class 11 Flashcards
what are the 4 reasons why we study international finance?
globalization and integration of financial markets has accelerated at a rapid pace in recent years
borrowing and lending often crosses boarders
many financial institutions operate internationally
people buy and sell goods from people in different countries
what is change rate?
the price of one countries price in terms of another country’s currency (USD/CAD)
what is foreign exchange?
all currencies other than the domestic currency of a given country
what is foreign exchange markets?
the financial market where exchange rates are determines
how are foreign exchange markets organized?
in to an over the counter market where several hundred dealers (mostly banks) stand ready to buy and sell assets denominated in foreign currencies
are foreign exchange markets very competitive?
yes
what is appreciation?
a currency rises In value relative to another currency
what is an example of appreciation?
when 0.7 USD/CAD increases to 0.8 USD/CAD
what is depreciation?
when a currency falls in value relative to another currency
what is an example of depreciation?
when 0.8 USD/CAD increases to 0.7 USD/CAD
what are the 2 reasons why exchange rates are important?
they effect the relative price of domestic and foreign goods
they affect the rate of return of the international investment which carries exchange risk
when a country currency appreciates how does it impact foreign goods and domestic goods?
the domestic countries goods abroad becomes more expensive abroad and foreign goods in that country become cheaper
when a countries currency depreciates how does it impact foreign goods and domestic goods?
the domestic countries goods abroad become cheaper and foreign goods in that country become more expensive
if the price of French wine is 100 euros, and the exchange rate increase from 1.32 CAD/EUR and then the euro appreciates to 1.50 CAD/EUR, how much is the wine in Canadian before and after the euro appreciates?
before appreciation 1.32 CAD/EUR, the cost is 132 canadian
after appreciation 1.50 CAD/EUR, the cost is 150 canadian
what are the 2 ways that that exchange risk impacts international investment?
they impact the performance of the investment in the local currency
exchange rate can impact at how much the investment is worth once it is exchanged back in to domestic currency
what is an example of exchange rate risk impacting an investment?
if UK interest rates are AT 10% and you want to invest 20,000 CAD to get that 10% rate, you have to first exchange CAD to pounds, at a rate of 2CAD/1POUND, you invest that 10,000 pound at 10%, gaining you 1000 pound and now you have a total of 11,000 pound, but when you exchange the pound back to CAD the rate falls to 1.80CAD/1POUND, once you convert that you 19,800 CAD, and you really don’t gain anything you actually lose 200 dollars CAD
how are exchange rates determined?
by the interaction of supply and demand in the exchange rate markets
how are exchange rates determined in the long run?
from the theory of purchasing power parity (PPP)
what is the theory of purchasing power parity?
the exchange rate between any two countries currencies is such that the same basket of goods and services, wherever it is produced, costs the same in both countries (law of one price) and if the price levels change in the two countries, the exchange rate between the two currencies will adjust to reflect the price changes
what is an example of the theory of purchasing power parity?
if canadian steel is $100/tonne and similar Japanese steel is 10,000 yen/tonne, the exchange rate is 100yen/1cad, but if the price of Japanese steel rises to 11,000 yen/tonne and no change of dollar price of Canadian staten, then the exchange rate rises to 110yen/cad
how is the relative price level and exchange rates related?
they are positively related, of prices go up then exchanges rates go up
what are the 4 factors that affect exchange rates in the long run?
relative price levels
trade barriers
preferences for domestic VS foreign goods
productivity
how do the 4 factors impact exchange rates?
if a factor increases then demand for domestic goods relative to foreign goods then the domestic currency will appreciate
how does relative price levels impact exchange rates in the long run?
a rise in the country’s price level relative to the foreign price level, it causes its its currency to depreciate, and if the relative price level drops then the countries currency appreciates
how do trade barriers impact exchange rates in the long run?
higher tariffs causes a countries a county currency too appreciate
how do preferences for domestic VS foreign goods impact exchange rates?
increased demand for a country’s exports causes its currency to appreciate, and lowered demand for a country’s exports causes its currency to depreciate
how does productivity impact exchange rates?
higher productivity leads to appreciation of the country’s currency and lower productivity leads to depreciation of the country’s currency
how does a increase and decrease in domestic price level impact exchange rates?
increase: exchange rates fall
decrease: exchange rates rise
how does a increase and decrease of trade barriers impact exchange rates?
increase: exchange rates increase
decrease: exchange rates decrease
how does an increase and decrease of imports in to a domestic demand impact exchange rates?
increase: exchange rates increase
decrease: exchange rates decrease
how does an increase and decrease of exports to a foreign country impact exchange rates?
increase: exchange rates increase
decrease: exchange rates decrease
how does an increase and decrease of productivity impact exchange rates?
increase: exchange rates increase
decrease: exchange rates decrease
how are exchange rates in the short run determined?
through supply and demand
what are the 5 things that would increase the demand of USD foreign currency and decrease the supply of Canadian dollars?
1) firms, households or government that import US goods into canada or wish to buy US made goods and service
2) Canadian citizens traveling to the US
3) holders of canadian dollars who want to buy US stock, bonds and other financial instruments
4) Canadian companies that want to invest in US
5) speculators who anticipate a rise in the value of CAD relative to USD
what are the 5 things that decrease supply of USD foreign currency and increase the demand of canadian currency?
1) firms, households or governments that import Canadian goods into the US or wish to buy canadian goods and service
2) US citizens travelling in canada
3) holders of US dollars who want to buy stocks, bonds and other financial instruments in canada
4) US companies that want to invest in canada
5) speculators who anticipate a rise in the value of the canadian dollar relative to the US dollar
if there us an excess supply of domestic currency at a certain exchange rate, what happens?
it causes the value of the dollar to fall and the exchange rate to fall
if there is an excess demand of domestic currency at a certain exchange rate, what happens?
the value of the dollar will rise and the exchange rate will rise
if the BoC increases interest rates, what does thus cause?
a shift in the demand curve to the right and increase the demand for currency
what are the 3 things that cause shifts in the demand curve for domestic currency?
change in domestic interest rate
change in foreign interest rate
change in expected future exchange rate
how does an increased domestic interest rate impact demand for domestic currency and the value of that currency?
it causes the demand for domestic currency to increase and causing the value of that currency to appreciate
how does an increased foreign interest rate impact demand for domestic currency and the value of that currency?
it causes decreases in demand for domestic currency and causing the value of that currency to depreciate
how does an expected rise in future domestic exchange rates impact the demand of domestic currency and the value of that currency?
it causes an increase in demand for domestic currency and causing its value to appreciate
how does an expected fall in future domestic exchange rates impact the demand of domestic currency and the value of that currency?
it causes a decrease in demand for domestic currency and causing its value to depreciate
how does an increase in canadian interest rates impact demand for canadian dollars and the strength of the Canadian dollar?
it increases the demand for Canadian dollars and makes the Canadian dollar stronger
what are the 5 things that expected future exchange rates are affected by?
expected domestic price level
expected trade barriers
expected import demand
expected export demand
expected productivity
how does an increase in domestic interest rate impact change in quantity of canadian dollars demanded and exchange rates?
increase in Canadian dollars demanded and an increase in exchange rates
how does an increase in foreign interest rate impact quantity demanded of canadian currency and the exchange rate?
quantity demanded of canadian currency would go down and the exchange rate would go down
how does a decrease in domestic interest rate impact change in quantity of canadian dollars demanded and exchange rates?
decrease in Canadian dollars demanded and a decrease in exchange rates
how does a decrease in foreign interest rate impact quantity demanded of canadian currency and the exchange rate?
quantity demanded of canadian currency would go up and the exchange rate would go up
how would an expected increase in domestic price levels impact quantity demanded of canadian dollars and the exchange rate?
quantity demanded of canadian dollars would go down and exchange rates would go down
how would an expected decrease in domestic price levels impact quantity demanded of Canadian dollars and the exchange rate?
quantity demanded of Canadian dollars would go up and exchange rates would go up
how would an expected increase in trade barriers impact quantity demanded of canadian dollars and exchange rates?
increase in quantity demanded of canadian dollars and an increase in exchange rate
how would an expected decrease in trade barriers impact quantity demanded of canadian dollars and exchange rates?
decrease in quantity demanded of canadian dollars and a decrease in exchange rate
how would an increase of expected import demand impact quantity of canadian dollars demanded and exchange rates?
quantity demanded of canadian dollars decreases and a decrease in exchange rates
how would a decrease of expected import demand impact quantity of canadian dollars demanded and exchange rates?
quantity demanded of Canadian dollars increases and increases exchange rates
how would an increase of expected exports demanded impact quantity of Canadian dollars demanded and exchange rates?
quantity demanded of canadian dollars increases and exchange rates decreases
how would a decrease of expected exports demanded impact quantity of canadian dollars demanded and exchange rates?
quantity demanded of canadian dollars decreases and exchange rates decreases
how would an increase of expected productivity impact quantity of canadian dollars demanded and exchange rates?
quantity demanded of canadian dollars increases and exchange rates increases
how would a decrease of expected productivity impact quantity of Canadian dollars demanded and exchange rates?
quantity demand of Canadian dollars decreases and exchange rates increases
if Switzerland suffered relatively mild effect from the 07 financial crisis and countries in the European Union were hit hard, how would this have effected the euro/swiss franc exchange rate?
the exchange rate would go down because the demand for euro and the value of the euro would down in comparison to the Swiss franc. this would cause the exchange rate between the 2 to go down
if the Indian government unexpectedly announces that it will be imposing higher tariffs on foreign goods one year from now, what will happen to the value of the Indian rupee today?
it would increase, because the demand for domestic goods would go up and the demand for domestic collar will go up
if the federal reserve announces a large-scale asset-purchase program designed to lower intermediate and longer term interest rates. what effect would it have on the US dollar/euro exchange rate?
decrease in US exchange rates would case the demand for US dollars to go down and make it lose value, therefore causing the US/euro exchange rate to go up
assume that the initial exchange rate is 0.55 pound per canadian dollar. if the price level recently increased by 20%in great Brittany while falling by 5% in canada, by how much must the exchange rate change if PPP holds?
UK prices +20% meaning the value of the pound would decrease by 20%
canadian prices -5% meaning the value of the Canadian dollar would increase by 5%
there would be a 25% increase in the pound / dollar, increasing from 0.55 pound/dollar to 0.69 pound/dollar
if a price of goods goes up in a country, how will that impact the value of their dollar?
it will decrease
if the price of goods goes down in a country, how will that impact the value of their dollar?
it will increase
what are the 3 kinds of exchange rate regimes?
fixed exchange rate regime
floating exchange rate regime
managed float regime (dirty float)
what is a fixed exchange rate regime?
when the value of a currency is pegged relative to the value of another currency
what is a floating exchange rate regime?
the value of a currency is allows to fluctuate against all other currencies
what is a managed float regime (dirty float)?
attempt to influence exchange rates by buying and selling currencies by a central bank
how is a managed float regime done?
the central bank of a country would make sure the the value of the currency would fluctuate within a narrow band so than it can only float within a certain floor and ceiling
what are the 2 things that will happen when a country chooses to have a fixed exchange rate regime?
the domestic currency will become overvalued
the domestic currency will become undervalued
what would the central bank have to do to decrease the the value of the overvalued currency?
it must purchase its own domestic currency with foreign reserves to keep the exchange rate fixed, but thus causes the central bank to lose international reserves or foreign reserves (devaluation)
what would the central bank have to do to increase the value of an undervalued currency?
sell domestic currency to keep the exchange rate fixed and it gains international reserves or foreign reserves (revaluation)
if intervention in the foreign exchange market under a fixed exchange rate regime a long term thing?
no it is just temporary
what may happen to a country that ties its exchange rate to an anchor currency?
it may lose control of its independent monetary policy
what are the 3 policies that a country cannot peruse at the same time?
fixed exchange rate
independent monetary policy
free capital mobility
what is the benefit of a fixed exchange rate?
there is no exchange rate risk
what are the 2 policies that the Hong Kong dollar has?
fixed exchange rate and free capital mobility but they do not have an independent monetary policy
what are the 2 policies that the Chinese dollar has?
fixed exchange rate and independent monetary policy but no free capital mobility
what are the 2 policies that Canada, the us and the EU have?
they have free capital mobility and an independent monetary policy but not a fixed exchange rate
what is free capital mobility?
that people can freely move money to invest in foreign projects
what are capital controls?
restrictions on the free movement of capital across the boarders
what is the goal of the controls on capital outflows?
to promote financial stability within the country
when are controls on capital outflows effective?
they are only effective during a crisis
what are the 3 negative side effects of controls on capital outflows?
may increase capital flight
may lead to corruption
may lose opportunity to improve the functioning of the economy
what is the goal of controls on inflows of capital?
may avoid a lending boom and excessive risk taking by financial intermediaries
what are the 3 negative side effects of controls on inflows on capital?
controls may block funds for productions uses
may produce substantial distortion and misallocation
may lead to corruption
what are the 2 reasons why a country may chose a managed float regime?
appreciation hurts exporters and employment and depreciation hurts imports and stimulated inflation
how does a managed float regime work?
there are small daily changes in response to market and these interventions prevent large fluctuations
what is the role of the IMF?
to act as the international lender of last resort, they make loans to countries and help them avoid defaults on their government debt
what form of currency does the IMF lend to countries in?
in foreign currencies
what does a country have to do before receiving a loan from the IMF?
they are often required to adopt austerity programs and reforms after receiving loans
why does the IMF act as the lender of last resort to other countries?
to help prevent contagion of central banks falling
what is the negative impact of the IMF acting as lender of last resort?
it may lead to excessive risking taking because the countries know they would get bailed out
what is the balance of payments?
a bookkeeping system used to record international receipts and payments of both private and government sector
what are the 2 accounts on a balance of payments?
current account
capital account
what is current account?
the record of a countries transactions in goods, and services with the rest of the world
what is capital account?
the record of a countries financial transactions (sources and uses of foreign exchange)
what are the 3 things that make up current account?
net exports of goods and services (NX)
net factor income from abroad (NFI)
net unilateral transfers abroad (NUT)
what is net exports (NX)?
a countries total exports minus a countries total imports
what is an example of net factor income from abroad (NFI)?
a canadian working in NY and getting paid in USD would increase net factor income from abroad, a US citizen working in canada getting paid in CAD would decrease net factor income from abroad
what is an example of net unilateral transfers abroad (NUT)?
foreign aid decreases net unilateral transfer abroad, a relative from the US sending money to me in canada increases net unilateral transfer abroad
what is an example of what would impact capital account?
bank loans
purchases from stocks and bonds
what must a current accord (CA) surplus be matched by?
by a capital account (KA) deficit or capital outflow
what must a current account (CA) deficit be matched by?
by a capital account (KA) surplus or capital inflow
what does current account+ capital account equal?
net change in government international reserves
when a nation has spent more on foreign goods and services than it has earned through the sales of its goods and services to the rest of the world, the balance on its capital account is normally, what?
positive, so that the current account being negative will be balanced out by the positive capital account
true or false, if a country wants to keep its exchange rate from changing, it must give up some control over its money supply?
false, they can have a fixed exchange rate by giving up their capital mobility freedom instead
what is a disadvantage of the Chinese yuan being pegged to the US dollar?
if their dollar is over valued or under valued, their central bank will have to get involved and this will cause inflation
true or false, in a pure flexible exchange rate regime, the foreign exchange market has no direct effect on the money supply?
true
true or false, in a fixed exchange rate regime the foreign exchange market has no direct effect on the money supply?
false, the central bank would have to buy and sell its own currency with foreign currency and this would impact the money supply
