Page 95 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes 3. The …………………… refers to the sum of all goods and services produced in the country,
either by domestic or foreign companies.
4. …………………… production consists of the total output of a nation’s plants, utilities, and
mines.
5. Capacity utilization refers to the …………………… level of output a plant can generate
under normal business conditions.
6. …………………… orders refer to the total of durable and nondurable goods orders.
7. Durable goods orders consist of products with a life span of more than ……………………
years.
8. …………………… reflects the average change in retail prices for a fixed market basket of
goods and services.

9. …………………… implicit deflator is calculated by dividing the current dollar GNP figure
by the constant dollar GNP figure.
10. The CRB Index consists of the equally weighted futures prices of ……………………
commodities.

6.2 Financial and Socio-political Factors

The Role of Financial Factors: Financial factors are vital to fundamental analysis. Changes in a
government’s monetary or fiscal policies are bound to generate changes in the economy, and
these will be reflected in the exchange rates. Financial factors should be triggered only by
economic factors. When governments focus on different aspects of the economy or have additional
international responsibilities, financial factors may have priority over economic factors. This
was painfully true in the case of the European Monetary System in the early 1990s. The realities
of the marketplace revealed the underlying artificiality of this approach. Using the interest rates
independently from the real economic environment translated into a very expensive strategy.
Because foreign exchange, by definition, consists of simultaneous transactions in two currencies,
then it follows that the market must focus on two respective interest rates as well. This is the
interest rate differential, a basic factor in the markets. Traders react when the interest rate
differential changes, not simply when the interest rates themselves change. For example, if all
the G-5 countries decided to simultaneously lower their interest rates by 0.5 percent, the move
would be neutral for foreign exchange, because the interest rate differentials would also be
neutral.
Of course, most of the time the discount rates are cut unilaterally, a move that generates changes
in both the interest differential and the exchange rate. Traders approach the interest rates like
any other factor, trading on expectations and facts. For example, if rumor says that a discount
rate will be cut, the respective currency will be sold before the fact. Once the cut occurs, it is quite
possible that the currency will be bought back, or the other way around. An unexpected change
in interest rates is likely to trigger a sharp currency move. “Buy on the rumor, sell on the fact...”.
Other factors affecting the trading decision are the time lag between the rumor and the fact, the
reasons behind the interest rate change, and the perceived importance of the change. The market
generally prices in a discount rate change that was delayed. Since it is a fait accompli, it is neutral
to the market. If the discount rate was changed for political rather than economic reasons, what
is a common practice in the European Monetary System, the markets are likely to go against the
central banks, sticking to the real fundamentals rather than the political ones. This happened in
both September 1992 and the summer of 1993, when the European central banks lost
unprecedented amounts of money trying to prop up their currencies, despite having high interest

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