Try it now!

USD
10

Calculate your price

Number of pages:

Order Now
Table of Contents

The Influence of the Exchange Rate of US Dollars on the Efficiency of Mutual Funds in China - Part 2

717

CHAPTER 2 – LITERATURE REVIEW

2.1 Introduction

The evolution of the yuan – dollar exchange rate along time, the multiple stages that it acknowledged because of different policies that China applied for protecting its currency rate will be explored in this chapter. In relation to this exchange rate, the mutual funds developed in China from 1997 will be also explored. Besides the theoretical background that will be explored within this chapter, there will be also created specific connections with the current research. From this chapter, with the help of the existent literature review, the researcher of this dissertation will try to answer the research question and to reach the objectives of the paper that will be developed in the following chapters.

Dreaming about the scholarship in the one of the most prestigious universities? Then, you have to know how to write college scholarship essays, otherwise you will not be accepted. Visit Pro-Papers and find a lot of useful things about scholarship essays.

2.2 Theoretical Background on Exchange Rate

The exchange rate defines the conversion rate of one currency into another. When real changes occur in the exchange rates, it also produces a difference between the rates of return on the domestic assets versus the foreign ones. Likewise, a difference in the operating profitability of the firms also occurs (Levi, 2005, p. 220).

The fixed exchange rate implies that countries’ governments operate under certain exchange rates (buying and selling its currency), against all other currencies. For the governments to be able to do this, they must accumulate large amounts of other currencies in order to sell them for maintaining the value of its currency (2006, Wessels, p. 295).

The real exchange rate defines the nominal exchange rate (the official exchange rate between two currencies) adapted to inflation differential between the two countries. In other words, the real exchange rate measures the real change that occurred in the relative purchasing power of the two countries, in their national currencies (Siddaiah, 2010, p. 97)

Barth, Tatom and Yago observe that China developed this exchange rate policy, based on the People’s Bank of China’s (PBC) contribution the foreign exchange market that intervened into buying and selling forex for maintaining the renminbi’s (RMB) value stable (Anderson in Barth, Tatom and Yago, 2009, p. 208).

Discussing about the real changes in the exchange rate, Levi also observes that this is a measure that identifies how much a specific real change has impacted the domestic versus the foreign returns or profitability (2005, p. 220).

Levi notes that while it is not possible to speculate if an exchange rate will increase or decrease unexpectedly, it is possible to determine whether an exchange rate will suddenly change in a specific direction, meaning that one can speculate about an exchange rate being volatile (2005, p. 283).

China’s currency exchange rate has known three stages before entering the World Trade Organization:

(1) The currency basket, between 1979 and 1985, when 1 U.S. dollar was exchanged for 1,45 RMB. Because the RMB was over valuated, the Chinese export was damaged there was established the “trade international settlement price” that lead to lowering the official rate, reaching to 2.80 RMB/US dollar, which announced a devaluation period for RMB;

(2) The second phase currency trade transformation, or the “Dual Exchange Rate Regime” that occurred between 1986 and 1993 was characterized by the existence of two effective rates: the official nominal rate (that implied an adjustable peg system) and the market rate (the unofficial managed floating rate). The specific tendencies that came with this dual system lead to a deeper devolution of the RMB, reaching 5.7 in 1993;

(3) The managed floating exchange rate regime was the third stage, between 1994 and 2001, when the two systems (the official and the market one) were combined to establish the exchange surrender system. This contributed to a stabilization of RMB, from 8.7 (in 1994) to 8.3 (in 1997), appreciating to 4.6 in about four years (Yuan, 2010, p. 9).

It is also important to note the strategic change that occur in China’s international exchange policy in 1997, when the mutual funds were also initiated. Before 1997, China encouraged the Real Target Approach, sustaining the exports for gaining foreign currency. After the Asia Financial Crisis, there was a shift from this policy into another one, the Nominal Anchor Approach. This implied that the RMB maintained a fixed rate to US dollar (Yuan, 2010, p. 9).

Starting with 2005 until 2008, the RMB appreciated against the dollar with 21%. Its appreciative rhythm halted suddenly, as soon as the effects of the global recession was felt and China needed to protect its industries that where dependent on the trade, implicitly the workers involved in those industries. Therefore, starting with July 2008 until June 2010, China kept a stable rate of 6.83 yuan to 1 dollar (Morrison and Labonte, 2011, p. i).

Practically, the exchange rate of yuan – dollar implies that the yuan price increases in value, gaining more dollars for its worth (being converted for an increased value yuan per dollar) if the dollar decreases in value. Similarly, the increases in the exchange rate are reflected in the valuation of the yuan’s (Barth, Tatom and Yago, 2009, p. 305).

The critics sustain that yuan is undervalued and fix, but actually this would give the opportunity to be appreciated through a faster inflation in China, which would accelerate its export and restrict the import, or would put pressure on the import prices. Like this, as the international economic exchanges are made in US dollars, China could easily accumulate large amounts of US dollars and this would support more inflationary growth for China in terms of money supply (Barth, Tatom and Yago, 2009, p. 305).

Even the United States President, Barak Obama considers China’s stable RMB to be a “currency manipulator”, sustaining that the RMB is intentionally under valuated, aiming to maintaining its exports in significant low prices, while increasing the prices in exports. The general opinion is that this under valuation of the RMB has a major impact upon the United States trade deficits and upon the recent job losses from U.S. (Morrison and Labonte, 2011, p. i).

In fact, the nominal, official exchange rate of China has strengthened with 2% since September this year and with 25% since 2005 (Yuan, 2002, p. 2). The real problem that affects the U.S. job market and in general, the value of the imports in China, is given by the real exchange rate. According to the definition of the real market exchange provided above, this translates into the purchasing power of the two currencies, the yuan and the dollar.

Looking for someone to help you apply for a position properly by writing an excellent referral paper? In such case, we’d like to present you the Pro-Papers - professional writing service that is ready to assist you anytime!

“The Economist” informs that China’s real exchange rate has strengthened with almost 50% in relation to U.S. since 2005. The publication also explains the relation of causality that lead to this high valuation of the yuan versus the dollar. While the prices have continued to rise faster in China than in America, China’s real exchange rate went up, while the nominal one remained stable. Rising the prices of the home products in China, makes them less competitive abroad, however, the rising of the prices in China implies an increased occupational rate of the population, which naturally leads to an increased purchasing power. “The Economist” also notes that in America the unit labor costs have risen with less than 4% since 2005 (Bureau of Labour Statistics), in the same period they have increased by 25% in China (“Nominally Cheap or Really Dear”, 2010).

Sutter underpinned an intriguing analysis of the purchasing power parity (PPP) of the Chinese population. Observing that the Chinese living standards were significantly below the U.S. and Japan’s (according to the nominal exchange rate), the World Bank understood that China’s economy was underestimated, because its prices for the common goods and services were also significantly lower than the other two markets. The PPP exchange rate was utilized for converting the national currency into U.S. dollars and because prices were lower than in U.S., Japan, and other developed countries, in 2007, China’s economy raised from $3.2 trillion in nominal dollars to $ 7.3 trillion in PPP dollars (Sutter, 2010, p. 74)


However, at the basis of the increased valuation of the yuan stays not only its exchange rate with the United States’ dollar, but overall, its policies and strategies targeted to promote China as a reliable economic partner.

The People Republic Party initiated its “open door” policy to Foreign Direct Investments in 1979. Since then, the FDI program experienced several transition phases (experimental periods: 1979 - 1983), which gradually conducted China from a poor FDI country into the top spot among the developing countries in attracting foreign investments (China Daily, 2008, web). The middle of the 80’s represented a considerable development period for the FDI in China (the gradual development period: 1984 - 1991), and it culminated at the beginning of the 90’s, also known as the peak period (1992 - 1993). Since 1994 until present, the country is in the adjustment phase. (Wei and Liu, 2001; Ali and Guo, 2005). In terms of FDI’s influence on China’s economic and social status, researchers identify major benefits coming from the foreign companies: higher employment, transfer of technology and improved management practices. (Huang, 2004, p. 15).

China is a giant international economic power. Because of its political stability, its industrial growth, its market size, its labor costs, its incentive policies, and most of all, its adaptability, it continues to attract FDI. The technological boom or the economic downturn periods were efficiently managed and China continues to re-invent itself and to propose new investments opportunities to adjust to the economic globalization standards.

The Chinese workforce market offers major possibilities in terms of qualifications. Relevant studies have identified that within the enormous Chinese population, there are skilled, qualified professionals, as much as there are unskilled, unqualified workers. (Ali and Guo, 2005; Wei and Balasubramanyam, 2005; Wei and Liu, 2001, Huang, 2003). In this context, the foreign clients are happy to discover the suited workforce for any type of economic sector, while spending smaller budgets on the workers’ remuneration.

2.2.1 Theoretical background on mutual funds

While some scholars study if the mutual funds are better perceived if their management invest in social responsibility causes – such as protecting the environment, or sustaining green technologies (Hamilton, Jo and Statman, 1993, p. 62) – others state that the responsibility of taking decisions of investing the mutual funds and executing them falls more often in the hands of the “relative unsophisticated individual investors” (Fisher and Statman, 1997, p. 9)

Mutual funds are institutions of financial intermediation, established by civil contract, without legal personality. The mutual funds are prohibited to realize investments with high risk in order to eliminate the possibility of losing money in risky transactions with financial titles. The mutual fund is usually managed by an investment company, which mobilizes resources and money from the members in order to realize investments especially in securities.

A mutual fund is a collective investment of a large number of individual investors that own a relatively small and limited by law part from the total capital, and that is realizing investments in various instruments from the financial markets, banking and capital, following the realization of the financial objective of the fund. In other words, the mutual fund gathers money from as many people as possible and invests them in stocks, bank deposits etc. in order to achieve its stated objective that can be an aggressive growth of the value of the fund unit or the ensuring of a regular and low risk income for investors, etc.

Mutual funds are managed according to specific regulations by a management company with has a single object of activity. By this collection of funds under a single administration, individual investors enjoy the following benefits:

  • Wide diversification of investment portfolio – the important funds available allow a wide diversification of the investment instruments reducing (but not eliminating) risks related to certain categories of investments (stocks, bank deposits, etc.).
  • Maximum individual investment liquidity – individual investors can liquidate their investment anytime, partially or completely, transforming it into cash at the current value of the securities, unlike other tools that can be sold more difficult or a higher cost.
  • Professional portfolio management – a fund management company backed by professional investors include financial analysts who study and monitor financial markets and companies individually and on branches. Professional management of investments is generally accessible to people who have significant funds, but mutual fund investors make these services available at a reasonable cost to any investor.

Having these features, mutual funds are appropriate investment instruments for both an investment strategy on a medium and long term (especially funds that invest in stocks) and also for short-term investors (funds that invest in bank instruments, bonds and commercial effects).

There are several types of mutual funds:

  • The Balanced Mutual Fund – the capital is invested only in those areas of activity, which offer primarily the security of the client’s deposits, even if the investor’s profits is lower than in other types of mutual fund
  • The Open-End Mutual Fund - investment Company that can issue an unlimited number of shares. In most cases, the shares have a recorded or accountable form, and have aclosed and continuous sale / redemption circuit between the investor and the fund, not being traded on the stock exchange or financial securities
  • The Closed-End Mutual Fund - investment companies to which the state has approved the issuing of a fixed number of financial titles that are traded whiting the national network.
  • The Growth Funds- which invests in companies that are in the development phase and which usually do not pay dividends, but whose shares register a significant growth in capital
  • The Income Fund -which invests in mature areas and companies that provide interest and dividends to the shareholders as the main source of income; usually the price of these shares is particularly stable
  • The Specialized Funds -that invest capital in specialized fields or in narrow or specific geographic areas that have a great potential for development and profit (Ferris and Chance, 1987, pp. 1077-82)

The Sovereign Wealth Fund - SWF is a state owned fund composed of financial assets that can be stocks, bonds, property or other financial instruments. SWFs are usually used in the benefit of the overall economy and to the use of the population that it owns them. SWFs come usually from amounts that are accumulated due to budget and trade surpluses or revenue generate from selling natural resources. These funds are financed, in general, either by profits from the sale of raw materials such as oil and gas in the Middle East, or from the current account surpluses, as is the case of China.

The Chinese mutual funds are regulated under the 2004 Law of the People’s Republic of China on Securities Investment Fund, and governed by the China Securities Regulatory Commission. Currently all of China’s 61 fund management companies, which have under their supervision the management of 763 mutual funds, reported losses in the first semester of this year, as stated by Reuters. China's mutual funds recorded a total loss of 125.4 billion yuan (18 billion dollars) in the first six month of 2011, caused mainly by weakness in the country's stock market (China Daily, “China to Relax Laws”, 2008).

Mutual funds in China first appeared as closed-ended funds but nowadays open-ended funds (which is the most common form of mutual funds in the global market) are gaining even more coverage. The Chinese mutual fund industry is even now seen as having the most important role in the Chinese economy as the largest institutional investor in the capital market (Bhattasali, Li, Martin, 2004, n.p.). Currently the entire mutual funds industry is responsible for the safe manage of assets in value of almost 250 billion Yuan (US$30.2 billion) (Wang, 2000). The Chinese mutual funds industry emerged in 1991 with the establishment of the first close-end mutual funds. The development over time was spectacular, and in 1997 there 72 funds with an asset value of 6.6 billion yuan. After 1997, the industry registered a stagnation that many specialists regard as generated from homogeneity and illiquidity of the funds (Xu & Yang, 2004).

It is interesting to note that the launch of the HuaAn Innovations fund – the first open-end Chinese fund, in 2001, generated a milestone in the Chinese mutual fund history. Since then the Chinese mutual funds registered an overwhelming boom both in numbers and in value.

With this booming development, the Chinese government realized the need for regulation within this industry and on October 28, 2003, was issued the Law of the People’s Republic of China’s Securities Investment Funds. The law was implemented as June 1, 2004, and established the legal background for the investment fund industry in China. As a result, in October 2004 NanFang Progressive Allocation Fund, the first mutual fund was listed (LOF) and China’s first ETF, SSE 50 ETF was created at the end of 2004 (Xu & Yang, 2004).

Another step towards the development of China’s mutual Funds Industry took place in 2006, when China Securities Regulatory Commission, People’s Bank of China, and the State Administration of Foreign Exchange issued a joint set of measures on admission of domestic securities investments of Qualified Domestic Institutional Investor (QDII). As a result, the value in assets of the Chinese Mutual Funds industry reached 3.28 trillion Yuan (Rodier, 2009).

Starting with 2008, the industry went through some drastic structural changes. Fund managers are seeking for both returns and fund flows. The fund managers shift to incorporate international bonds and equity into their portfolio and start to attract more institutional investors. Also in 2008, China established a partnership with the US, so that Chinese citizens to able to invest in the U.S. stock market using the mutual fund organizations or other asset fund companies in China as intermediaries. For the first time, Chinese were allowed to invest in the U.S. stock market, (Rodier, 2009).

In the years of economic crisis, the Chinese mutual funds also registered major decreases. In 2008, the asset value dropped to 1.94 trillion yuan – the same year, that the global mutual industry had a value of 18,970 billion dollars. However, by the end of 2009, the Chinese mutual funds industry recovered a part of the loss and closed the year with a value of 2.68 trillion yuan. In addition, considering the recent introduction of more permissive and elaborated tools of investment, it is expected that the industry to reach 9.6 trillion yuan by 2012. This statement is supported also by the fact that China promised to open its markets to U.S. companies, following a visit to Washington by officials in Beijing. According to the U.S. Treasury Department, China will allow foreign banks - including the U.S. ones, to sell mutual funds and act as custodian for these funds. The U.S. asset managers, including "Fidelity Investments" Boston "T Rowe Price Group" Inc. Baltimore and "Franklin Resources' Inc. San Mateo, California, have as priority the expansion abroad, most often being interested in creating joint ventures with local partners. Until now, China has limited the involvement of US investment funds, in joint ventures with local partners, aiming to build their own asset management industry. Following the visit mentioned above, the U.S. Treasury said that the Chinese authorities have promised to gradually increase the amounts that foreign banks can invest in local shares and bonds, in accordance to the Qualified Foreign Institutional Investors program.

High school capstone project is challenging, so if you are stuck and do not know what to do, you are welcome to order it with Pro-Papers, the best capstone project writing service that will always cover your back.

Engage China, a group of financial institutions including "Citigroup" Inc. "JPMorgan Chase & Co." and "Bank of America" co., says that the steps taken by China these days need to be followed also by other measures. According to the group, "the reform and the modernize of the financial system in China - including a greater involvement of foreign companies in the field, must remain the focal point of attention, if you want real progress in reducing trade imbalances". (Bawa, 1975, p.41)

Leave a Reply

Your email address will not be published / Required fields are marked *

USD
10

Calculate your price

Number of pages: