Dollar Versus Euro

INDEX

1. INTRODUCTION...................................................................................................................

2. DOLLAR ANALYSIS.................................................................................

3. EURO EVOLUTION..................................................................................

3.1 Euro Depreciation 1999 - 2002...................................................................

3.2 Euro Appreciation 2002 - 2004..................................................................

4. SHORT TERM FORECASTING...................................................................

5. LONG TERM.............................................................................................. FORECASTING...........................................................................................

5.1

5.2

6. HEDGING EXERCISE................................................................................

7. CONCLUSION.........................................................................................

8. REFERENCES............................................................................................

1. INTRODUCTION

On January 1, 1999 Euro became the currency for 11 member states of the European Union. Since then the Dollar-Euro exchange rate has completed a full turning. Euro depreciated since its introduction steadily and without any major interruption until February 2002. Then it began to rise against Dollar smoothly and reached a height of 0.74 Euros to 1 US$ in December 2004.

Three years of depreciation of the Euro followed by three years of appreciation without wild fluctuations asks for an explanation which would adequately account for the position of the Euro as an emerging international currency.

Dollar replaced its predecessor sterling already in the immediate post-war years as the dominant world money and is today the leading international currency with vast scale economies and externalities due to its long standing international monetary functions. The common European currency Euro is in the process of assuming an important role as an international currency.

This paperwork will explain you the evolution of the Euro, the impact on the exchange rate versus the US Dollar, the interest of keeping a low exchange rate in the US today, and also the short term and long term of the exchange rate forecasting.

2. US DOLLAR ANALYSIS

The dollar has shown weakness against other currencies as well, including the British pound, Australian pound and Japanese yen. However, the most dramatic losses have occurred against the Euro. From its low of 84 cents in July 2001, the Euro has risen steadily in value, stopping just short of $1.29 on January 13, 2004.

When currency exchange rates change, businesses must adapt quickly. Knowing how a weaker American dollar is likely to affect businesses may save some critical mistakes.

What does the decline in the value of the dollar against the Euro mean to U.S. firms? Is the decline a sign of looming economic problems, or will it increase the competitiveness of U.S. products in Europe and lead to increased corporate profits, new jobs, GDP growth, and decreased government deficits?

A weaker dollar would be good for American exports. But how low will it go?

The exchange rate between the dollar and the Euro is set by supply and demand. That is, the exchange rate "floats" or adjusts to the demand for (and supply of) Dollars versus Euros. Why has the value of the dollar declined so much, so quickly against the euro? Economic theory states that there are four major factors that determine the exchange rate between two currencies: the comparable interest rates, the relative inflation rates, the comparative level of income, and the macro policies of the respective governments. Two of these factors are most commonly cited as the causes of the loss in value of the dollar against the euro: interest rates and macro policies (both the trade and budget deficits).

A trade deficit is created when the aggregate imports of a country exceed its aggregate exports. A trade deficit must be financed with government issued securities. To finance the deficit, the government must attract funds domestically and/or globally. Some market participants fear the size of the deficit coupled with the low interest rates discussed above could cause financing problems.

Who benefits from the weaker dollar? European tourists are flocking to U.S. destinations such as New York City. New York stores report a surge in sales, particularly in high-end items. New York hotels report high occupancy rates and restaurants report increased reservations.

However, the major impact is to U.S. firms, who benefited from a weaker dollar that made their products less expensive in overseas markets. Less expensive products translate into increased sales and higher earnings. Large companies are not the only ones to benefit from the weaker dollar, but also small businesses.

The weaker dollar has had a positive impact on GDP. International trade represents a portion of GDP, so one may infer a positive effect of the weakened dollar on GDP growth.

Who is hurt by the weaker dollar? Domestic consumers are paying substantially more for imported goods and U.S. tourists in Europe are finding their dollars buy much less. Some U.S. businesses are also hurt by the decrease in the value of the dollar.

A more subtle and difficult-to-measure problem develops for industries that ship raw materials to Europe for manufacture into finished products, which are then shipped back to the U.S.

An additional problem may be developing with the price of oil. Oil producing countries have traditionally denominated transactions in dollars because of the dollar's strength and relative stability. Use of dollars has thus allowed such countries to set their dollar target price per barrel and regulate supply