtained from the article "Australian Dollar tipped to slide back to 70 US cents". It will pay special concentration to the AUD/USD determination and features that manipulate the variation of the trade rate (AUD/USD). This report will also analyse the flow of the AUD comparative to that of the USD on the basis of nominal exchange rate data and trade weighted index data for the last three years. It will also present the impact of devaluation of Australian dollar in business and role of government in stabilising the exchange rate.

1. Determination of exchange rate of AUD in the forex market

Exchange rate is a rate at which money of one state is swapped for the money of another nation. Forex (Foreign Exchange or FX) market is a worldwide decentralized market where currencies of different countries are traded. This market determines the foreign trade rate. Systems in which trade rates are decided by the rule of demand and supply are called flexible or flexible exchange rate system. The exchange rate of Australian dollar is established by exports and imports, by foreigners' desire to invest in Australia and Australian's desire to invest abroad, and by speculation. It can be made clear by the following figure:

Figure 1. Demand and Supply of Australian Dollar

AUD/USD

        D1[pic 1][pic 2][pic 3][pic 4][pic 5]

        D0        S0[pic 6]

e1        [pic 7]

        E1

e0        E0[pic 8]

[pic 9]

D1

        S0        D0

[pic 10]

0        Q0        Q1                          AUD

In the figure, the descending inclined demand curve D0D0 reflects the demand of Australian buck whereas, the uphill inclined supply curve S0S0 demonstrates the supply of Australian dollar. The demand and supply intersects at a spot called equilibrium E0 where demand for AUD equals supply of it. When the demand of AUD increases to D1D1, the new equilibrium point E1 is created shifting the demand curve to the right..

1.1 Factors that manipulates the exchange rate

The factors that influence the exchange rate are as follows (Pettinger, 2015):

1.1.1 Inflation. Generally lower inflation rate in Australia than elsewhere results Australian exports more focused, and the demand for Australian dollar will increase to purchase Australian products. As the demand rises, Australian dollar appreciates, i.e., affects the exchange rate.

1.1.2 Interest rates. When interest rates rise in Australia, it becomes more attractive place for the investors to invest with the hope of getting more return. This will eventually boost the demand for Australian dollars. This increase in demand for Australian dollars causes their price to rise.

  • Higher interest rates result an appreciation.
  • Lower interest rates tend to result a devaluation.

1.1.3 Exports and imports. Exports and imports have positive connection with the money valuation. High export implies that the goods are cheaper. Goods become cheaper when the demand is low or when the currency depreciates. Likewise, high import entails products are costly which results due to the appreciation of the currency. Thus, exports and imports influence the exchange rate.

1.1.4 Speculation. If speculators believe Australian dollar is going to be expensive or the value of Australian dollar will be costly in the future, they will demand more Australian dollar in order to make a revenue which will cause the value of Australian dollar to rise.

1.1.5 Change in competitiveness. When Australian products become more striking and spirited, the value of the exchange rate of Australian buck will augment.

1.1.6 Government intervention. Government interference also plays a vital role in determining the exchange rate of any country. In order to stabilize the exchange rate, government interferes by formulating certain policies and regulations which will consequently impact the exchange rate in foreign trade market.

1.1.7 Economic growth/ recession. At the time of economic expansion or recession state of economy, the interest rates typically plunge due to which the currency is undervalued and eventually the exchange rate swings.

2. Analysing the effects in Australian Dollar

Exchange rates matter to Australian economy due to their impact on trade and monetary streams between Australia and the rest of the world.

2.1 Movement of AUD relative to USD

Australian economy is extremely urbanized and one of the leading diverse market economies in the globe. Australia is the second richest country in expressions of prosperity per adult, after Switzerland. Despite the fact that it has more participation in these global market, the estimation of Australian dollar seems to be fluctuating in a few resulting years. The exchange rate of Australian dollar in relation to US dollar is denoted as AUD/USD. The money brace tells how many US dollars (the extract money) are required to acquire one Australian dollar (the base money). Exchanging the AUD/USD is also called dealing the "Aussie". The movement of AUD in respect to that of USD for the year 2015, 2016 and 2017 is revealed in the subsequent chart:

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