Factors Affecting Exchange Rate

Introduction:
Now a day exchange rate is consider one of the most crucial factor for any
organization. Exchange rates perform very essential role in any organization,
and attract more attention of the organization analyst because the exchange
rate can affect the value of an organization as the amount of cash inflow
receive from exporting goods to abroad and cash out flow need for imports
and investment in foreign country. For this reason, the financial manager of
an organization doing international business must continuously watching
exchange rates movement. They need to understand what factors influence
exchange rate. Here we look at some of the major forces behind exchange
rate movements. But first we should understand the exchange rate and
foreign exchange market.
Exchange rate is the convertibility rate of one currency for another currency,
different currencies have different prices seem like different commodities
have different prices determined by demand and supply force in the goods
markets. The market forces (demand and supply) may influence exchange
rate. The demand comes for a currency from exchanging local currency into
another currency and supply of the currency comes from converting foreign
currency into local currency. Any change in exchange rate is due to change in
market forces, if the people wants for a particularly currency goes up its
convertibility rate increase, while if its demand remain the same and supply
of currency exceed its demand its economic value or convertibility rate goes
to decline in the exchange market.
Foreign exchange market is a place where people are involved in the trading
of different currency simultaneously. Foreign exchange transaction can be
take place with the help of

exchange broker or dealer. Buying and selling of

foreign currency is done in pair like Indian rupee against Bangladesh taka or
Swiss franc against Russian robles.

Literature review:
The main aim of this study is to analyze the relationship between exchange
rate variability and its factors. Exchange rates are basically the prices of one
currency in terms of other currencies driven by the normal forces of supply
and demand. There are a fixed number of Euros, Dollars, Yen, etc.
(Zada in 2010) studied the relationship between exchange as dependent
variable and macroeconomic factors such as inflation, interest rate, foreign
exchange reserve, trade balance, money supply as independent variables of
Pakistan for the period 1979 to 2008. The multiple regression model was
applied in which inflation, interest rate was found extreme influential factors
for fluctuation in exchange rate of Pakistani rupee.
(Hussain and Farooq, 2009) for the period of 1982 to 2007 the variability of
Pakistani rupee was examined and found that the Pakistani rupee volatility is
positively effected cause of net export and foreign reserve.

(Ahmed, and Hyder 2005) according to them that perhaps internal shock the
external shock also play a crucial role in the exchange rate volatility. The
external shock consist of foreign remittances. They found that internal shock
have very small influence on Pakistan real exchange rate. The good shock to
remittances is cause of significant increase in demostic productivity and
Pakistani rupee value is appreciate. For this VAR model was tested on the
data.
(Galati and Ho 2003) according them that the bad and good news is also a
cause of fluctuation in the exchange rate of any currency. They conclude that

currency value is increase as good news spread I the market while currency
value goes down as bad news occurred in market.
(Ejaz, Abbas and Saeed 2002) they conclude that in the exchange rate
fluctuation deficit budget also play a crucial role. For this study the data was
taken from 1982 to 1998 and simple regression model was used.

Data collection and Methodology:

Data was collected from different sources such as state bank of Pakistan,
world development indicator, the global economy web sites etc. For this
study we take annual exchange rate as dependent variable and inflation,
interest, income level and government control are independent variable for
the period of 2000 to 2013. The nature of the data is panel data for three
countries china, Japan and Pakistan.
Methodology:
A multiple regression model is used for this panel data set to analyze the
exchange rate behavior. The exchange rate is taken as a dependent variable
and the inflation rate, interest rate, income level and government control are
taken as an independent variable or explanatory variable.
The multiple regression model is under

Y=

+ (inf)+ (int)+ (inc)+ (gc)+u

Where,
Y = exchange rate = intercept
= slope
INF = inflation

Int= interest
Inc= income
GC= government control

Purpose of the Study

The main purpose of this study is to examine the relationship between the
exchange rate and interest rate, inflation and government control. Through this
study we analysis the impact of interest, inflation rates and government control on
the exchange rate will be examined.

Limitations:
The time period was too short and it was not possible due to limited time
frame to get adequate knowledge on the topic. Moreover it should be kept in
mind that this research proposal has been written as a class assignment for the
subject of research methodology by a M.Phil. student

References:
Zada, B. (2010), An Analysis of Factors Affecting Exchange Rate of Pakistan1979-2008.
(Unpublished master thesis) .Hazara University, .Pakistan.
Ahmad,S., Ara,I&Hyder, K(2005). How External Shocks and Exchange Rate Depreciations
Affect Pakistan? Implications for Choice of an Exchange Rate Regime
Galati, G. & Ho, C.(2003) Macroeconomics News and the Euro/Dollar Exchange Rate.
Economic Notes, 32(3), 371-398.
Galati, G. & Ho, C.(2003) Macroeconomics News and the Euro/Dollar Exchange Rate.
Economic Notes
Hussain, Z J &Farooq M (2009).Economic Growth and Exchange Rate Volatility in Case of
Pakistan.Pakistan journal of life and social sciences,7(2):112-118PPakistan Kalra
www.theglobleconomy.com
www.sbp.org.pk
www.quandl.com