Cross rates and history (lecture #9) Flashcards
def. cross rates
the exchange rate between two currencies calculate using a third currency
when is there an arbitrage opportunity?
if there is a posted rate that isn’t the number of the calculated cross rates, there is an arbitrage opportunity
What is the global capital market?
a collection of institutions (central banks, commercial banks, investment banks, not-for-profit financial institutions like the IMF and World Bank) and securities (bonds, mortgages, derivatives, loans, etc.) which are all linked via a global network (the Interbank Market)
the interbank market, in which securities of all kinds are traded, is the _______ for the movement of capital
critical pipeline system for the movement of capital
def. eurocurrencies
domestic currencies of one country on deposit in a second country
T or F: any convertible (exchangeable) currency can exist in “Euro-“ form
true
What two purposes can eurocurrency markets serve?
– Money market device for excess corporate liquidity
– Source of short-term bank loans
What is the reference rate of interest? and who is it officially defined by?
LIBOR (the London Interbank Offered Rate)
-officially defined by the British Bankers Association
What is LIBOR used in?
standardized quotations, loan agreements, or financial derivatives valuations
What is the US dollar LIBOR (ie how is it calculated)?
mean of 16 multinational banks interbank offered rates as sampled at 11am London time in London
Describe the gold Standard
- 1876-1913
- countries set par value for their currency in terms of gold
- exchange rates were in effect “fixed”
- gold reserves were needed to back a currency’s value
- –if you wanted to print more money, you needed more gold
- worked until outbreak of WW1, which interrupted trade flows and free movement of gold
describe the Inter-War years and WW2
-1914-1944
-During this period currencies were allowed to fluctuate in
terms of gold and each other
-Increasing fluctuations in currency values became realized as speculators sold short weak currencies
—people were betting on money to go down, this put even more pressure on currencies and causes lots of fluctuation
-In 1934, the U.S. dollar was devalued to $35/oz from
$20.67/oz
-During WWII and its chaotic aftermath the US dollar was the only major trading currency that continued to be convertible
descirbe the Bretton Woods and the IMF era (1944)
-Allied Powers met in Bretton Woods, NH and created a post-war international monetary system
-The agreement established a US dollar based monetary system and created the IMF and World Bank
-Countries fixed their currencies in terms of gold but were not required to exchange their currencies
-Only the US dollar remained convertible into gold (at $35/oz with
Central banks, not individuals)
-– Therefore, each country established its exchange rate vis-à-vis the USD
and then calculated the gold par value of their currency
-Participating countries agreed to try to maintain the currency values within 1% of par by buying or selling foreign or gold reserves
- Devaluation was not to be used as a competitive trade policy and upto a 10% devaluation was allowed without formal approval from the IMF (they didn’t want a currency war)
describe what the IMF was created to do
- help countries defend their currencies against cyclical, seasonal, or random occurrences
- assist countries having structural trade problem,s if they promise to take adequate steps to correct these problems
- Special drawing Right (SDR) serves as a unit of account for the IMF and other international and regional organizations
- –essentially a separate bank account
Why are the World Bank and the IMF very valuable?
they creat a more fair, robust system
describe the fixed exchange rate era (1945-1973)
•Bretton Woods and IMF worked well post WWII, but diverging fiscal and monetary policies and external shocks caused the system’s
demise
– The US dollar remained the key to the web of exchange rates
• Heavy capital outflows of dollars became required to meet investors’
and deficit needs and eventually created a lack of confidence in the US’ ability to convert dollars to gold
• This lack of confidence forced President Nixon to suspend official
purchases or sales of gold on Aug. 15, 1971 (this essentially paused the global economy)
• Exchange rates of most leading countries were allowed to float in relation to the US dollar
• A year and a half later, the dollar came under attack again and lost 10% of its value
• By early 1973 a fixed rate system no longer seemed feasible and the dollar, along with the other major currencies was allowed to float
describe the floating era (1973-1997)
– Exchange rates became much more volatile and less predictable
than they were during the “fixed” period
– Several emerging market currency crises
– EMS restructuring (1992) and introduction of the Euro (1999)
describe the emerging era (1997-present)
– Growth in emerging market economies and currencies
What are the three components of the impossible trinity? What are the restrictions?
- exchange rate stability
- monetary independance
- full financial integration
-can only have two of the three
What are the attributes of an ideal currency, is it attainable?
- exchange rate stability
- monteraty independence
- full financial integration
its not fully attainable
what brings exchange rate stability
a managed or fixed exchange rate
what brings monetary independence
an independent monetary policy
what brings full financial integration
the free movement of capital
