COMSATS University Islamabad (Lahore Campus)

Department of Management Sciences

12/3/2021
International Finance

Assignment 2

Bachelors of Business Administration

(BBA)
Session 2018-22

Submitted To:

Mr. Usman Bhutta

Submitted By:

Hamad Raza (FA18-BBA-191)

Muhammad Shahzad Hassan (FA18-BBA-163)
Abdullah Shahzaib (FA18-BBA-051)
Umair Farooq (FA18-BBA-179)
Question:
Discuss the government control for a currency, where the government eventually
frees the exchange rate system.
Answer:
Government influences the amount of money in circulation by purchasing or selling government
assets by Central Bank, a process known as open market operations (OMO). A central bank
purchases government securities from commercial banks and institutions to boost the amount of
money in circulation.
The government determines the fixed or pegged rate through its central bank. The exchange rate
is determined against another major world currency (such as the US dollar, euro, or yen). To
keep its exchange rate stable, the government will purchase and sell its own currency against the
currency with which it is pegged.
Government-imposed restrictions on the buying or sale of currencies are known as exchange
controls. These regulations help governments sustain their economies by controlling currency
inflows and outflows, which can cause exchange rate instability. Not every country can use the
measures not legal. To avoid speculation, government with weak or growing economies may
impose limits on where and when local currency can be exchanged or transferred, or simply ban
foreign currencies.
Exchange control can be implemented in various ways. A government may restrict to use foreign
currency and its ownership among people. They can also impose fixed exchange rate system to
prevent speculation, limiting foreign exchange to government approved exchangers, or restrict
the amount of cash that can be sold worldwide from the country.
Examples:
Iceland Exchange Controls
Iceland is a recent example of how currency restrictions were used during a financial crisis.
Iceland, a small country with a population of around 334,000 people, witnessed its economy
crash in 2008. Its fishing-based economy had been transformed into a massive hedge fund by the
country's three major banks (Landsbanki, Kaupthing, and Glitnir), whose assets were 14 times
the country's total economic output.
The country profited, as least in the beginning, from a large infusion of money because of the
banks' high interest. When the financial crisis occurred, unfortunately, investors in need of cash
left Iceland, leading the local currency, the krona to plummet. The banks failed as well, and the
IMF stepped in to save the economy.
Brazil’s Exchange rate:
The time when URV was set at 2,750 cruzeiros reais, the average exchange rate between the US
dollar and the cruzeiro real on that day. As a result, when the real was first created, it was valued
exactly one dollar. This reform rendered the new real equivalent to 2.75 x to (2.75 quintillion) of
Brazil's original reais when combined with all prior currency adjustments in the country's
history.
Due to huge capital inflows in late 1994 and 1995, the real unexpectedly gained value versus the
US dollar shortly after its debut. During that time, it had its highest dollar value, about US$ 1.20.
The Central Bank of Brazil firmly managed the currency rate between 1996 and 1998, allowing
the real to fall steadily and gradually against the dollar, sliding from near 1:1 to roughly 1.2:1 by
the end of 1998.In January 1999 the deterioration of the international markets disrupted by the
Russian default, forced the Central Bank, under its new president Arminio Fraga, to float the
exchange rate. This decision produced a major devaluation, to a rate of almost R$2:US$1.