Book 1_Econ_CAPITAL FLOWS AND THE FX MARKET Flashcards
sell side
large multinational banks
buy side
Corporations
Investment accounts
Governments and government entities,
Retail FX market
nominal exchange rate
The exchange rate at a point in time
real exchange rate
the purchasing power of one currency in terms of the amount of goods priced in another currency, relative to an earlier (base) period.
real exchange rate formula
real P/B ex rate = nominal P/B ex rate x (CPI base/CPI price)
USD/EUR decrease 1.44 to 1.42
EUR decrease by 0.02/1.44
USD increase by (1/1.42)/(1/1.44)
A nominal exchange rate of 1.44 USD/EUR
$1.44 per euro.
An increase (decrease) in an exchange rate
an appreciation (depreciation) of the base currency relative to the price currency
hedgers
they enter into transactions that decrease an existing foreign exchange risk
speculators
they enter into transactions that increase their foreign exchange risk
formal dollarization
a country uses the currency of another country.
monetary union
several countries use a common currency
currency board arrangement
an explicit commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate
conventional fixed peg arrangement
a country pegs its currency within margins of ±1% versus another currency
pegged exchange rates within horizontal bands or a target zone
the permitted fluctuations in currency value relative to another currency or basket of currencies are wider (e.g., ±2%)
crawling peg
The exchange rate is adjusted periodically, typically to adjust for higher inflation versus the currency used in the peg.
management of exchange rates within crawling bands
the width of the bands that identify permissible exchange rates is increased over time.
managed floating exchange rates
the monetary authority attempts to influence the exchange rate in response to specific indicators, such as the balance of payments, inflation rates, or employment, without any specific target exchange rate.
independently floating
the exchange rate is market determined
objectives of capital flow restrictions
- Reducing the volatility of domestic asset prices
- Maintaining fixed exchange rates
- Keeping domestic interest rates low and enabling greater independence regarding monetary policy
- Protecting strategic industries from foreign ownership
