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Analysis of the change in foreign exchange rate of US dollar against any currency of emerging market Answer

Introduction

The objective of the paper is to analyze the change in foreign exchange rate of US dollar against any currency of emerging market. The currency selected against US dollar is Chinese Yuan. The change in two currency rates for 5 years starting from 2006 to 2010 has been included.   The impact of appreciation and depreciation of currency for importers and exporters has also been discussed. The FXI ETF has been selected for impact of change in currency rate on investment made. The impact of currency rate for borrower has also been included.

Analysis

Year End Rate 2006 2007 2008 2009 2010
US $ to Chinese Yuan 0.1281 0.1369 0.1465 0.1465 0.1517
Trend in % 100% 106.87% 114.36% 114.36% 118.42%
           
Yuan to US $ 7.8075 7.3046 6.824 6.828 6.5916
Trend in % 100% 93.56% 87.40% 87.45% 84.43%

 

During the five year of analysis, the value of Chinese currency has appreciated while the value of US $ has depreciated. The Chinese currency increased by around 18% in 5 years time period, while the US $ has declined by around 6% from 2006 to 2010.

The above changes would be beneficial for the exporters of US and Importers of China and vice versa. For example if goods worth $100000 would have been sold from China to USA, the value of the $100000 will be equal to 780750 Yuan (100000*7.8075. The value of this $100000 would have declined for Chinese exporters in the following manner.

2006 780750
2007 730460
2008 682400
2009 682800
2010 659160

 

The above value will be beneficial for the importers of China as the payment would be declined from 780750 Yuan to 659160 in 5 years time period, therefore the goods worth of $100000 would be lower for Chinese importer.

iShares FTSE China 25 Index Fund (FXI)          
Year Price In $ Converted to Yuan Value on 2010 in Yuan Total Return Annualized Return
2006 31.51 246.014 207.701 -38.31 -3.89%
2007 41.21 301.023 271.640 -29.38 -2.44%
2008 65.91 449.770 434.452 -15.32 -0.85%
2009 102.15 697.480 673.332 -24.15 -0.87%
2010 120.45 793.958 793.95822 0.00 0.00%

 

Note: The ETF price for 2008 has been multiplied by 3 as there was stock split for 3 to 1 before the end of 2008.

FXI is an ETF which was listed on New York Stock Exchange on October 05, 2004. It is a Non-Equity Investment Instrument. The above table shows that if the investment would have been made in this security, the value of $31.51 would be equal to 246.014 Yuan and by the end of 2010 the value of this equity would have gone down to 207.70 Yuan, which is showing a decline of around 4% of investment made by the Chinese investors. It is quite apparent that the investment has been showing declining trend in all the years for Chinese investors. The analysis does not include the increase in value of security in dollars; the analysis has just focused on the impact due to change in foreign currency rate. However the overall impact of investment in ETF due to change in price in dollars and also due to change in foreign currency rate has been shown in table given below:

 Year Price In $ Converted to Yuan Value on 2010 in Yuan Total Return Annualized Return
2006 31.51 246.014 793.958 547.94 55.68%
2007 41.21 301.023 793.958 492.94 40.94%
2008 65.91 449.770 793.958 344.19 19.13%
2009 102.15 697.480 793.958 96.48 3.46%
2010 120.45 793.958 793.958 0.00 0.00%

 

The above analysis shows that the value of ETF was $31.51 in 2006 which is equal to 246.014 but by the end of 2010, the value of ETF would have increased to $120.45 and 793.958 Yuan therefore any investment would have been made in 2006 would have earned around 55.68% annually and so on. Therefore it may be conclude that the Chinese investors would be in profit if both factors are considered. The change in dollar value depends on the performance of the ETF itself while the change in foreign currency is not based on the performance of the ETF. If the ETF would have not performed better the Chinese investors would have lost the money due to appreciation of Chinese Yuan against US dollar.

However, the appreciation of Chinese currency would be beneficial for the borrower of Chinese businessmen, assuming that the interest rates of both countries are the same to see the impact of change in foreign currency for borrowers. For example, if $100000 would have been borrowed this is equal to 780750 Yuan. The following table shows the cost if the principal and interest would have been repaid in dollars and Yuan:

Yield to Maturity Cash Flows in
Year Dollar Yuan
Start of 2006 -100000 -780750
End of 2006 6000 46845
End of 2007 6000 43828
End of 2008 6000 40944
End of 2009 6000 40968
End of 2010 106000 698710
YTM 6% 2.48%

 

It is quite apparent that the cost of borrowing in US $ is higher than cost of borrowing to be repaid by the Chinese borrower due to change in exchange rate.

Conclusion

It may be concluded easily that the appreciation of Chinese Yuan will benefit the importer and borrower of the China and the depreciation of US dollar will benefit the importer and investors of US, if the interest rates of the two countries are the same. However, the investors may also benefit from investment if the performance of selected security is outstanding which can offset the impact of decline in value of investment due to appreciation of currency.

References

http://www.x-rates.com/historical/?from=CNY&amount=1&date=2010-12-31

http://etf.stock-encyclopedia.com/category/china-etfs.html

http://www.nyse.com/about/listed/fxi.html

http://finance.yahoo.com/q/hp?s=FXI&a=11&b=31&c=2006&d=00&e=16&f=2011&g=m

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