Currency Fluctuation and its Impact on Capital Market
Currency fluctuation is the movement of a currency’s value with another currency. It is the change in the price of one currency against another currency. Currency fluctuations usually refer to changes in value against the US dollar. For example, if the euro falls or rises against the dollar, the euro experiences currency fluctuation. A currency fluctuates because there is always demand for it. When demand is high, the price goes up. When demand is low, the price goes down. The fluctuation can be anything from political stability to the weather.
A currency in high demand is typically seen as being more valuable than one in low demand. This is because people are willing to pay more for a currency they believe will hold its value or appreciate in the future. On the other hand, a currency in low demand implies that people are not willing to pay as much for the currency, which they believe will depreciate in value or is not as stable.
A currency’s exchange rate is determined by several factors, including the economic conditions of the country or countries that use it, more specifically, foreign exchange reserve, the balance of payment, interest rate, inflation, policies, rules, and regulations, etc., and the currency’s political stability.
A currency may appreciate or depreciate relative to other currencies due to changes in any of these factors. A currency that appreciates is said to have strengthened, while a currency that depreciates is said to have weakened.
Currency fluctuations can also affect the value of a country’s stocks and bonds and the prices of other assets, such as real estate. Generally, a strengthening currency is associated with higher asset prices, while a weakening currency is associated with lower asset prices.
Currency fluctuations can also impact consumers, especially consumers of import-driven countries, as changes in the exchange rate can affect the prices of goods and services purchased overseas. For example, a strengthening dollar makes imported goods and services more expensive, while a weakening dollar makes them cheaper.
Why does currency fluctuation happen?
Several factors, including economic indicators, global events, and political instability, causes currency fluctuation. When any of these factors change, it can cause a currency to appreciate or depreciate. For example, if a country’s economy grows faster than other countries, its currency will appreciate. On the contrary, if a country is experiencing political turmoil, its currency may depreciate.
- Economic conditions: Changes in economic conditions, such as interest rates, economic growth, and inflation, can influence the demand for a currency. For example, if a country’s interest rates rise, this will usually lead to increased demand for that currency as investors seek to take advantage of the higher returns.
- Political conditions: Political instability or uncertainty can also lead to currency fluctuations. For example, suppose a country is experiencing political turmoil. In that case, this may decrease demand for its currency as investors seek to avoid the risk of investing in that country.
- Natural disasters: Natural disasters, such as earthquakes or tsunamis, can also influence currency fluctuations.
- Currency fluctuations can provide opportunities for investors to make profits. For example, if a currency is predicted to appreciate, investors may buy that currency to sell it later at a higher price.
- Currency fluctuations can also benefit exporters. For example, if a country’s currency depreciates, this generally makes the country’s exports more competitive in the global market and may increase exports.
- Currency fluctuations can also lead to losses for investors. For example, if a currency is predicted to depreciate, investors may lose money if they sell the currency at a later date at a lower price.
- Currency fluctuation is one of the main reasons for a country’s economic slowdown. For example, a sharp depreciation in one country’s currency causes the country’s exports, if the exports are backed by imports, to become more expensive on the foreign markets, thus leading to a fall in its exports. Another example is that currency fluctuation in the country will lead to the price increase of imported goods and services, resulting in inflation in the country.
Impact of Currency Fluctuation
Economy: Currency fluctuations can have a significant impact on the economy. When the value of a currency decreases, the cost of imports will increase. This can lead to inflation and a decrease in the standard of living. Conversely, when the value of a currency rises, the value of exports in local currency will decrease, which has a side effect on the economy.
Investment: Currency fluctuations can also have a significant impact on investment. When the value of a currency decreases, the return on investment will also decrease; when the value of a currency increases, the return on investment will also increase.
Exchange Rate: The exchange rate is the rate at which one currency can be exchanged for another. When the value of a currency decreases, the exchange rate will also decrease. This can make it more expensive to travel to another country. When the value of a currency increases, the exchange rate will also increase. This can make it cheaper to travel to another country.
Effects of Currency Fluctuation on the Share Market
Currency fluctuation is one of the most critical factors that affect the share market. When the value of currency changes, it can directly impact the price of shares. For example, if the US dollar value decreases, the cost of claims in US companies will become cheaper for foreign investors. This can lead to an influx of foreign investment, which can cause the price of shares to increase. Conversely, if the US dollar value rises, the cost of shares in US companies will become more expensive for foreign investors. Again, this can lead to a decrease in foreign investment.
Currency fluctuation is a crucial factor in the business of companies. The cost of goods and services purchased from abroad by a company and the income generated can be impacted by foreign exchange fluctuations. The goods and services may be bought or earned through foreign currency. Either way, the exchange rate can affect the bottom line. Therefore, a company’s accountant should be able to understand the effect of currency fluctuations on income and expenses.
A company has to deal with currency fluctuations, primarily when it exports products to other countries. So it has to adjust the price according. But sometimes, due to competitive advantages, bargaining power, and retaining market share, price adjustment is not possible. Which ultimately affects the profitability of a company.
Currency fluctuations can also affect the share prices of companies that operate in multiple countries. Since the company covers the subsidiary’s accounts in the parent company’s local currency, translation gains or losses are always possible.
Hence, currency fluctuations can directly and indirectly, impact the share market. In short, as an example, a strong currency makes exports more expensive and imports cheaper, which can lead to a reduction in demand for a company’s products. This can cause a reduction in the share price. Conversely, a weak currency has the opposite effect, making exports cheaper and imports more expensive, which can increase demand for a company’s products. This can cause an increase in the share price.
The effect of currency fluctuations on the share market can be challenging to predict in the short run. Therefore, it’s essential to keep an eye on currency movements to understand how they might affect the share market. This can help investors to make proper decisions about when to buy and sell shares.
Currency fluctuations are a normal part of the global economy and can create opportunities and risks for investors. For example, those who can correctly predict currency movements can potentially make large profits, while those who make incorrect predictions can lose money. While currency fluctuations are inevitable and international, large and sudden changes can cause instability and adversely affect economic growth. For this reason, central banks and governments often intervene in the foreign exchange market to stabilize their currencies.