Chapter 4 Flashcards

1
Q

Percentage change in currency value

A

(S - St-1 )/ St-1

Positive = appreciate
Negative = depreciate

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2
Q

Demand for Currency

A

increases when the value of the currency decreases, leading to a downward sloping demand schedule.

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3
Q

Supply of Currency

A

increases when the value of the currency increases, leading to an upward sloping supply schedule.

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4
Q

Factors that Influence Exchange Rates ***

A

Inflation
Interest rate
Income
Government Controls
Expectations of future rates

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5
Q

Impact of higher US Inflation on Equilibrium for foreign value

A

US Increase foreign currency demand (demand out)

Lower foreign demand for US currency (supply in)

Increase in exchange rate

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6
Q

Impact of Higher US Interest Rates on Equilibrium for foreign value

A

Foreign want US = More supply sale of foreign = supply shift outward

Less demand for foreign = inward shift demand

Decrease exchange rate

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7
Q

Real interest rate **

A

nominal rate - inflation rate

aka fisher effect

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8
Q

Impact of Higher US Income Levels on Equilibrium for foreign value

A

Spend more = more foreign demand = shift outward

Higher exchange rate USD/Foreign

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9
Q

Methods of Government Controls

A

imposing foreign exchange barriers;

imposing foreign trade barriers;

intervening (buying and selling currencies) in the foreign exchange markets; and

affecting macro variables such as inflation, interest rates, and income levels.

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10
Q

Impact of Expectation on Rates

A

Favorable: invest in the country = more demand for currency = increase rate

Unfavorable: downward pressure

Signals: may overreact -> temp overvalued or undervalued

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11
Q

Impact of a Currency Crisis

A
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12
Q

How does liquidity impact rate changes

A

Liquid market = not sensitive = change small

Illiquid market = highly sensitive = change more volatile

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13
Q

Movements in Cross Exchange Rates

a. move same
b. A appreciate more than B
c. A appreciate, B remain same

A

A and B move in same direction = no change in cross rate

Currency A appreciates vs dollar
more > than Currency B appreciates = A appreciates vs B
OR
A appreciate less than B appreciate = A depreciates vs B

Currency A appreciates vs dollar, Currency B remains same = Currency A appreciates vs Currency B (same amount as appreciate vs dollar)
OR
Currency A depreciates vs dollar, Currency B remained same = Currency A depreciates vs Currency B (same amount as depreciate vs dollar)

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14
Q

Speculate based on expected appreciation (undervalue) **

A

Invest now before appreciate, liquidate after appreciate (sell higher than buy)

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15
Q

Speculate based on expected depreciation (overvalue) **

A

Borrow funds of foreign (overvalued) currency and convert to local currency now, invest local now

Wait till deppreciet, Convert (foreign) later at lower (rcvd more than start) to repay loan (profit)

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16
Q

What is a carry trade? (practice) Risks?

A

Where investors attempt to capitalize on the differential
in interest rates between two countries

Borrow at lower rate, and invest in currency w higher rates

Can move at opposite way than expected

17
Q

Impact of appreciation on carry trade

A

if British pound (invest in) appreciated against euro (borrow) & USD (borrow) = profits higher

Pound (invest) appreciate vs euro (borrow) -> Each pound = more euros (Step 6)

Need less pounds to repay euro loan

Pound appreciate vs dollar -> remaining pounds after loan repaid = more dollar (step 8)

Downward pressure on currency being converted (sold) and upward on currency purchased

18
Q

Carry Trade Profit:
Earn 1% of funds invested in pounds
Pay 0.5% on euros borrowed
$1.8 (per) pound spot rate
1 pound = 1.5 euros

invest 100,000 USD , 600,000 euros borrowed, invest in pounds

A

Profit 4598

19
Q

Carry Trade Profit:
Earn 1% of funds invested in pounds
Pay 0.5% on euros borrowed
1.8 pound spot rate
1 pound = 1.456 euros

invest 100,000 USD , 600,000 euros borrowed, invest in pounds

A

Loss: -17268