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