International financial management Essay Example | Topics and Well Written Essays - 2250 words

International financial management - Essay Example Foreign exchange market makes it possible for both private and commercial transactions including loans, investments, and foreign trade. The existence of a foreign exchange market is a result of economies employing national currencies rather than a common currency (Kumar, and Mukherjee, 2007; Butcher, 2011). If the world economy was to use a single currency, foreign markets could not be a necessity. The foreign exchange market is exceedingly active, and it is largely an over the counter market. Although the exchanges trade futures and option, a number of transactions are over the counter (Brigham, and Houston, 2009). The future expected spot price is the market's belief about an asset’s spot price in the future (Poniachek, 2012). This leads to a question of whether or not one can use the current forward price to predict the particular future spot price. A number of hypotheses have been in place to try clarifying the relationship between the expected future spot price, and the c urrent forward price (Wang, 2009). In the field of financial economics, there has been intensive examination by researchers on the â€Å"Forward Rate Unbiased Hypothesis† (FRUH), as Kumar (2011) indicates. ... This means that organizations can look upon a future exchange rate that is prevailing today as the spot rate of the future date (Sharan, 2006; Carbaugh, 2011). In the case of an assumption that the forex market is rational or efficient, the spot rate that is common at the future date should be in tandem with the future rate for that date established in the market today. Contrary to this belief, scientific evidence indicates that there are significant variations between the forward market rates and the spot rates (Kumar, 2011). In addition, the studies have not been able to produce any material evidence to prove that forward market rate can predict the future spot rates. Some forecasters hold the believe that foreign exchange markets for the principal floating currencies are efficient, and that forward market rates are an unbiased indicators of the future spot exchange rates. Unbiased prediction implies that the forward exchange rate will, on average, underestimate and overestimate th e actual future spot exchange rate in equivalent degree and frequency. There is a probability that the forward market rate may not be equivalent to the future spot exchange rates. This relationship’s rationale is founded on the assumption that: a) There is a quick reflection of all relevant information in both the forward exchange markets and spot exchange markets b) Instruments that are denominated in the various currencies are perfect alternates for each other c) Operation costs are minimal 3. The future spot rate and the forward rate One can make out the relationship between the forward market rate and the expected future spot rate on the unbiased forward rate theory. This theory claims that the forward exchange rate is the superlative, and a balanced,