Class 8

Question 1

Name the 3 determinant of exchange rate

Answer 1

1) Parity conditions approach
2) Balance of payments
3) Monetary Approach and asset market approach

Question 2

Of the 3 determinants of exchange rate, which is the most relative or used? What does this mean?

Answer 2

Relative purchasing power parity
This means that changes in relative prices (considering inflation) between countries drive the change in exchange rates over time

Question 3

Has PPP proven to be accurate for exchange rates in the short term? Why?

Answer 3

Not it hasn’t proven to be good in the short term since its basic assumption is that the only thing that matters is relative price changes which isn’t true since many currencies are driven by supply and demand

Question 4

What is the second most used approach to exchange rates? Why?

Answer 4

Balance of Payment because it takes into account supply and demand and current and financial account of a country

Question 5

In BOP exchange rate, how do you know when the equilibrium exchange rate is found

Answer 5

When the inflow of foreign exchange from current accounts matches net outflow of foreign exchange coming from financial account activities

Question 6

What is a criticism of the BOP approach

Answer 6

It emphasis on flow of currency an capital rather than on stocks of money and financial assets

Question 7

Who hates and who used the BOP approach for FX

Answer 7

Hated by academic community but used by market participants

Question 8

What is the monetary approach to FX

Answer 8

exchange rate is determined by supply and demand of national monetary stocks and the expected futures levels and rates of growth of monetary policy

Question 9

Are other financial assets useful in monetary approach FX? Why?

Answer 9

No, because both domestic and foreign bonds are viewed as perfect substitiues

Question 10

What is used in the monetary approach to determine inflation?

Answer 10

Supply and demand for money

Question 11

What is a weakness of monetary models

Answer 11

That real economic activity is relegated to a role in which it only influences exchange rates through changes in the demand for money

Question 12

What is the asset market approach

Answer 12

States that the supply and demand for many financial assets determines the exchanger rates

Question 13

What impacts does the supply and demand of financial assets have?

Answer 13

Has an impact on exchange rates since it alters expected returns and perceived risks of financial asstes

Question 14

When are the foreign exchange rate theories most useable

Answer 14

in the short to medium term, but not in the long term

Question 15

How may a currency be valued by an investor?

Answer 15

Similar to a bond or stock, based on the expected future events and flows of cross-border funds

Question 16

What is currency market intervention?

Answer 16

When the government steps in and plays with the market’s valuation of a currency

Question 17

What are the 3 intervention methods?

Answer 17

Direct intervention
In-direct intervention
Capital control

Question 18

What is direct intervention?

Answer 18

Central bank buys or sells its own currency in the foreign exchange market to influence the exchange rate

Question 19

What is indirect intervention

Answer 19

Shape value through economic policies and signals which could be interest rates, economic forecasts or announcements

Question 20

How does increasing interest rates make a currency more attractive?

Answer 20

Because it makes the investments more attractive, which increases demand

Question 21

What is capital control

Answer 21

Limit the ability to exchange domestic currency for foreign currency which means more trading takes place

Question 22

What is an institutional investor? How do they have an impact on the market

Answer 22

An investor that invests large sums on behalf of others. Since they are so big and make such big trades there create movements in the market

Question 23

Do institutional investors have a long term or short term length of investments? Why?

Answer 23

Long term since they are often done for pensions or insurances

Question 24

Why do institutional investors invest in foreign markers

Answer 24

Because they are so big in terms of capital they are “forced” to invest foreignly

Question 25

How is there agency problems in these institutional investors

Answer 25

The investors get paid on medium to short term basis but the investments are supposed to be made for long term. As well, the investors get bonuses based on investment performance which may be a short term spike in investements

Question 26

How is hedging for institutional investors?

Answer 26

Imperfect because of their large value and its fluctuation therefore it is hard to predict how much to hedge for

Question 27

What is fair value hedging

Answer 27

It is a type of hedging that is particular to institutional investors where hedging can be done on the whole amount invested, the expected future yield as well as the expected future value of the investment

Question 28

When can institutional investors hedge all of their investments with long term investments

Answer 28

When currencies involved are stable and have liquid long-term FX derivative markets

Question 29

If you’re a canadian pension fund and want to make decision to invest or not in the US, how do you weigh that investment versus making an investment in Thailand

Answer 29

-Look at the ability to hedge either investment
-Since you are a pension fund, look at time horizon of investments