Capital Flows and FX Market Flashcards
What is the Foreign Exchange Market?
The market in which currencies are traded against each other. By far the largest market in the world, international trade wouldn’t be possible without the trade in currencies that facilitates it.
Give the currencies that belong to the following three letter codes:
AUD
BRL
CAD
CHF
CNY
EUR
GBP
HKD
INR
JPY
KRW
MXN
NOK
NZD
RUB
SEK
SGD
USD
ZAR
Australian Dollar
Brazilian Real
Canadian Dollar
Swiss Franc
Chinese Yuan
Euro
British Pound Sterling
Hong Kong Dollar
Indian Rupee
Japanese Yen
South Korean Won
Mexican Peso
Norwegian Krone
New Zealand Dollar
Russian Ruble
Swedish Krona
Singapore Dollar
US Dollar
South African Rand
What is an exchange rate?
The price of a currency in terms of another one.
What does an exchange rate of USD/EUR of 1.1700 mean?
1.17 dollars are equal to 1 euro
With an exchange rate of 1.1700 USD/EUR, if this rate drops, the USD appreciates/depreciates?
USD appreciates and EUR depreciates
What are real exchange rates versus nominal exchange rates?
Real exchange rates incorporate relative purchasing power of one currency compared with the other
What is the purchasing power parity (PPP)?
PPP asserts that nominal exchange rates adjust so that identical goods (or baskets of goods) will have the same price in different markets. Or, put differently, the purchasing power of different currencies is equalized for a standardized basket of goods.
How to calculate the real exchange rate?
Exchange Rate (domestic/foreign) * (Price foreign / Price domestic)
Who are 7 FX market participants on the buy side?
Corporate accounts (corporations)
Real money accounts (investment funds who cannot use leverage)
Leveraged accounts
Retail accounts
Governments
Central banks (to intervene)
Sovereign wealth funds (SWFs)(Government entities)
Who are the FX market participants on the sell side?
FX dealing banks that sell FX products to the buy side. Largest proportion are large money center dealing banks, such as Deutsche Bank, Citigroup, UBS, HSBC etc. Other participants are Tier 2 & 3 banks.
What is the BIS?
Bank for International Settlements. An umbrella organization for the world’s central banks.
What is the top three trading places in the FX market?
- London
- New York
- Tokyo
What type of FX transactions have the most volume?
FX swaps
What is the difference between direct and indirect exchange rates?
Direct exchange rate: Domestic currency per unit of foreign currency → (e.g., USD/JPY = 150, where JPY is the domestic currency and USD is the foreign currency in Japan).
Indirect exchange rate: Foreign currency per unit of domestic currency → (e.g., JPY/USD = 0.0067, where JPY is the domestic currency and USD is the foreign currency in Japan).
What is an exchange rate regime?
A policy framework that each central bank adopts to manage FX rate volatility.
What is an Ideal Currency Regime?
The ideal currency regime has three properties:
- The FX rate would be credibly fixed.
- All currencies would be fully convertible = unrestricted flow of capital.
- Each country would be able to undertake fully independent monetary policy in pursuit of domestic objectives.
Why is an Ideal Currency Regime not feasible?
If the first two conditions were satisfied, there would really be only one currency in the world. Also, independent monetary policy is not possible if exchange rates are credibly fixed and currencies are fully convertible.
In an Ideal Currency Regime, with credibly fixed FX rates and unrestricted outflow of capital, why can’t a country undertake independent monetary policy?
If a country is lowering its interest rates, there will be an unlimited outflow of capital to countries where the rates are higher. The central bank would then be forced to buy the domestic currency to maintain the fixed rate. This leads to a loss of reserves and reduction in money supply, which causes upward pressure on domestic interest rates until they are forced back to equality.
What is dollarization?
The country uses the currency of another nation as its medium of exchange and unit of account.
What are two arrangements for countries that do not have their own legal tender?
Dollarization or the country participates in a monetary union whose members share the same legal tender. In each case, the country gives up the ability to conduct its own monetary policy.
What is a currency board system (CBS)?
A monetary regime based on an explicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate, combined with restrictions on the issuing authority to ensure fulfillment of its legal obligation. This implies that domestic currency will be issued only against foreign exchange and it remains fully backed by foreign assets.
What are capital restrictions and why should governments use them?
Governments restrict inward and outward flow of capital for many reasons. For example, the government may want to meet some objective regarding employment or regional development, or it may have a strategic or defense-related objective.
In times of macroeconomic crisis, capital mobility can result in capital flight out of the country, especially if most of the inflow reflects short-term portfolio flows into liquid assets rather than foreign direct investment in productive assets. In such circumstances, capital restrictions are often used.
In forward exchange rates, what are pips or points?
The points on a forward rate quote are simply the difference between the forward exchange rate quote and the spot exchange rate quote, with the points scaled so that they can be related to the last decimal in the spot quote.
