03. Economics for Valuation

Question 1

Up-the-___, ___?

Answer 1

Up-the-Bid, Multiply

Question 2

Down-the-___, ____?

Answer 2

Down-the-Ask, Divide

Question 3

Premium(discount) for base currency = ?

Answer 3

= forward price - spot price

Question 4

What does mark-to-market measure?

Answer 4

The profit that would be realized by closing out the position at current market prices.

Question 5

Mark-to-Market(forward contract) equation:

Answer 5

Question 6

Uncovered Interest Rate Parity Equation:

Answer 6

Question 7

International Fisher Relationship Equation:

Answer 7

Question 8

Relative PPP Equation:

Answer 8

Question 9

What is carry trade?

Answer 9

profit on carry trade = interest differential − change in the spot rate of investment currency

• In an FX carry trade, the investor invests in a high-yield currency while borrowing in a low-yield currency.
• If the higher yield currency does not depreciate by the interest rate differential, the investor makes a profit.
• Carry trade has exposure to crash risk.

Question 10

Which factors are positively related to economic growth rate:

Answer 10

1. Sufficient level of savings and investment.
2. Development of financial markets and financial intermediaries.
3. Political stability, sound laws, and property rights.
4. Investment in education and health care systems.
5. Lower taxes and regulatory burdens.
6. Free trade and unrestricted capital flows.

Question 11

What is capital deepening?

Answer 11

• An increase in the capital stock and the capital to labor ratio.
• Due to diminishing marginal productivity of capital, it will lead to only limited increases in output and labor productivity if the capital to labor ratio is already high.

Question 12

What are the two equations for long term growth rate of potential GDP?

Answer 12

=long-term growth rate of technology
+ α (long-term growth rate in capital)
+ (1 – α) (long-term growth rate in labor)

or

long-term growth rate of labor force
+ long-term growth rate in labor productivity

Question 13

Classical growth theory:

Answer 13

States that growth in real GDP per capita is temporary—when the GDP per capita rises above the subsistence level, a population explosion occurs, and GDP per capita is driven back to the subsistence level.

Question 14

Neoclassical Growth Theory:

Answer 14

States that the sustainable growth rate of an economy is a function of population growth, labor’s share of income, and the rate of technological advancement. Growth gains from other means such as increased savings are only temporary.

Question 15

Endogenous Growth Theory:

Answer 15

Includes the impact of technological progress within the model.

States that investment in capital can have constant returns, unlike neoclassical theory that assumes diminishing returns to capital. This assumption allows for a permanent increase in growth rate attributable to an increase in savings rate. Research and development expenditures are often cited as examples of capital investment that increase technological progress.

Question 16

Absolute Convergence Theory:

Answer 16

States that the standard of living of less developed countries will converge to the standard of living of developed countries.

Question 17

Conditional convergence hypothysis:

Answer 17

Assumes that convergence in living standards will only occur for countries with the same savings rate, population growth, and production functions.

Question 18

Club convergence hypothesis:

Answer 18

Contends that living standards in some less developed countries may converge to living standards of developed standards if they are in the same “club”.

A club comprises countries with similar institutional structures (such as property rights and political stability). Countries outside of the club (without the appropriate institutional structures) will not see their living standards converge.