Chapter 9 Flashcards
What is the Foreign Exchange Market?
The market in which the currency of one country is exchanged for the currency of another
What is a foreign exchange rate?
The price at which one currency exchanges for another
What is currency depreciation?
A fall in the value of one currency in terms of another currency
What is currency appreciation?
A rise in value of one currency in terms of another currency
How is the exchange rate determined?
By the foreign exchange market
How does the expected future exchange rate effect the Supply of CAD?
Expected future exchange rate ↑ - Supply of CAD ↓
What is the demand for one currency?
The supply of another currency
What is the Interest Rate Differential?
Interest rate Canada - Interest rate rest of world
What does the demand for Canadian currency depend on?
- The exchange rate
- World demand for Canada’s exports
- Interest rate in Canada compared to rest of the world (interest rate differential)
- The expected future exchange rate
What is the law of demand for foreign exchange?
The higher the exchange rate, the smaller is the quantity of Canadian dollars demanded in the foreign exchange market
How does the exchange rate influence the quantity of Canadian dollars demanded?
Exports effect
Expected profit effect
What is the Exports Effect?
Exchange rate ↓ - Value of Canadian exports ↑ - Qd CAD ↑
What is the Expected Profit Effect?
Exchange rate today ↓ - expected profit from buying Canadian dollars ↑ - Qd CAD ↑
What does the supply of Canadian currency depend on?
- The exchange rate
- Canadian demand for imports
- Interest rates in Canada and other countries (interest rate differential)
- The expected future exchange rate
What is the law of supply
The higher the exchange rate, the greater is the quantity of Canadian dollars supplied in the foreign exchange market
How does the exchange rate influence the quantity supplied of Canadian dollars?
- Imports effect
- Expected profit effect
What is the imports effect?
Exchange rate ↑ - value of Canadian imports ↑ - Canadian dollars supplied ↑
What is the expected profit effect?
If the expected exchange rate ↑ - expected profit ↑ - Qs CAD ↓
What causes a change in Demand for CAD?
- World demand for Canadian Exports
- Interest rate differential
- Expected future exchange rate
How does the world demand for Canadian exports influence the Demand for CAD?
World demand for Canadian exports ↑ - Demand CAD ↑
How does the interest rate differential effect the Demand for CAD?
Canadian Interest Rate Differential ↑ - Demand CAD ↑
How does the expected future exchange rate effect the Demand for CAD?
Expected future exchange rate ↑ - Expected future profit ↑ - Demand CAD ↑
What factors create a change in the Supply of CAD?
- Canadian demand for imports
- Interest rate differential
- Expected future exchange rate
How does Canadian demand for imports effect the supply of CAD?
Demand for Imports ↑ - Supply of CAD ↑
How does the interest rate differential effect the supply of CAD?
Interest rate differential ↑ - Supply of CAD ↓
How does the expected future exchange rate effect the Supply of CAD?
Expected future exchange rate ↑ - Supply of CAD ↓
What is Arbitrage?
The practice of seeking to profit by buying in
one market and selling for a higher price in another related market
What outcomes does Arbitrage achieve in the foreign exchange market?
The law of one price
No round-trip profit
Interest rate parity
Purchasing Power Parity
What is the law of one price?
If an item can be traded in more the one place, the price will be the same in all locations
What is no round-trip profit?
A round trip is using the currency A to buy currency B, and then using B to buy A. Arbitrage removes profit from all transactions of this type
What is the return on a currency?
The interest rate on that currency plus the expected rate of appreciation over a given period
What is interest rate parity?
When the return on two currencies are equal
What is purchasing power parity?
When 2 quantities of money buy the same quantity of goods and services
What is speculation?
The expectation of making a profit
What is the Real Exchange Rate?
The relative price of Canadian-produced goods and services to foreign-produced goods and services
OR
The quantity of real GDP of other countries that a unit of Canadian real GDP buys
What is the equation for Real Exchange Rate?
(E × P)/P*
E = Exchange Rate
P = Canadian price level
P* = Price level of foreign country
Does a change in the quantity of money affect the exchange rate?
Yes
What are the 3 possible exchange rate policies?
- Flexible Exchange Rate
- Fixed Exchange Rate
- Crawling Peg
What is Flexible Exchange Rate policy?
Exchange rate is decided by market
What is Fixed Exchange Rate policy?
It pegs the exchange rate at a value decided by the government or central bank
How do governments pursue Fixed Exchange Rate policy?
If E > Target → Government SUPPLIES (sells) CAD (aka buys a foreign currency with CAD)
If E < Target → Government DEMANDS (buys) CAD (aka buys CAD with foreign currency kept in reserves)
What is a Crawling Peg Exchange Rate policy?
Fixed exchange rate BUT target changes
Helps avoid wild swings
What does a country’s balance of payments account record?
International:
- Trading
- Lending
- Borrowing
What are the 3 balance of payments accounts?
- Current Account
- Capital and Financial Account
- Official Settlements Account
What does the Current Account record?
= NET Exports
+ Net interest paid abroad
+ Net transfers
What does the Capital and Financial Account record?
= Foreign investment in Canada
- Canadian investment abroad
What does the Official Settlements Account record?
The change in Canadian official reserves
What are the Canadian Official Reserves?
Government’s holdings of foreign currency
if COR ↑ - Official Settlements Account is more negative
What does the sum of; Current Accounts + Capital and Financial Account + Official Settlements Account; ALWAYS EQUAL
0
Current Accounts + Capital and Financial Accounts + Official Settlements Account =
0
INGRAIN THIS IN MEMORY, PROF SAYS #1 THING PEOPLE LOSE MARKS IN FINAL
What is a Net Borrower?
A country that borrows more from the rest of the world than it lends
What is a Net Lender?
A country that lends more to the rest of the world than it borrows
What country do funds flow into, and what country do they flow out of?
The country in which the real interest rate is the highest, and out from the country in which the real interest rate is the lowest
Is the loanable funds market GLOBAL or NATIONAL?
Global. Duh
How does a country’s loanable funds market connect to the global market?
Through Net Exports
If a country’s net exports are NEGATIVE which is larger:
World’s supply of funds OR Funds supplied to world?
Quantity of Loanable Funds OR National Savings?
World’s supply of funds to the country is higher
Quantity of loanable funds is higher
If a country’s net exports are POSITIVE which is larger:
World’s supply of funds OR Funds supplied to world?
Quantity of Loanable Funds OR National Savings?
Funds supplied to the rest of the world is higher
National savings is higher
What is a debtor nation?
A country that during its entire history has borrowed more from the rest of the world than it has lent to it
What is a creditor nation?
A country that has invested more in the rest of the world than other countries have invested in it
What is the Current Account Balance?
Net Exports + Net interest income + Net transfers
What is the Government Sector surplus or deficit equal to?
Net Taxes - Gov. Expenditure
T - G
What is the Private Sector surplus or deficit equal to?
Saving - Investment
S - I
What is Net Exports equal to in CAB?
NX = (T - G) + (S - I)
How does the Exchange rate effect the CAB in the Short Run?
Nominal Exchange Rate ↓ - Current Account Deficit ↓
How does the Exchange rate effect the CAB in the Long Run?
Nominal Exchange Rate ↓ - Real Exchange Rate does not change - Current Account Balance does not change
