Exchange rate concepts
[You must be registered and logged in to see this image.] |
Use works that are open and operating in one country , the local currency to pay for the costs of production and wages of employees, and accrued interest on loans, and perhaps the distribution of profits to partners. However, companies that operate in multiple countries may sell their products in different currencies and pay their suppliers spread across distant countries in the currencies of those countries, and therefore they need to change the local currency to many foreign currencies.
It is also known that companies and countries use the international financial system to borrow in foreign currencies. The best example of this is the Iraqi government issuing treasury bonds denominated in dollars that it sells in the American and European financial markets to borrow amounts in dollars to fill the Iraqi budget deficit. When countries and companies use foreign currencies, they have to deal with changes in the exchange rate.
In this article, we will review some basic concepts related to the exchange rate, the change in the currency rate, the nominal and real exchange rate, as the beginning of a series of articles related to this vital matter, so that the reader is better informed about concepts that have been mixed in the media, which causes distortions in the understanding of the topic and its effects on the economy.
The nominal exchange rate
Also called the exchange rate for convenience, it is the price of one unit of one currency in the equivalent in another country's currency. For convenience, we express the nominal exchange rate as the ratio of the number of units of foreign currency against one unit of local currency. For example, we say one dollar for 1,450 Iraqi dinars. On the other hand, we express the nominal exchange rate in Iraq by saying that every Iraqi dinar can be exchanged for 0.0007 dollars.
Fluctuations in the exchange rate can play an important role in determining the ability of companies to sell their products to other countries and on the prices that local consumers pay for imported goods and commodities. Take, for example, a bag of rice exported from the United States to Iraq. If the price of a bag of rice in the United States was 50 dollars, then its price in Iraq would be 72,500 dinars, if the exchange rate was 1,450 dinars per dollar. But if the exchange rate of the dinar decreased against the dollar and became 1,600 dinars per dollar, the price of a bag of rice would be 80,000 Iraqi dinars. Although the price of a bag of rice has not changed in the United States, the decrease in the Iraqi dinar exchange rate (about 10%) will cause the American exporter to lose some of his sales in the Iraqi market due to the high domestic price of the goods he exports to Iraq.
Likewise, due to the depreciation of the dollar's exchange rate against the Japanese yen between 2008 and 2012, many Japanese automakers faced a decrease in their sales of cars exported to the US market. In order to avoid the risks that include selling cars against the dollar while bearing the cost of production in Japanese yen, these cars have established factories to produce their cars in the United States itself.
As exports have become a large part of the gross domestic product of most countries of the world, fluctuations in the exchange rate increasingly affect local economies. It can result in any increase in the exchange rate resulting in a significant decline in exports to reduce domestic production companies and laying off some workers. It is not surprising that important economic publications around the world publish exchange rate data and articles on the effect of exchange rate movement on corporate sales and production. Economists and policymakers are closely watching the movement in the exchange rate due to its effect on the economy in general.
The immediate exchange is made between two currencies according to the current exchange rate or what is called the spot exchange rate. Buyers and sellers of currencies can also agree today to exchange currencies at a later date based on a forward exchange rate. The agreements to exchange currencies in future times are called futures swaps and futures swaps.
Forward swap contracts are negotiated between two financial institutions, usually commercial banks. For example, the Bank of Baghdad agrees with a US bank today that after 90 days, it will buy $ 100 million for Iraqi dinars at an exchange rate of 1,450 dinars to the dollar. Whereas futures exchange contracts are made to exchange financial products such as stocks and bonds by people in the markets for exchanging those products, such as the Chicago Mercantile Exchange. Details of futures contracts, such as the amount of currency that each contract contains and the time that the contract expires, are formulated by the management of the market in which the contract is made. The existence of futures and futures contracts allows companies to hedge or reduce the risk of losses that can result from exchange rate fluctuations.
For example, the Iraqi Oil Export Company (SOMO) might suffer some losses if the exchange rate of the dinar rose against the dollar. Suppose that SOMO sells an oil shipment to an American company for an amount of 50 million dollars, and it is agreed that the American company will pay the amount after 90 days when the shipment is delivered. SOMO faces some risks, or the so-called exchange rate risk, as the exchange rate of the dinar may rise against the dollar in the ninety-day period between the agreement to sell and when the payment is received. If that were to happen, SOMO would receive less Iraqi dinars for the $ 50 million. By entering into a forward exchange rate contract at the time of the sale agreement, SOMO can fix the exchange rate to a certain percentage in which it can exchange the dollars that you will receive after 90 days for it, and accordingly reduces the exchange rate risk. Usually companies do not write forward exchange contracts themselves, but rather rely on specific banks to provide these services for a fee.
Each currency has an immediate exchange rate against every other currency, or what is called the binary exchange rate. Economists and policymakers see more benefit in looking at a multiple exchange rate, which shows the price of one country's currency against a group of other countries' currencies. This group of currencies is called the basket of currencies and usually includes the US dollar, the British pound, the euro, the Swiss franc, the Japanese yen, the Canadian dollar, and possibly other currencies. Each currency in this basket is given a weight according to the amount of trade exchange between the countries of those currencies and the country of origin. In this case, the exchange rate is referred to as a semantic number, not a direct price. And like any other indicator, what matters is the movements of the multiple exchange rate over time rather than its value at a specific time.
The exchange rate of the dollar has fluctuated greatly since 1973. It witnessed a rise during the eighties against many other currencies, which created great difficulties for American companies to export their products to other countries of the world. But since 2001, the exchange rate of the dollar in the market witnessed a decline compared to other currencies, which helped American exporting companies to increase their sales around the world.
Real exchange rate
The nominal exchange rate tells us how many units of foreign currency can be exchanged for one unit of local currency. But economists and policymakers are more interested in the prices of foreign commodities and goods as opposed to domestic goods and goods. In other words, they are concerned with the terms of trade, that is, the ratio in which domestic goods and goods can be exchanged for foreign goods and goods. That exchange ratio is called the real exchange rate. The real exchange rate provides a better measure of the change in the prices of a country's goods and commodities in comparison to foreign goods and commodities than the nominal exchange rate provides. Therefore, when economists and policy makers try to estimate the effect of a change in the exchange rate on exports and imports, they rely on the real exchange rate and not the nominal exchange rate.
Measuring the real exchange rate using a single commodity: the PVC Mac Index
The Economist in Britain introduced the use of the PCMAC index in September 1986 as an index of purchasing power parity of currencies. The index is based on the logical premise that two different processes should naturally adapt until the cost of an identical basket of goods and commodities is the same in the two currencies. Accordingly, the McDonald's sandwich company called Your Mac was chosen to represent the basket of goods and those similar goods because it is available in a largely identical way in many countries of the world. Therefore, the index helps to compare the currencies of two different countries.
If we take, for example, the price of a sandwich in the United States is five dollars, for example, and in Iraq, seven thousand dinars. Meanwhile, the nominal exchange rate between the two currencies is 1,750 dinars to the dollar. In order to calculate the real exchange rate, we have to find the number of Iraqi sandwiches that can be exchanged for one American sandwich. We can achieve this in two steps. First, we use the nominal exchange rate to convert the US sandwich price into Iraqi dinars. The second step is to divide that by the price of the sandwich in Iraq in Iraqi dinars, to get to the number of Iraqi sandwiches that buy one American sandwich. Which:
The real exchange rate = 1750 dinars per dollar * 5 dollars for the American sandwich / 7000 dinars for an Iraqi sandwich = 1.25 Iraqi sandwiches for every American sandwich
That is, your Mac sandwich in the United States, given the prices in the two countries and the nominal exchange rate in mind, can buy a sandwich and a quarter of similar sandwiches produced in Iraq. It is worth noting that the real exchange rate tells us how much foreign goods and commodities a single unit of domestic goods and commodities can buy. That is, we can measure the real exchange rate through the exchange of goods and commodities instead of currencies.
Usually we do not measure the real exchange rate using the price of a single commodity but using the average price, or the general price level, in each country. Accordingly, a simple equation can be constructed to compare the local rate and the average prices in the other country with the nominal exchange rate to determine the real exchange rate as follows:
Real exchange rate = nominal exchange rate * (domestic rate / foreign rate)
For example, if the real exchange rate of the Iraqi dinar is 1,500 dinars per dollar, then that value indicates that an ordinary commodity produced in the United States could buy 1,500 units of a similar ordinary good produced in Iraq.
The real exchange rate and the nominal exchange rate move symmetrically only if the ratio of the domestic price rate to the foreign rate rate is nearly constant. This clearly indicates the risks of a significant rise in domestic prices, that is, inflation, compared to inflation in the other country on a change in the real exchange rate.
* Professor of Economics and Political Science, Kansas State University, USA.
[You must be registered and logged in to see this link.]
Today at 7:52 am by Rocky
» utube 3/28/24 MM&C Iraqi Dinar - IQD Update - SWIFT - Purchasing Power - Urban Renaissance - Releas
Today at 7:51 am by Rocky
» Al-Mandalawi: Iraq is witnessing competition between major companies...and the House of Representati
Today at 7:49 am by Rocky
» The President of the Republic stresses the importance of the role of programmers in developing the w
Today at 7:46 am by Rocky
» The Minister of Industry and Minerals follows up on the technical and production performance of the
Today at 7:45 am by Rocky
» The Minister of Finance is following up on the field the progress of the newly implemented ASYCUDA s
Today at 7:44 am by Rocky
» Statistics: There are more than 15 million bank accounts in Iraq
Today at 7:42 am by Rocky
» Representative: One paragraph hinders the passage of a general amnesty within the House of Represent
Today at 7:37 am by Rocky
» Parliamentary Finance: “The draft federal budget law will be devoid of new job grades.”
Today at 7:36 am by Rocky
» Parliamentary action to resolve the fate of “food security contracts” in 15 governorates
Today at 7:35 am by Rocky
» 300 factories turned into "iron scrap" in Diyala
Today at 7:34 am by Rocky
» A deputy expects the dollar exchange rate to reach 140 Iraqi dinars
Today at 7:32 am by Rocky
» Al-Yasiri: The American administration is working hard to destroy the Iraqi economy
Today at 7:31 am by Rocky
» Infographic: The highest annual salaries of leaders of Arab countries
Today at 7:30 am by Rocky
» Communications announces that the electronic signature project has reached advanced stages
Today at 7:29 am by Rocky
» Parliamentary Integrity presents a file related to Kuwaiti violations of Iraqi oil
Today at 7:27 am by Rocky
» Parliamentary move to include amendments to Parliament’s internal regulations on the agenda (documen
Today at 7:25 am by Rocky
» The Iraqi President urges the Minister of Finance to expedite the payment of salaries to the Kurdist
Today at 7:23 am by Rocky
» Central Bank of Iraq sales exceeded $251 million at today’s auction
Today at 7:21 am by Rocky
» The Foreign Minister questions the "Iraqi resistance" attacks against Israel: the other side did not
Today at 7:20 am by Rocky
» The Minister of Labor announces progress in the electronic payment system
Today at 7:17 am by Rocky
» Interior Ministry: For the first time, we controlled the smuggling of petroleum derivatives by 98 pe
Today at 7:16 am by Rocky
» International companies offer offers to invest in the Dhi Qar marshes.. What distinguishes them?
Today at 7:15 am by Rocky
» “Tough” comments on interest rates raise the dollar globally
Today at 7:14 am by Rocky
» Iraq is the fifth largest oil supplier to South Korea in a month
Today at 7:12 am by Rocky
» Recovering more than 100 billion as a result of more than 200,000 employees on social welfare
Today at 7:11 am by Rocky
» The Sudanese consultant announces the completion of Baghdad Metro track designs
Today at 7:08 am by Rocky
» Al-Sudani stresses ending the problem of triple-shift schools
Today at 7:07 am by Rocky
» Iraq begins building two new tankers to transport petroleum products
Today at 7:06 am by Rocky
» Forming a council for “competition and preventing monopoly”
Today at 7:04 am by Rocky
» Features of an Iraqi-Turkish agreement regarding the status of the Kurdistan Workers’ Party
Today at 7:02 am by Rocky
» {Al-Buzrajiya} between the hammer of fraud and the power of the owners
Today at 7:01 am by Rocky
» Ministry of Oil: The gas sector is witnessing great development
Today at 6:59 am by Rocky
» An agreement with Britain in the field of securities
Today at 6:58 am by Rocky
» Discussions between Baghdad and Ankara to open a new port
Today at 6:57 am by Rocky
» Trade: About 11 million citizens updated their new card information
Today at 6:56 am by Rocky
» Electronic payment is sustainable growth
Today at 6:55 am by Rocky
» Experts: Iraq qualifies to be an important tourist country
Today at 6:54 am by Rocky
» Amending the Health Professions Law “robs” scientists of the central appointment 3 years after it wa
Today at 5:20 am by Rocky
» Is the “blessings package” that Erbil paid to the citizens of Kurdistan related to the elections?
Today at 5:19 am by Rocky
» Exceeded 5,000 projects.. Allocating 10 trillion dinars to support governorate reconstruction plans
Today at 5:18 am by Rocky
» “His need no longer exists.” Parliamentary Finance confirms the necessity of returning the retiremen
Today at 5:17 am by Rocky
» To communicate with the bases... 12 directives from Al-Sadr, including blocking numbers for non-gove
Today at 5:15 am by Rocky
» In an interview with "Baghdad Today"... an Iranian researcher reveals the importance of Haniyeh's vi
Today at 5:14 am by Rocky
» After it was 63 trillion in 2023... the 2024 budget deficit will rise to 80 trillion dinars
Today at 5:13 am by Rocky
» Parliament reveals the date of the first evaluation of the governors and determines the party respon
Today at 5:11 am by Rocky
» The President of the Republic informs Al-Araji and Al-Basri: Momentum must be mobilized to eliminate
Today at 5:10 am by Rocky
» Can the Federal Court sue others? A legal clarification of its response mechanism to abuse
Today at 5:09 am by Rocky
» Despite promises to soon stop burning gas.. What is the secret behind Iraq renewing the Iranian gas
Today at 5:07 am by Rocky
» Advisor to Al-Sudani: The dollar is on the way to further decline, and 70% of Iraqi traders have ent
Today at 5:06 am by Rocky
» Iraq exported more than 99 million barrels of oil last February
Today at 5:04 am by Rocky
» Barzani “gives good news” to Kurdistan employees: salaries, land, and loan exemptions
Today at 5:03 am by Rocky
» Alia Nassif: Nour Zuhair returned to the port of Umm Qasr to make deals.. An influential Shiite forc
Today at 5:02 am by Rocky
» The Prime Minister announces the movement of nearly 500 stalled projects
Today at 5:00 am by Rocky
» A government strategy to enhance investments.. Iraq is on the verge of a new era of economic develop
Today at 4:59 am by Rocky
» Ranging between 20% and 50%.. The Kurdistan government decides to reduce service fees, customs dutie
Today at 4:58 am by Rocky
» Al-Sudani: The reform approach in the security services is an integral part of reform in other secto
Today at 4:56 am by Rocky
» Everyone in Iraq wants the Sudanese visit to Washington to be successful, even the factions!
Today at 4:55 am by Rocky
» Sources and experts expect the agenda.. in his bag is the Baghdad dollar and the factions’ truce, bu
Today at 4:54 am by Rocky
» The decision to raise gasoline prices arouses the ire of drivers...a reminder of the large demonstra
Today at 4:53 am by Rocky
» Parliamentary services: 3 important hospitals in Baghdad will enter service at the end of the year
Today at 4:52 am by Rocky
» Iraq signs a contract to supply Iranian gas for a period of five years
Today at 4:50 am by Rocky
» Parliament adds a voting paragraph on amending the Penal Code to its agenda
Today at 4:49 am by Rocky
» His political advisor: We are not afraid of Sudanese entering the elections alone
Today at 4:48 am by Rocky
» Parliamentary services explain the reasons for the rise in real estate prices in Baghdad
Today at 4:46 am by Rocky
» Attia, criticizing the government's decisions: "The citizen's feathers will be ruffled without servi
Today at 4:45 am by Rocky
» Parliamentary Communications: Zain Iraq and Asiacell did not pay their debts
Today at 4:44 am by Rocky
» The Governor of Karbala announces the imminent establishment of the largest industrial city in the c
Today at 4:43 am by Rocky
» A government determination to end the issue of displaced persons in the middle of this year
Today at 4:42 am by Rocky
» Iraq buys gas from Kurdistan to generate electricity
Today at 4:41 am by Rocky
» Parliamentary signatures to include an amendment to the internal regulations to decide the choice of
Today at 4:40 am by Rocky
» In Basra.. a demonstration against foreign workers in Iraqi companies (video)
Today at 4:38 am by Rocky
» Al-Samarrai: Presidency of Parliament is an entitlement to the constituents, and calling it a “frame
Today at 4:36 am by Rocky
» Electronic food supplies in 6 governorates... covering 11 million Iraqis and “writing off” about 700
Today at 4:34 am by Rocky
» Corruption of the Ministry of Transport.. Representatives express their surprise at the minister’s s
Today at 4:32 am by Rocky
» The biggest supporter of the invasion of Iraq.. The death of former US Senator Joe Lieberman
Today at 4:31 am by Rocky
» Iraq is ranked “late.” A list of the most and least safe Arab countries for women
Today at 4:30 am by Rocky
» The Council of Ministers exempts the Gulf Interconnection Authority from guarantee fees: it is a gov
Yesterday at 7:48 am by Rocky
» The Iraqi government raises the size of the 2024 budget, and Parliament is “surprised”
Yesterday at 7:46 am by Rocky
» Popular Movement: We have many economic options away from American hegemony
Yesterday at 7:42 am by Rocky
» The Oil Parliament stresses the need to transfer part of the revenues to the producing governorates
Yesterday at 7:41 am by Rocky
» It will cover 14 regions in eastern Iraq.. A deputy reveals the “border electricity” project
Yesterday at 7:40 am by Rocky
» Experts Warn Mass Migration Threatens US Food Security
Yesterday at 7:37 am by Bama Diva
» Al-Fateh: America occupies Iraq through agreements
Yesterday at 7:37 am by Rocky
» Anger in Iraq over a "sudden decision"... and a reminder of a "general strike" that paralyzed the co
Yesterday at 7:34 am by Rocky
» Parliamentary Committee: Parliament is discussing today a decision that “disturbed” the Iraqis
Yesterday at 7:33 am by Rocky
» Ministry of Electricity: Our production will reach 27 thousand megawatts by May
Yesterday at 7:31 am by Rocky
» Diagnosing the “most important” problems in the oil file between Baghdad and Erbil.. What is the rel
Yesterday at 7:30 am by Rocky
» The Iraqi Fiqh Academy and the Sunni Endowment issue a fatwa to pay Zakat al-Fitr
Yesterday at 7:28 am by Rocky
» The National Bank of Iraq continues its digital transformation by launching its new banking system a
Yesterday at 7:26 am by Rocky
» Parliamentary Investment and the Central Bank are discussing the housing initiative
Yesterday at 7:25 am by Rocky
» The Prime Minister announces the restart of 500 suspended projects
Yesterday at 7:23 am by Rocky
» Al-Barti assesses the region's employees: Your salaries are insured and will be paid after resettlem
Yesterday at 7:21 am by Rocky
» Iraqi-American discussions in anticipation of the Sudanese visit
Yesterday at 7:20 am by Rocky
» Iraq and Turkey hold meetings in Ankara to discuss technical issues related to the development road
Yesterday at 7:17 am by Rocky
» A government parliamentary agreement to support budget revenues and governorate allocations for inve
Yesterday at 7:16 am by Rocky
» Oil: The gas sector is witnessing great development
Yesterday at 7:15 am by Rocky
» A Kurdish-French agreement to develop trade and economic relations
Yesterday at 7:13 am by Rocky
» Exchange companies in Mosul demand that they be entered into the currency selling window
Yesterday at 7:12 am by Rocky