Sunday 1st April, 2007


Power to guide investment

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It is estimated that some $2 trillion dollars in United States currency change hands on a daily basis on the international foreign exchange markets. Now the world doesn’t work with US dollars alone, so trade requires that different currencies be valued in terms of the currencies of different countries.

In the international financial arena, the value of currency alters from day to day against the currencies of trading partners. The foreign exchange rate or simply the exchange rate, places a value for the currency of one country, relative to that of another country. For example, what is the value of one TT dollar in terms of the Canadian dollar.

Many people are still confused by the terms buying rate and selling rate. In general these rates are published on boards in banking and financial institutions and in the newspapers.

The rates are quoted from the perspective of the bank or institution. It is as though the bank is buying from the customer or selling to the customer. It is never the customer selling to the bank. Normally the bank will buy a foreign currency from the customer at a rate lower than it will sell the same currency to another customer.

Last week, we noted that monetary policy uses tools such as the exchange rate and the managed float, in order to further its aims and objectives.

Limit foreign exchange

A managed float refers to the fact that the central bank has the ability to intervene when exchange rates drop below a certain level or vice versa. The Central Bank intervenes in order to bring the level back to a predetermined rate of exchange. The managed rate is never really made known to the public.

The opposite of this is a free floating dollar. This means the currency exchange rate is constantly changing according to forces of supply and demand. Demand is fuelled either by an increase in the amount of transactions, or as a result of speculation. Speculation increases when interest rates in the foreign currency are getting higher, but it is not limited to that factor alone.

The majority of governments intervene in the exchange rate, so as to avoid untoward pricing effects in the market. Some types of interventions are called pegged. This means that the floating currency is maintained within a plus or minus one range in relation to a named foreign currency.

Sterilisation is a strategy to insulate the local currency from the changes occurring in the foreign exchange currency market. In its simple form, the amount of local currency available for exchange is limited, thus leading to an inability to participate on the foreign exchange market.

One must remember too, that these measures are never in isolation. They tend to work alongside other policy measures to create a desired result.

It is not so important to know what all these terms mean, as it is important to recognise that the variables can be manipulated. In this recognition, individuals will come to value their own ability to influence the variables in their own savings plans to create desirable yields.

—next week we look at individual variables.

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