CHAPTERONE

I
NTRODUCTI
ON

Thisr esear chwor kexami nest hei mpactofmonet arypol i

ciesonf oreignt r
adei nNi geri
a.The
resear chmadeuseofsecondar ydat awhi char ecol lectedf rom t heCent ralBankofNi geria,
Statistical Bulleti
n( 2010) .Thedat awer ecollectedf ort heper i
odoft hi rt
yy ear s(i.e.
)981- 2010) .
Thest udyempl oyedquant itati
v eanal ysi
sappr oach.Thev ariablesconsi deredappr opr i
ate
i
ndi cesf ormonet arypol i
cywer eMoneySuppl y,InterestRat e,ExchangeRat e,Inflat
ionaryRat io
andLi qui dlyRat io.Themaj ortool ofanalysisisamul ti
pler egr essionanal ysismodel speci fi
ed
ont hebasi sofper ceivedf unct ionr el
ationshipbet weenmonet arypol i
ciesandf oreignexchange
earningsi nNi geria.Treat i
ngf or eignexchangeear ningsast heexpl anat oryandt heot her sast he
explanat oryv ari
ables, amul ti
pler egressionmodel wasspeci fiedtof orgeal inkbet weent he
variableset s.Themodel wasest imat edusingt heor dinaryleastsquar es( OLS)t echni quesand
evaluat edbasedonr elevantdat af rom theregr essionout put .Ther esul tshowedt hatMoney
Suppl y, ExchangeRat e,Infl
at i
onar yRat ioexer t
edposi tiveef fectonf or eignexchangewhi le
InterestRat eandLi quidityRat i
oexer tednegat iveinf l
uenceonf oreignexchange.I naddi ti
on, t
he
model exhi bitedhi ghexpl anat orypowerandi ndicat edabsenceoff ir
stor derser ialcorrelati
oni n
theexpl anat oryvar i
able.Basedont hef i
ndings, thest udyconcl udedt hatacl ear-outand
obv i
ousr el
ationshipexi stedbet weenmonet arypol icyandf or eignt radei nNi geriaand, thus
recommendedf orconsci ousef fortstobemadet ofine-tunet hev ar i
ousmonet aryv ari
abl esin
ordert opr ovideanenabl i
ngenv ironmentt ost imul atef oreignt rade.  

1.
1  BACKGROUNDTOTHESTUDY

Monet arypolicyi soneoft hemacr o-economi cinst

rument swithwhichnat i
ons( i
ncluding
Nigeri
a)domanaget heeconomi cs.Itentail
st hoseactionsiniti
atedbyt hemonet ar
yaut horit
ies
whichaim ati nfluenci ngt hecostandav ai
labil
ityofcredits(Wr i
ghtsman1996) .I
tcov ersgamut
ofmeasur esorcombi nationofpackagesi ntendedt oinfl
uenceorr egulatethevolumespr i
ceas
wellasdi recti
onofmoneyi ntheeconomy .
 Speci fi
cal
ly,i
tper meatesallthedeli
berateeffortby
themonet aryauthor it
iest ocont r
olthemoneysuppl yandcr edit
scondi t
ionsforthepur poseof
achievi
ngdeser vemacr oeconomi cobjectives,AjieandNenbee( 2010).Chamber l
ainandYueh
(2006)addst hatthesuppl yorpri
ceofmoney -mayex ertapower fuli
nfluenceovertheeconomy .
Accordingt oNnana( 2006) ,general
ly,macr oeconomi cpoliciesindevelopingcountri
esar e
designedt ost abil
izet heeconomy ,stimulategr owthandr educepov erty.Thepri
mar ygoal of
monet arypol i
ciesi nNi geriahasbeent hemai ntenanceofdomest icpri
ceandexchanger ate
stabi
li
tysi
nceiti
scr
it
ical
fort
heat
tai
nmentofsust
ainabl
egr
owt
handext
ernal
sect
orv
iabi
l
ity
(sanusi
,2012)
.

Economi stshavelongbeeni nter

estedinf act
orswhi chcausediffer
entcountri
estogr owat
dif
ferentratesandachievediff
erentlevelsofwealt h.Oneofsuchf act
orsisforei
gntrade.
Nigeri
aisbasi cal
lyanopeneconomywi t
hint er
nationalt
ransact
ionsconstit
uti
ngasi gnifi
cant
proporti
onofheraggr egat
eout put.Toal argeextent ,
Nigeri
a’
seconomi cdevelopmentdepends
onthepr ospectsofherexportt r
adewi t
hot hernations.Forei
gntradeprovi
desbot hforeign
exchangeear ningandmar ketsti
mul usforacceleratedeconomicgr owth(Obadan,2004) .

Sev er
al countr
ieshaveachievedgr owthanexpor t-
ledstr
ategy.Smalleconomiesinparti
cular
havev erylit
tl
eoppor t
unit
ytoachi ev eproducti
vityandeffi
ciencygai
nst osupportgrowth.
Withouttappi ngint
olargemar kett hroughexternaltr
ade,Nigeri
a’
srelati
velyl
argedomestic
mar ketcansuppor tgrowthbutal onecannotdel iversust
ainedgrowthatt herat
esneededt o
makeav isibl
eimpactonpov ert
yr eduction.HenceNi ger
iahascontinuedt or
elyonforei
gn
mar ketaswel l(Worl
dBank, 2002) .

Manyeconomi st
sgenerall
yagreethatopennesstoi nt
ernati
onaltradeaccel
erat
e
development.Themorer api
dgrowthmaybeat ransi
tioneffectrat
herthanashifttoadiff
erent
steadystatesgrowthr
atesclear
ly,t
hetradi
ti
ontakesacoupl eofdecadesormor eso,t
hatitis
reasonabletospeakofforei
gntradeopennessaccelerati
nggr owthrathert
hanmer el
yleadi
ng
toasuddenonet i
meadjustmentinnetincome( Doll
arandKr aay,2001).

InNiger i
a,theachievementoft hisobjecti
vesar epredicatedont hest anceoff i
scal monet ary
poli
cies.Monet arypoli
cyf or
mul at
ioni sbasedont heduoofmoneysuppl yandcr editavailabil
it
y
i
nt heeconomy .I
nensur ingmonet arystabil
ity
,thecent ralbankthr ought hedeposi tmoney
banksi mplement spolici
esthatguar anteetheorderlydev elopmentoft heeconomyt hrough
appropriatechangei nthelevelofmoneysuppl y.Ther eservesoft hebanksar ei
nf l
uencedby
thecentral bankthroughitsvari
ousi nstrumentsofmonet arypolicy .Thesei nstr
ument sinclude
thecastr eserverequir
ement ,l
i
quidityratio,
openmar ketoper at
ionsandpr i
mar yoper ati
onst o
i
nfluencet hemov ementofr eserves( Aji
randNenbee, 2010andMashaetal ,2004).

Sequel t
oourdi scussionssof ar,
onecoul dbei nducedt oconcludethattheuseofmonet ary
poli
cyinNi geri
aseemsnott oattractthedesi redlev elofeconomicstabil
i
ty.Thisconclusi
on
fol
lowst hedismal perf
ormanceoft heeconomyi nrecenty ear
s.Lit
tl
ewonderDonl i(2004)
writ
est hatthelasttwodecadeswi tnessedser iesofr efor
msar medatt herevit
ali
zati
onofthe
Nigeri
aeconomyowi ngtoseriesofcr isesthatinfluencet hegrowthoftheeconomydur i
ngthis
peri
od.Thepr oblemswer eseent obeadi r
ectder ivati
veofst r
uctur
alimbalancesinour
economysy st
em.Thei mbalancest art
edr i
ghtf rom colonialer
anur t
uredbyinappropri
ate
poli
ciesafterindependencein1960, andreinforcedbyt hewindfacegainsform petr
oleum in
the1970s.

Donl
i(2004)fur
thercontendsthatt
hesestruct
uraldef
ectsconsist
edorundiversi
fi
ed
monolit
hicandmonocul t
ureproducti
onbases,unduerel
ianceonagricul
tur
alproductsfr
om
1973.Theoutcomeoft hoseeventswasthatthegrowthprocessreli
edheavil
yonexternal
fact
orsinsteadont heinter
nal ones.Howev er,
ofall
theindependences,
theexclusiverel
i
ance
onpetroleum turnedouttobet hemustdev ast
ati
ngtotheeconomy .Thedismal economic
outl
ookinNi geri
aabov edismal economicoutl
ookinNigeri
asaaabovedesiresi
nv esti
gat
ioni
nto
whetherornotmonet ar
ypr ol
i
cyascl ai
medbyt hemonet ar
ist
simpactonNi ger
ia’s
esdeconomi cstabil
it
yandf oreignt r
ade.

1.
2  STATEMENTOFTHERESEARCHPROBLEM 
  
  
  
  
  
  
  
  
  
  
  
  

Monet arypoli
cyasat echni
queofeconomi cmanagementt obringaboutsustai
nable
economi cgrowthanddev el
opmentthroughforei
gnt r
adehasbet hepursui
tofnationsand
for
mal arti
culat
ionofhowmoneyaf fectseconomicaggr egatesdatesbankt heAdamsSmi th
andwat erchampi onedbythemonetaryeconomists.Sincetheexposit
ionsoft her
oleof
monetarypol i
cyininfl
uenci
ngmacroeconomi cobject
ivesli
keeconomi cgrowt hpr
icestabi
l
ity
,
equi
li
brium inbalanceofpaymentsandhostofot herobjecti
ves,monetaryauthori
ti
esare
saddl
edt heresponsibil
it
yofusi
ngmonet arypoli
cytogr owththei
reconomi es.

I
nNigeri
a,monet arypolicyhasbeenusedsi ncecentr
alBankofNi geri
awassaddl et
he
r
esponsibi
li
tyofformul at
ingandi mplement i
ngmonet arypoli
cybyCent r
alBankactof1958.
t
hisrol
ehasf aci
li
tatingtheemer genceofact ivemoneymar ketwheret r
easur
ybill
s,af
inancial
i
nstr
umentusedf oropenmar ketoper at
ionsandr ai
singdebtforgovernmenthasgrowni n
vol
umeandv al
uedbecomi ngapr ominentearningassetforinvest
orsandsourceofbalancing
l
iqui
dit
yinthemar ket.Thesehav ebeenv ar
iousregi
mesofmonet aryinNiger
iasometimes,
monetarypoli
cyistightandatot herti
mesi tisloosemost l
yuset ostabi
li
zepri
ce.

Theeconomyhasal sowit
nessedt i
mesofexpansionandcont ract
ionbutevi
dentl
y,thereport
ed
growthinforeigntradehasnotbeenasust ainabl
eoneast hereisevi
denceofgrowingpov er
ty
amongt hepopul aces.Thequesti
oni s,
couldtheperi
odofgr owthinfor
eignt
radebeat t
ribut
ed
toappropri
atemonet ar
ypoli
cy?Andcoul dtheperi
odsofeconomi cdownt er
m beblamedon
fact
orsonot herthanmonet arypoli
cyinef
fecti
ve?Whatmeasur esaretobeconsideredif
monetarypolicywoul dbeeffect
iveinbri
ngingaboutsust
ainableeconomicgrowthand
devel
opment ?

1.
3  OBJECTI
VESOFTHESTUDY 
  
  
  
  

Themai
nobject
iveoft
hest
udyi
stoi
nvesti
gatet
hei
mpactofmonet
arypol
i
ciesonf
orei
gn
t
radeinNi
ger
iaeconomyandhowi
taff
ecteconomi
cdevel
opment
.

Speci
fi
cal
l
y,t
hest
udyseekst
o:

Toexami
net
hei
mpactofmonet
arypol
i
ciesonf
orei
gnt
rade.

Toexami
net
hehi
ndr
ancest
omonet
arypol
i
ciesoper
ati
onsi
nNi
ger
ia.
 

Topr of
fersuggest
ionsonhowmonetar
ypol
ici
escanbemanagedf
orbet
tercont
ri
but
iont
o
for
eigntradeandtheeconomydev
elopment
.

1.
4  RESEARCHHYPOTHESES
Ho:
 
 Amonet
arypol
i
cieshav
enosi
gni
fi
canti
mpactoff
orei
gnt
radei
nNi
ger
ia.

Hi
:Amonet
arypol
i
cieshassi
gni
fi
canti
mpactonf
orei
gnt
radei
nNi
ger
ia.

Ho:
Amonet
arypol
i
cieshasnosi
gni
fi
canti
mpactoneconomi
cdev
elopmenti
nNi
ger
ia.

Hi
:
  
 AMonet
arypol
i
cieshassi
gni
fi
canti
mpactoneconomi
cdev
elopmenti
nNi
ger
ia.
  
  
  
  
  
  

1.
5  SCOPEANDLI
MITATI
ON 
  
 

Ther esearchworkwillbecent eredont hebeginningstr

ucture,operat
ionsandobj ecti
vesof
monet arypolici
esonforeigntrademar ketmanagementi ndeterminingtheforeigntr
adei n
Nigeria.Thi
sst udywi
l
l bepar t
icularlyl
imitedtopre-
oilandpostoi l
boom int hemi d1981,soas
tobeabl etomaker at
ional compar isonbet ween.Hi
stori
calandcur r
entarti
cleli
keunpubl i
shed
project,j
ournalsandt
extbooksofdi ff
erentauthor
.Thepublicati
ondat arangingfrom 1981up
ti
ll2010.

Financeisoneoftheelementthatassi
stagoodresearchoff
inancialconstrai
ntcreated
dif
ficul
ti
esi nt
heprocessofthi
sresearchworkhowever,
itdi
dnothindert heresearch.Chapt
er
twoi sbasical
l
yli
ter
aturerev
iewsli
mitedbookwerefoundtoaccompl i
sht hi
swor k.Timeframe
withinwhichther
esearchmustbecar ryoutIsanot
herprobl
em.  
  
  
  

1.
6  DEFI
NITI
ONOFTERM 

Monet arypolicies: Monetarypolicycanbedef i
nedasthemeasur esorcombi nat i
onof
measuresdesi gnedt oinfl
uenceorr egulatesthev ol
umepriceanddirecti
onofmoneyandcr edi
t.
[Nwankwo, 1979] .Itcanaswel lbeseenast hemanagementoft heexpansionandcont raction
ofthevolumeofmoneyi ncirculati
onsfort hepurposeofachievi
ngcertaindeclarednational
object
ives(Uzoaga, 1981).Thest ockofmoneyi smanagedt hroughexpansion( l
ower i
ngt he
costandr educing/ i
ncreasingt hequanti
ty)ofmoneydependi ngont hemacr oeconomi cpol icy
tar
get.Economi st sagr eethatmonet ar
ypol icyentai
l
stheprocessofdet ermini
ngandv arying
thecostandav ailabilit
yofcr edit
.Theyar ealsounanimousont hefactthatthepur poseist o
enhancemonet aryst abil
it
y(Nwi ki
na,1993) .

Economicgr
owt h:
 Refer
stotheincreasedev eryti
meofaneconomy ’
scapaci
tytopr oduce
thosegoodsandservicesneededtoimpr ovethewel l
-bei
ngofthecit
izeni
nincreasingnumber
anddiver
sit
y.I
tisthestudyprocessbywhi chpr oduct
ivecapaci
tyoftheeconomyi sincr
eased
everyt
imetobringaboutrisi
nglevel
innat i
onal i
ncome.

Economicdevelopment
: Economicdevel
opmentisamul t
idi
mensional
processinvol
vi
ngthe
provisi
onofbasicneeds,acceler
ati
onofeconomicgrowthreducti
onofi
nequali
tyand
unempl oy
ment,eradi
cati
onofpov ert
yaswellaschangesinatti
tudei
nst
it
uti
onandst r
uctur
ein
theeconomy .

For
eignt
radei
sthet
radebet
weent
woormor
ecount
ri
es;
iti
nvol
vest
radeout
sidet
he
nat
ional
boundar
iesofacount
ry.

CHAPTERTWO

2.
1 I
NTRODUCTI
ON

Monet arypolicyisthepol i
cyadoptedbyt hemonet aryauthor
ityofanationt ocontrolei
ther
theinterestratepay ableforveryshort
-term borr
owi ng( borr
owingbybanksf rom eachotherto
meett heirshort -
term needs)orthemoneysuppl y,oftenasanat tempttor educeinfl
ati
onort he
i
nterestr ate,toensur epricestabi
li
tyandgener altrustofthevalueandst abili
tyofthenation'
s
currency.Furtherpur posesofamonet arypoli
cyareusual l
ytocontri
butetot hestabil
it
yof
grossdomest icpr oduct,t
oachieveandmai nt
ainlowunempl oyment, andt omaintain
predictableexchanger at
eswi t
hothercur r
encies.

2.
2.CONCEPTOFMONETARYPOLI
CY

Thisr esear chwor kinv estigatedt heimpactofmonet arypolicyonf oreignt radei nNi ger iadur i
ng
theper iod1981t o2017.Ther esearchmadeuseofsecondar ydat awhi char ecol lectedf rom
theCent ral BankofNi ger i
a,Statisti
cal Bul letin(2017) .Themodel obt ainedf rom t her esul t
represent saEr r
orCor rect i
onModel (ECM)whi chr el
atesthedependentv ari
abl et osev eral
predictorv ari
abl es MoneySuppl y
,InterestRat e,ExchangeRat e,For eignDi rectInvest mentand
TradeOpenness.Fr om t hefindingsoft hest udy ,theerrorcor r
ect i
ont er m( speedofadj ustment
towar dsequi libr
ium)v al ueof- 0.53581i ssi gnificantat5%andi mpl iest hatt hereisal ongr un
causal ityrunni ngf rom monet arypol i
cyact iviti
esmeasur esoff oreignt rade.Howev er, onlyal l
thev ariablewasusedi nt hest udywassi gni fi
cantat5%l ev elofsigni fi
cance.Thi si mpl iest hat
monet arypol icyi nNi ger iahasaposi tivei nfluenceonf oreignt radewi t
hi ntheper i
od, exceptf or
i
nterestr atet hathasanegat ivecoef fici
entandnotsi gnifi
cant .Theusual goal s
of monet ary policyar et oachi eveormai ntai nful lemployment , toachi ev eormai ntainahi gh
rateof  economi cgr owt h,andt ost abili
zepr icesandwages.Unt iltheear l
y20t hcent ury ,
monet arypol icywast houghtbymostexper t stobeofl i
ttl
eusei ninf l
uenci ngt heeconomy .
Infl
ationar yt rendsaf ter  Wor l
dWarI I,howev er,causedgov ernment stoadoptmeasur est hat
reduced  inflation byr est ri
cti
nggr owthi nt he  moneysuppl y.

2.
2.1TYPESOFMONETARYPOLI
CY

Ther
ear
etwomai
nty
pesofmonet
arypol
i
cy:

Contractionarymonetarypol
icy. 
Thistypeofpolicyi
susedtodecreasetheamountofmoney
ci
rcul
atingt hr
oughouttheeconomy .Itismostoftenachi
evedbyactionssuchassel
li
ng
gover
nmentbonds, r
aisingi
nterestratesandincreasi
ngt
hereserverequi
rement
sforbanks.
Thismet hodisusedwhent hegov ernmentwant stoavoi
dinf
lat
ion.
 Expansionarymonet arypoli
cy. 
Thepurposeoft hi
sty peofmonet ar
ypol i
cyist oincr easethe
moneysuppl ywi t
hintheeconomybycompl eti
ngactionssuchasdecr easi
ngi nterestr at
es,
l
ower i
ngreserver equi
rementsforbanksandpur chasinggov ernmentsecur it
iesbycent r
al
banks.Thistypeofmonet ar
ypoli
cyhelpstolowerunempl oymentr atesaswel l asst i
mul at
e
businessacti
viti
esandconsumerspendi ng.Theov erallgoaloft hi
spol i
cyistof uel economi c
growth.Neverthel
ess,itcanalsohaveanadv erseeff
ect ,occasionall
yleadingt ohy perinfl
ati
on. 

2.
2.2 OBJECTI
VESOFMONETARYPOLI
CY?

Nomatt
erwhatt
ypeofmonetar
ypol
i
cyi
sbei
ngused,
iti
sal
way
sconnect
edt
ooneoft
he
f
oll
owi
ngthr
eeobject
ives:

Manageinfl
ati
on. 
Mosteconomist
sconsi
derthi
stheonetr
ueobject
iveofmonet arypol
i
cy.In
gener
al,l
owinfl
ati
oni
smostconducivetoahealt
hy,t
hri
vi
ngeconomy .Ther
efore,wheninf
lat
ion
i
sont heri
se,t
heFederalReser
vemayadjustmonet
arypol
icyt
oreduceinfl
ati
on.

Reduceunempl oyment .
 Duri
ngdepr essionsandr ecessi ons,unemploymentrat
estendtosoar .
Howev er,monetarypoli
ciesalsoplayamaj orroleinunempl oymentrat
es.Onceinf
lat
ionissues
havebeenaddr essed,expansionarypolici
escant henbei mpl ementedtohel
preduce
unempl oymentratesThiswor ksbecauset hei ncr
easei nt hemoneysupplyhelpstosti
mul at
e
thebusinesssector,whichalsohelpstocr eatemor ejobs.Whi l
etheremaybenowayt ofull
y
achi
ev etr
uefullemployment ,thegoalistor educet herateofunempl oymentamongt hosewho
arereadyandwi l
li
ngt owor kfortheexisti
ngwages.

Balancecurrencyexchanger at es.
 Gi
venthatstableexchangeratesplaysuchamaj orrol
ein
i
nternati
onaltrade,it
'sessentialtofi
ndway stokeept hem bal
anced.Cent r
albankshav ethe
powert oregulat
eexchanger atesbetweenforeignanddomest iccurr
encies.Forinstance,i
fthe
central
bankopt st oissuemor ecur r
encytoincreasethemoneysuppl y,domesticcur r
enci
es
becomecheapert hanf or
eigncur r
encies.

TOOLSOFMONETARYPOLI
CY

TheFederalReserve'
sthr
eeinst
rument
sofmonet
arypol
icyareopenmar
ketoperat
ions,
the
di
scountrat
eandr eserv
erequi
rement
s.Openmar
ketoper
ationsi
nvol
vet
hebuyingandsell
ing
ofgover
nmentsecur i
ti
es.

OPENMARKETOPERATI
ON

Openmar ketoper
ati
on(OMO)isanacti
vit
ybyacent r
albanktogiv
e(ortake)l
i
quidi
tyi
nit
s
cur
rencyt
o( orfr
om)abankoragroupofbanks.Thecentr
albankcanei
therbuyorsel
l
governmentbondsi ntheopenmar ket(t
hisi
swherethenamewashi stori
cal
lyder
ivedfrom)or
,
i
nwhati snowmost l
ytheprefer
redsoluti
on,ent
eri
ntoarepoorsecuredlendi
ngtransacti
on
withacommer cialbank:t
hecentralbankgiv
esthemoneyasadeposi tforadefi
nedperiodand
synchronousl
ytakesaneligi
bleassetascoll
ater
al.

Centr
albanksusual
lyuseOMOast heprimarymeansofi mplement
ingmonetarypol
icy.The
usual
aim ofopenmarketoper
ati
onsis—asidefr
om supply
ingcommer ci
albankswit
hliquidi
ty
andsometimestaki
ngsurpl
usli
quidi
tyf
rom commer ci
albanks—tomanipul
atetheshort-
term

i
nter
estr
ateandt
hesuppl
yofbasemoneyi
naneconomy
,andt
husi
ndi
rect
lycont
rol
thet
otal

moneysuppl
y,i
neff
ectexpandi
ngmoneyorcontr
acti
ngthemoneysuppl
y.Thi
sinvol
ves
meeti
ngthedemandofbasemoneyatthet
argeti
nter
estrat
ebybuyi
ngandsell
inggover
nment

securi
ti
es,
orotherfi
nanci
ali
nst
ruments.Monetarytar
get
s,suchasi
nfl
ati
on,
int
erestr
ates,
or
exchangerat
es,areusedtogui
dethi
simplementati
on.

Inthepost-
cri
siseconomy,convent
ional
shor
t-
ter
m OpenMar
ketOper
ati
onshav
ebeen
supersededbymajorcent
ralbanksby

quanti
tati
veeasing( QE)programmes.QEar etechni
cal
lysimil
aropen-mar ketoperat
ions,
but
entai
lapre-commi tmentoft hecent
ralbanktoconductpurchasestoapr e-defi
nedlargevol
ume
andforapr e-
definedperiodoftime.UnderQE,centr
albankstypical
l
ypurchaser iski
erand
l
onger-ter
m securiti
essuchasl ongmat ur
it
ysoverei
gnbondsandev encor por
atebonds.

DI
SCOUNTRATE

The  discountr ate i

st hei nterestrat eReser v
eBankschar gecommer cial banksf orshort-
ter
m
l
oans.Feder alReser vel endingatt hedi scountr at
ecompl ement sopenmar ketoper at
ionsin
achievingt hetargetf eder alfundsr at eandser v
esasabackupsour ceofl iqui dityfor
commer cialbanks.Lower ingt hedi scountr at
ei sexpansi onarybecauset hedi scountrate
i
nfluencesot herinterestr ates.Lowerr at
esencour agel endingandspendi ngbyconsumer sand
businesses.Li kewi se,raisingt hedi scountr at
ei scont ract i
onarybecauset hedi scountrate
i
nfluencesot herinterestr ates.Hi gherr atesdiscour agel endingandspendi ngbyconsumer sand
businesses.Di scountr atechangesar emadebyReser veBanksandt heBoar dofGov ernors.
Thedi scountr atewhi chi susedi nf inancialcalculationsi susuallychosent obeequal tothe
costofcapi t
al.Thecostofcapi tal,inaf i
nancial mar ketequi l
ibr
ium, wil
l bet hesameast he
mar ketrateofr etur nont hef inancial assetmi xturet hef i
rm usest ofinancecapi tali
nvestment.
Someadj ustmentmaybemadet ot hediscountr atet otakeaccountofr i
sksassoci at
edwi th
uncertaincashf l
ows, withot herdev elopment s.

Thediscountr
atest
ypi
cal
l
yappl
i
edt
odi
ff
erentt
ypesofcompani
esshow si
gni
fi
cant
di
ff
erences:

St
art
-upsseeki
ngmoney
:50–100%

Ear
lyst
art
-ups:
40–60%
Lat
est
art
-ups:
30–50%

Mat
urecompani
es:
10–25%

Thehi
gherdi
scountr
ateforst
art
-upsr
efl
ect
sthev
ari
ousdi
sadv
ant
agest
heyf
ace,
compar
edt
o
est
abl
i
shedcompanies:

Reducedmar
ket
abi
l
ityofowner
shi
psbecausest
ocksar
enott
radedpubl
i
cly

Smal
lnumberofi
nvest
orswi
l
li
ngt
oinv
est

Hi
ghr
isksassoci
atedwi
thst
art
-ups

Ov
erl
yopt
imi
sti
cfor
ecast
sbyent
husi
ast
icf
ounder
s

Onemethodt
hatlooksi
ntoacorr
ectdiscountr
atei
sthecapit
alassetpri
cingmodel
.Thi
s
model
takesi
ntoaccountt
hreev
ariabl
esthatmakeupthediscountrat
e:

1.Riskfr
eerate:Theper
cent
ageofr
etur
ngener
atedbyi
nvest
ingi
nri
skf
reesecur
it
iessuchas
governmentbonds.

2.Bet a:Themeasurementofhowacompany '

sstockpri
cereact
st oachangeinthemar ket.A
bet ahigherthan1meansthatachangei nsharepri
ceisexagger
atedcomparedtot herestof
shar esinthesamemarket.Abetalessthan1meanst hattheshareisst
ableandnotv ery
responsivetochangesint
hemar ket.Lessthan0meanst hatashareismovingintheopposi t
e
directi
onf r
om ther
estoft
hesharesi nthesamemar ket.

3.Equi
tymar
ketr
iskpr
emi
um:
Ther
etur
noni
nvest
mentt
hati
nvest
orsr
equi
reabov
ether
isk
fr
eerat
e.

Di
scountr
ate=(
ri
skf
reer
ate)+bet
a*(
equi
tymar
ketr
iskpr
emi
um)

RESERVEREQUI
REMENTS

Reserver equir
ement s aret hepor ti
onsofdeposi tsthatbanksmusthol dincash, eit
herint hei
r
vaultsorondeposi tataReser v eBank.Adecr easei nreserverequirement sisexpansi onary
becausei tincreasest hef undsav ai
lableinthebanki ngsy st
em tol endtoconsumer sand
businesses.Ani ncreasei nr eser verequirementsiscont r
acti
onar ybecausei treducest hefunds
avail
ableint hebanki ngsy stem t olendt oconsumer sandbusi nesses.TheBoar dofGov ernors
hassol eaut hori
tyov erchangest or eserverequir
ement s.TheFedr ar
elychangesr eser ve
requirement s.Thereser ver equirement( orcashr eserv erat
io)isacent ral bankregulati
ont hat
setsthemi nimum amountofr eser vesthatmustbehel dbyacommer cialbank.Themi nimum
reserveisgener all
ydet erminedbyt hecent ralbankt obenol essthanaspeci fi
edper centageof
theamountofdeposi tliabil
iti
est hecommer ci
albankowest oi t
scust omer s.Thecommer cial
bank'sreser vesnormal lyconsi stofcashownedbyt hebankandst or
edphy si
call
yint hebank
vault(vaultcash),plust heamountoft hecommer ci
al bank'
sbal anceint hatbank'saccountwi t
h
thecent r
al bank.
 Ther equi
redr eserverat
ioissomet i
mesusedasat ooli
nmonet arypoli
cy, influenci
ngthe
count ry'
sborrowingandi nter
estratesbychangi ngtheamountoff undsav ail
abl eforbankst
o
makel oanswi t
h.[1]West er
ncentralbanksr arel
yincr
easethereserverequirement sbecauseit
woul dcausei mmedi ateli
quidi
typroblemsf orbankswi t
hlowexcessr eserves; t
heygeneral
l
y
prefertouseopenmar ketoperati
ons( buyi
ngandsel l
inggover
nment -i
ssuedbonds)t o
i
mpl ementt heirmonet arypoli
cy.ThePeopl e'sBankofChinauseschangesi nr eserve
requirementsasani nfl
ati
on-fi
ghti
ngt ool,
andr ai
sedthereserv
er equi
rementt ent i
mesin2007
andel eventimessi ncethebeginningof2010.

CONCEPTOFFOREI
GNTRADE

Forei
gnt radeisexchangeofcapital
,goods,andser vi
cesacrossinter
nati
onalbor
dersor
ter
rit
ories.Inmostcountri
es,i
trepresentsasi gni
fi
cantshareofgrossdomesticpr
oduct(
GDP).
Whileinternat
ionaltr
adehasbeenpr esentthroughoutmuchofhi stor
y,i
tseconomic,
soci
al,
and
poli
ti
cal i
mpor tancehasbeenont heri
seinr ecentcent
uries.

Al
lcountr
iesneedgoodsandser vicestosati
sfywant softhei
rpeople.Producti
onofgoods
andservi
cesr equi
resresources.Ev erycountr
yhasonl yli
mitedresources.Nocount rycan
produceallt
hegoodsandser vicest hatitr
equir
es.Ithastobuyf r
om othercountrieswhatit
cannotproduceorcanpr oducel esst hanitsr
equir
ement s.Simi
larl
y,i
tsell
st oothercountr
ies
thegoodswhi chithasinsurplusquant i
ti
es.I
ndiatoo,buysfrom andsell
st oothercountr
ies
vari
oustypesofgoodsandser v i
ces.

General
l
ynocountryisself
-suff
ici
ent
.Ithastodependuponothercountri
esforimport
ingthe
goodswhichar
eeit
hernon-av ai
l
ablewit
hitorareavai
labl
eini
nsuffi
cientquant
it
ies.Si
milar
ly,
it
canexpor
tgoods,
whi chareinexcessquanti
tywit
hitandarei
nhighdemandout si
de.

Int
ernati
onaltr
ademeanst radebetweenthetwoormor ecountri
es.I
nter
nati
onaltr
ade
i
nvolvesdi
ffer
entcur
renciesofdif
fer
entcountri
esandisregulat
edbylaws,rul
esand
r
egulati
onsoftheconcernedcountri
es.Thus,I
nter
nat
ionaltr
adeismor ecomplex.

Accor
dingtoWassermanandHal
tman,
 
“Int
ernat
ional
tradeconsi
stsoft
ransact
ionbet
ween
r
esi
dentsofdif
fer
entcount
ri
es”
.

Accor
dingt
oAnat
olMar
ad,
 
“Int
ernat
ional
tradei
sat
radebet
weennat
ions”
.

Accor
dingt
oEugewor
th,
 
“Int
ernat
ional
trademeanst
radebet
weennat
ions”
.

I
ndustri
ali
zat
ion,advancedtr
anspor
tat
ion,global
ization,
mul t
inationalcor
porati
ons,and
outsour
cingareallhavi
ngamajorimpactont heinternat
ionaltradesy st
em.Increasing
i
nternat
ional
tradeiscruci
altot
hecontinuanceofgl obal
izat
ion.Wi thouti
nter
nationalt
rade,
nati
onswouldbel i
mi t
edtothegoodsandser vi
cespr oducedwi thinthei
rownbor ders.
 I
nternational
tradeisinprinci
plenotdi
ff
erentfr
om domestictr
adeasthemot iv
ationandthe
behaviourofparti
esinvolvedinatradedonotchangefundament al
l
yregardl
essofwhet her
tr
adeisacr ossabor derornot.Themaindiff
erencei
sthatinter
nati
onalt
radeistypical
l
ymor e
costl
yt handomest i
ctrade.

Thereasoni sthatabor
dert ypical
lyimposesaddit
ional costssuchast ari
ff
s,t
imecost sduet o
borderdelaysandcostsassoci atedwithcountr
ydif
ferencessuchasl anguage,thelegal
sy st
em
orcult
ure.Inter
nati
onalt
radeconsi stsof‘expor
ttr
ade’ and‘importtrade’
.Exportinv
olvessale
ofgoodsandser vi
cest
oot hercount r
ies.I
mportconsistsofpur chasesfrom ot
hercountries.

Internati
onalorFor
eigntradeisrecognizedasthemostsignifi
cantdet
ermi
nantsofeconomic
developmentofacount ry,
alloverthewor l
d.Thefor
eigntr
adeofacount r
yconsi
stsofinwar
d
(i
mpor t)andoutward(export)mov ementofgoodsandservices,whichr
esul
tsi
nto.out
flowand
i
nflowoff orei
gnexchange.Thusi tisal
socalledEXI
M Trade.

2.
3.1EXCHANGERATE

Foreignexchangerat
eist
hepriceatwhi
chonecur r
encycanbeconv er
tedint
oanother
.It
representst
herateatwhi
chafirm mayexchangeonecurr
encyforanother
.Thus,t
heexchange
rateissimplyt
heamountofanat i
on’
scurrencyt
hatcanbeboughtatagi v
entimefora
specifi
edamountofthecurr
encyofanothercount
ry.

Theactual
amountrecei
vedinconversi
onortheef f
ectiv
eexchangerate,usuallydi
ffer
sfrom
thest
atedrat
ebecausei
ttakesintoaccountal
ltaxes,commi ssi
onsandot hercoststhatthe
publ
icmustpaytocomplet
ethet r
ansacti
onandact uall
yreceiv
etheforei
gnf unds.

Ty
pesofFor
eignExchangeRat
e:

1.Fi
xedandFl
oat
ingRat
es:

WhenGov ernmentofacountr
yfi
xestherat
eofexchangef ori
tsowncurrency
, i
tistermedas
‘
FixedExchangeRate’
.Thi
sisalsoknownasoffi
cialrat
eofexchange.Fi
xedexchanger atesar
e
f
ixedbytherespecti
veGovernment
sfrom t
imetot i
mef ort
hebetter
mentoftheireconomy .

Incontrastexchangerat
esmov e,
asinanyothermar
ketplace,dependi
ngont
hedemand
andsupplypressureandarefurt
heri
nfl
uencedbythemarketfor
cesandeconomiccondit
ions
oftherespecti
vecountri
es.Fl
oati
ngexchanger
atemaybef r
eef l
oati
ngoramanagedfloati
ng.

Acurrencyi
sfreel
yfl
oati
ngiftheredoesnotexi
stasyst
em offi
xedexchanger
atesandift
he
Cent
ralBankofthecount
ryinquestiondoesnotat
temptt
oinfl
uencetheval
ueofthecur
rency.
However,i
nreal
i
tythi
skindofsituat
iondoesnotexi
st.

I
nmostoft hecount
riesGover
nmentsat
tempttoi
nfluencemovement
sofexchangerat
e
ei
thert
hroughdi
recti
nterv
ent
ionint
heexchangemarketorthr
oughamixoff
iscaland
monet
arypol
i
cies.Undersuchci
rcumst
ances,
float
ingi
scal
l
edas‘
managed’
or‘
dir
tyf
loat
’.

Anumberofcount ri
esuseapeggedf loatasasy st
em ofexchanger at
es.Thevalueofone
cur
rencyispeggedtot heval
ueofanothercurrencythatit
sel
ffloat
s.Inaj oi
ntf
loat
, cur
renci
es
i
napar t
icul
argrouphav eafi
xedexchangev al
uei ntermsofeachot her,
butthegroupof
cur
renci
esfloat
sinrelati
ontoothercur
renciesoutsidethegroup.

Thefixedexchanger at
esystem hasinbuil
tad-vant
ageofsimpli
fyi
ngexchanget r
ansacti
ons.
Itimbibesself
-di
scipl
ineforeconomicpoliciesbypart
ici
pat
ingcountr
ies.I
nIndi
at heexchange
rateregimeofrupeehasev olvedoveraper i
odoft i
memov i
nginthedirect
ionoflessexchange
controlsandcurrentaccountaccountabi
li
ty.TheRBImanagestheexchanger at
eoft herupee.

Inrecentfewy ear
stheRBIhasbeenv er
yactiv
elyinterv
eningi nt
hemar kettoholdtherupee-
dol
larrateswit
hinti
ghtboundswhi ler
upeeratesinrelati
ont oothercur
renciesf
luctuat
ein
corr
espondencewi t
ht hefl
uctuati
onofthi
sUSdol laragainstthem.Inadditi
on,t
heRBIt ook
sever
al measurestorelaxexchangecontr
olandliberal
izeforeigntr
ade.

2.SpotandFor
war
dRat
es:

Spotrat
esrefertothoserat
eswhichareappl
i
cableonthedayoft r
ansact
ioninwhichphysi
cal
deliv
eryismadewi thi
ntwowor ki
ngdaysaft
erthedateoft
ransact
ionthespotexchange
betweent wocurrenci
esshouldbethesameacrossthevar
iousbanksengagedinrender
ing
forei
gnexchangeser vi
ces.

I
ncaseofl ar
gediscrepancycustomersorotherbankswoul
dbuylargeamount sofacur
rency
fr
om whateverbanksquotingrelat
ivel
ylowpri
ceandsell
thesameimmedi atel
ytoabank
quot
ingarelati
vel
yhighprice.Thiswil
lcauseadj
ustment
sintheexchangeratequot
ati
onsthat
woul
doffsettheexisti
ngdiscrepancy.

InFor wardrat
es,exchangerat
esar ef
ixedinadvanceforat
ransact
ionwhichmaturesatsome
specifiedfut
uredate.Theexchangeatthedateinfut
urewil
lbeatthepri
ceagreeduponnow.
Foreignexchanger at
esarefuncti
onofforwarddemandandf or
wardsupplyofvar
ious
currencies.

Aforeigncur r
encyissaidt
obeataf or
wardpremium ifi
tsfutureval
ueexceedsi t
spr esent
valueint ermsofdomest i
ccurr
encyanditi
ssaidtobeatdi scountift
hereverseistrue.For
exampl espotr atebet
weenrupeesanddoll
arisS(Rs/$)=Rs.45. 50andthreemont hsf or
ward
i
sF3( Rs./ $)=Rs.46.70/
$;t
heserat
essigni
fythatdol
lari
satapr emi
um andr upeeisat
discounti ntheforwar
d.

Forwar
dex changerat
esar
equotedonmostmaj orcur
renci
esf
ordif
fer
entmaturi
ti
es.Standar
d
maturi
ti
esquotedbybanksar
eof1, 3,6,
9and12mont hs.Mat
uri
ti
esbeyondoney earar
enow
becomingmor ecommon.Matur
ityext
endingt
o5andbey ond5year
sisalsopossi
bleforgood
bankcustomers.