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Factors Affecting Foreign Exchange Rates

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1) Introduction
Foreign exchange transaction comprises of everything ranging from converting a currency to another currency by an individual, to giant companies and governments making payments overseas in exchange for goods and services. These foreign transactions are done in various currencies, and for better precision, determination of the exchange rates is crucial. Exchange rates distinctively vary from country to country, owing to the fact that economic variables or determinants of currency values, such as national income, inflation, trade balances, etc., which are inconstant in nature, keep changing from time to time (Wang 2008). For example, if the exchange rate of a particular country is fluctuating at the average rate of 3 per cent per month, in another country it might be fluctuating at 7 per cent per month due to the dissimilarity in the economic variables of these countries. Hence, …show more content…

According to Madura (2008) even though the fundamental forecasting accounts for predicting vital relation between factors and currency value, the following limitations exist:
1) Exact timings of impact of certain factors on the currency’s value is unknown. The full impact of these factors on the exchange rate will not be seen until the second, third or fourth quartile.
2) Certain factors have an immediate impact on exchange rates. Only those factors that can be forecasted, are used in this model as the accuracy of exchange rates depend on the accuracy levels of the factors. If a firm knows how the movements of these factors affect the exchange rate, but cannot predict the value of the factors associated, exchange rate forecasting may not be accurate.

3) Certain factors that need to be considered are not included, as they cannot be quantified. In addition, the coefficients of the regression model may not remain

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