Question

Question 6

Countries around the world historically used the Gold standard (1890-1914), which, however, was changed to fixed exchange rate system through Bretton Woods since the WWII. The Bretton Woods System collapsed and most countries around the world today use either a clean float or dirty float as an exchange rate system. While removing FX controls and increasing economic integration enable investors to roam around the world, this also means that investors and countries face diverse challenges, risks and uncertainties, which they have to manage through different tools (e.g., measuring country risk and using debt management strategies such as Paris and London Club, debt-for-debt swap and debt-for-equity swap). Generating profits from investments is becoming increasingly challenging even from international diversification. Hence, some investors prefer to tilt towards their home assets (home bias).

Highlight the key differences between the following terms:

i) Gold standard vs Bretton Woods

ii) Clean float vs dirty float

iii) Paris vs London Club

iv) International diversification vs home bias

[4 x 3 = 12 marks]

Answer 1

The Bretton wood system is a merger of various rules and policies that allowed a regulatory framework to make constant or fixed foreign currency exchange rates. Crucially, the agreement is known for the recently created International Monetary Fund (IMF) to regulate the fixed rate of exchange for foreign currencies internationally. The gold system was a system in which all the foreign countries in the world fixed the value of their currencies in terms of an identified amount of gold, or bind their home currency to that of a country that did so. Continuing fiat currency convertibility into the fixed price of gold and safeguarding the rate of exchange. The Key difference was the Bretton wood was a fixed exchange rate system and the gold standard was a floating exchange rate system.

2. A dirty float means a floating exchange rate where an economy’s Federal Reserve Bank (central bank) sometimes intercede to swap or change the direction or the step of the variance of a currency value of a country. Managed floating rate is a reign that provides a supplying central bank to intercede on regular basis in the foreign exchange market to variance the direction of a float of the currency and shore up its balance of payment (BOP) in inordinately explosive time. This reign is also called as a dirty float. A clean float also called as pure exchange rate, it occurs when the currency value, or its rate of exchange is evaluated cleanly by the force of demand and supply in the market. Clean float is the contrast of a dirty float, which occurs only when the rules and laws of government influenced the currency’s prices.

3. The Paris Club is a group of informal creditor’s economies who connect every month in the capital of French whose main aim is to search the solution of workable to the problem of payment suffers by debtors economy. The Paris club handles the debts which are due by the government of the debtor economy and entities of some private sector as pledged by the public sector to members of the Paris club. The same process happens for the debt of the public held by the private creditors in the club of London which happened or organized in the year 1970 on the Paris club model The London first meeting took place in 1976 related to Zaire’s problem of debt. The London club is a group of informal private creditors on the international stage, and is homogenous to the public lenders of the Paris club. London club is not only a group of informal private payables.

4.Rising globalization ( integrating home economy to the world economy) and interconnectivity, increment in the period of unstable, lower bonds yield and fall expected stock returns than as compare to past all advised it’s wise for the investors to spread out the world. Global diversification can aid in risk management and locating the portfolio for long term growth. The home or domestic bias throwback the expanse to which the investors of mutual fund overweight domestic market in their holdings of mutual funds, however the foreign bias throwback the expanse to which investor underweight or overweight the foreign market.