Essay Example on The fundamental equilibrium path









Section D Question 1 Answered The fundamental equilibrium path FEP is an artificial process that is used to limit the movements of currency either above or below another as a result of external events that occur randomly as well as the influence of the short term forces With regards to exchange rates for currencies the fundamental equilibrium is focused on maintaining an external balance In other words it refers to the real exchange rate that influences the external balance by matching with the medium term capital flows accurately to ensure an equilibrium There is a requirement for the drawing of FEP that there must not be official intrusion of the government or other regulatory bodies in the worth of the currency The FEP is an essential tool for currency traders and market analysts as it facilitates the making of informed decisions regarding the purchase or sale of currency Additionally it enables a party to carefully assess and predict the direction a currency will move at a particular time FEP is utilized by technical analysts to provide their decisions regarding probable movement of currency though the considerations of necessary factors to help investors It is important for importers and exporters of hedging activities to safe guard businesses for currency fluctuations Question 2 Answered A credit risk refers to the probability that a borrower will fail to make the required payments on a particular date In other words it is a tool used to assess the chances that a default on the loan or credit payments will be fulfilled as dictated In efficient markets the level of credit risks has a positive correlation with borrowing costs In other words when the risk is high then the borrowing costs also increase 

According to Moffett the definition of credit risk is the possibility that a borrower s credit worth at the time of renewing a credit is reclassified by the lender Moffett Stonehill Eiteman 2015 The repricing risk occurs when the interest rate is rest together with the financial contract s rate Therefore the changes in the fixed income term structure might result in the occurrence of the repricing risk As opposed to the credit risk the repricing risk is not associated with the loan payment but the changes in the income structure Moreover credit risk is inferred by borrowing costs measures such as the yield spreads Moffett s definition of repricing risk is the risk of changes in interest rates changed or earned at the time a financial contract s rate is reset Moffett Stonehill Eiteman 2015 Question 3 Answered Technical analysis is an approach where experts use to forecast or predict the direction of prices via the trends depicted by the past market data The price and volume variables are of the most significance in technical analysis Technical analysts employ charts to identify the patterns and market trends depicted by the financial markets as well as exploit them This approach uses different market indicators which are mostly transformations of the product price and the volume

According to Moffett technical analysis is the focus on price and volume data to determine past trends that are expected to continue into the future Analysts believe that future exchange rates are based on the current exchange rate Moffett Stonehill Eiteman 2015 p 199 The Balance of Payments BOP approach to forecasting determines the direction of an exchange rate by determining the current account balances portfolio investment foreign direct investment FDI the exchange rate regimes and the monetary reserves Unlike the technical analysis which uses the past market data to fish out trends the BOP approach follows the changes in the current and capital accounts to predict the trends or behavior of the exchange rate Also Moffett describes BOP as a financial statement summarizing the flow of goods service and investment funds between residents of a given country and resident of rest of the world Moffett Stonehill Eiteman 2015 Question 4 Answered An interest rate swap is reached when two counterparties reach a consensus regarding the exchange of cash flows on set dates in the near future

Two types of series of cash flows are used to describe this swap namely fixed and floating rate The fixed rate demands that a fixed amount is paid in defined periods and the cash flows are made known when the swap ends The floating rate is the opposite as a series of payments based on the future interest rates and most of the cash flows are not known even when the period in question terminates A currency swap on the other hand is said to have occurred when the interest and or the principal are exchanged from one currency to another of the same value The exchange from one currency to another is referred to as the cross currency swap Unlike the interest rate swap which is an agreement between two parties the currency swap is focused on the exchange of the interest and principal from different currencies Moffett defines currency swap as a transaction in which tow counterparties exchange specific amounts of two different currencies at the outset and the repay over time according to an agreed upon contract that reflects interest payments and possible amortization of principal Moffett Stonehill Eiteman 2015

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