The author of the article is Glenn Curtis, independent financial analyst and author, working with such publications as Investor's Business Daily, The Washington Times, Investopedia.com, Forbes and CNN.
Traders are accustomed to the fact that in the market there are daily currency fluctuations, but what does this mean for those who do not trade in the Forex market? Exchange rates affect exports, imports, economy and tourism. In this article we will discuss the essence of currency exchange and its impact on the economy and daily life.
For simplicity, as an example, take the ratio between the Euro and the us dollar. More precisely, we will discuss what happens to the economies of the US and Europe, when the Euro increased significantly against the dollar. Although in recent months the Euro dipped slightly (1 USD =0.89 EUR), we will discuss what happens if 1 dollar will be worth 0.7 euros.
Effect of changes in exchange rate in tourism
If 1 dollar will be worth 0.7 euros, U.S. citizens will probably be less willing to travel to Europe, as everything from food to Souvenirs, it will be expensive — approximately 43% more expensive than in parity between currencies. This illustrates the effect of the theory of purchasing power parity (PPP).
In contrast, the European tourists would be more inclined to visit the United States for business purposes and for travelers. The American company and the municipalities (through taxes) will thrive in areas that are visited by European tourists, although it is seasonal.
The impact of exchange rates on corporations and the stock market
The impact of our scenario on corporations (especially large multinationals) is more complex because these businesses often conduct transactions in different currencies and, as a rule, receive raw materials from different sources. However, the US-based companies that generate the bulk of their revenues in the United States (but receiving raw materials from Europe) is likely to face a decline in profit levels due to higher costs.
Similar problems would be faced by American companies that must pay their employees in euros. Naturally, this reduced level of profit is likely to have a negative impact on total corporate profits and therefore on the rating of their shares in the domestic market. In other words, stock prices may fall due to lower income and negative predictions about potential future profits.
On the other hand, American companies with considerable presence abroad and a significant amount of revenue in euros (instead of dollars), but who pay to their employees and incur other costs in dollars, can be winners.
European companies which get the lion's share of revenues in euros, but also in the framework of its business components use or hire employees of the U.S. is likely to see an increase in profits because their costs will decrease. Naturally, this can lead to higher corporate profits and rising stock prices in some foreign markets. However, European companies that derive a significant portion of their income in the United States, and shall pay expenses in euros are likely to suffer from rising costs.
The impact of exchange rates on foreign investment
Europeans (both individuals and corporations) would probably increase their investments in the United States under these circumstances. It is also better suited for the acquisition of a business or property in the United States. For example, when the Japanese yen in the 1980s was trading at record highs against the dollar, Japanese firms are actively buying U.S. real estate, including the world-famous Rockefeller center.
On the contrary, American corporations will be less likely to acquire a European company or European real estate when you convert the dollar rate of 1 USD = 0.70 EUR.
How to protect yourself from currency fluctuations
It is important to make currency work for you. For example, when planning a trip is to choose the most current currency conversion before booking the tickets. Also, tourists making purchases abroad is to use credit cards.
This is because companies usually agree on the best courses and the most favorable conversions because making a huge volume of transactions. These companies do all the work for you, making it easier (and possibly cheaper making) transactions.
One of the outputs for businessmen working in the United States and receiving raw materials from Europe to increase the supply, if the Euro against the dollar begins to rise.
On the contrary, if the Euro starts to fall against the dollar, it may make sense to reduce stocks to a minimum in the expectation that the Euro will drop enough that the company could save on the purchase of goods.
Also for insurance against fluctuations there are futures and options contracts.
Exchange rates usually fluctuate depending on various economic factors that affect large and small investors. Individuals, investors and businessmen, taking into account exchange rates can mitigate the financial risks and take advantage of currency fluctuations to reduce costs of business or their transport costs.