The theory of fundamental analysis
Purchasing Power Parity
The basis for analysis in the framework of this theory is the concept of "purchasing-basket" (the same in different countries a set of products). Accordingly, the exchange rates are determined by the relative price of this "market basket". It is expected that changes in the level of inflation should be offset by the same force in the opposite direction, changes in price "market basket".
The higher prices and production costs in the country compared to foreign ones, the greater the increases imports compared to exports. Therefore, a high level of domestic prices and low prices abroad usually means higher prices for foreign currency. According to the concept of purchasing power parity, the ratio between the two countries' exchange rates, other things being equal, in proportion to the ratio between house prices and prices abroad.
If one and the same product costs $ 2 U.S. and 2 euros in Europe, according to the theory of equality of purchasing power of currencies, the euro against the dollar should be 1:1. If the current average rate - 1,16 dollars per 1 euro, saying that the dollar is "undervalued" and the euro "overvalued." This theory says that exchange rates should strive towards 1:1.
The relative weakness of this theory is that it involves the free trade of goods without tariffs, quotas and taxes. Another drawback - its application to a limited set of standard products, but not to services, where there are significant price differences.
Moreover, there are many factors that affect exchange rates, except for the difference in inflation and interest rates. Among them, press releases and reports about the state of the economy, asset markets, political developments and the alignment of political forces. Until the 90s there was little practical evidence of the effectiveness of the theory of equality of purchasing power. After the 90th it became evident that this theory is applicable only in terms of orientation for the analysis of long-term (approximately 3-5 years).
Interest rate parity
The theory of equality of interest rates states that the revaluation or devaluation of one currency relative to another should be counteracted by changing the difference in interest rates. If the interest rate exceeds the U.S. interest rate in Japan, the dollar should depreciate against the yen at the same value (ie fixed-term exchange rate is reflected in today's spot rate). We say that the term dollar below par, because it buys fewer yen for a fixed exchange rate than the spot rate. Yen, in this case exceeds the face value.
The theory of equality of interest rates, however, not confirmed by the practice 90. In contrast to this theory, currencies of countries with a higher interest rate to revalue (risen in price), but not devalued (decreased). This occurred because the rates laid the expectation of inflation and income from foreign currency-related increase in interest rates.
Balance of payments
This theory states that exchange rates should be in a state of equilibrium, ie at a level at which the balance of the country (like a bank account balance) remains constant. A country with a trade deficit will experience a decrease in foreign exchange reserves, which leads to a devaluation of its currency. The cheaper currency makes the world market of goods in this country (exports) is cheaper, and imports - expensive. After some time, the volume of imports decreased and exports - is increasing, which in turn leads to the trade balance and balance of foreign currency.
The balance of foreign payments and receipts of the country include: trade balance (trade balance) and the capital account (capital payments gap). Excess of income from abroad on payments abroad is a positive balance of payments and lead to an increase in the national currency. Excess payments over receipts abroad creates a balance of payments deficit (shortfall) and leads to a drop in the national currency.
Like the theory of equality of purchasing power, the theory of balance of payments is largely based on the flows of goods and services, ignoring the increasing role of global capital flows. In other words, the money in today's economy, not only to buy goods and services, and securities such as stocks and bonds.
Increased global mobility of capital has led to the theory of the securities market.
Securities market
The exchange rate should be in a state of equilibrium, ie at a level to balance the country (like a bank account balance) remained constant. A country with a trade deficit will experience a decrease in foreign exchange reserves, which leads to a devaluation of its currency. The cheaper currency makes the world market of goods in this country (exports) is also cheaper, and imports - expensive. After some time, the volume of imports decreased and exports - is increasing, which in turn leads to the trade balance and balance of foreign currency.
The balance of foreign payments and receipts of the country include: trade balance (trade balance or the trade gap) and the capital account (capital payments gap). Excess of income from abroad on payments abroad is a positive balance of payments and lead to an increase in the national currency. Excess payments over receipts abroad creates a balance of payments deficit (shortfall) and leads to a drop in the national currency.
Like the theory of equality of purchasing power, the theory of balance of payments is largely based on the flows of goods and services, ignoring the increasing role of global capital flows. In other words, the money in today's economy, not only to buy goods and services, and securities such as stocks and bonds. Increased global mobility of capital has led to the theory of the securities market.
