Currencies Flashcards
Currency Main Currency Traders
- Financial Investors (45%) – banks, security firms, institutional investors
- Corporations – global business selling goods and services
- Travelers
What are pegged currencies?
Currencies from countries that lock their exchange rate to another major currency. Therefore, there will be little change in the currency pair value (ratio of one currency to another?)
Currency crises (pegging)
Successful defense:
1. Hong Kong dollar against the US dollar in 1997
Devaluations:
2. Argentine peso against the US dollar in 2002
3. British sterling against the Deutsche mark in 1992
4. Mexican peso against the US dollar in 1994
How many currencies are traded every day?
Over $5T
What date market the dawn of the modern currency market?
1971
Why do countries still peg their currencies to other currencies?
To foster stability and contain inflation
Are locked exchange rates set in stone?
No, they are government aspirations
Why do 85% of all FX trades involve US dollars?
One reason is that the US dollar is frequently used as a currency through which two less liquid currencies are converted
To determine the overall strength/ weakness of a certain currency?
Trade-weighted basket: indices that calculate the aggregate value of one currency against it’s main trading partners, with larger partners weighted more heavily.
What is the law of one price?
With enough time, the same product should cost the same anywhere (cue big mac index – proxy on currency under- and over-valuation).
What are the three main short-term currency drivers?
Surprise changes in interest rates
Surprise changes in inflation
Surprise changes in trade
What happens when Country A finds Country B’s bonds appetizing?
Country A must exchange their domestic currency for Country B’s currency. All else being equal, surprise rises in interest rates will allow Currency A to strengthen.
What happens when interest rates rise?
Interest rate hikes generally cause a currency to strengthen
What happens when a central bank unexpectedly decreases interest rates?
Govt bond yields go down, deterring investment from around the world. This reduces demand for the currency which therefore weakens.
What happens when the supply of one currency expands more rapidly compared to another?
The exchange rate of the country that has higher inflation will tend to weaken against the other.
Example of a country where inflation weakened the currency?
India: inflation rose, Rupee weakened against the dollar.
Import and export – currency?
Country A exports goods – Buy home currency. Country A sells currency, foreign buyer buys Country A’s currency.
Country A imports goods – Sell home currency. Country A buys other currency, importer has to buy Country A’s currency.
Surprise decline in net exports leading to collapse in currency?
Russia: major oil exporter, 75% of total exports are oil and gas. When the price of oil decreased in 2008 due to a decrease in demand, Russian exports collapsed, leading to a collapse in the value of the ruble. Happened again in 2014 and 2015.
What happens when a currency is overvalued?
Domestic products appear more expensive so exports decrease. Foreign products become cheaper, leading to more imports. Risks deflation.
Net exports higher?
Generally more attractive currency
Mark of a developed economy?
2% inflation – low but positive inflation is a plus. Protects consumers’ purchasing power, keeps borrowing costs low, and provides a stable backdrop for companies to make investments and hiring decisions
What is the inflation vicious cycle?
Pay increases leading to price increases
Workers expect prices to increase –> demand higher pay –> company wages go up –> companies raise prices to offset cost increase
How might the central bank tackle inflation?
To clear up inflation, Fed might enact interest rate hikes to suck money out of the system. Interest rate hikes make saving money relatively more attractive than spending money on goods and services.
Deflation vicious cycle?
Purchase deferrals and layoffs.
Prices decline –> consumers delay purchases to await lower prices –> company revenues decline –> companies let go of workers to cut costs (leading to less demand, leading companies to lower prices to keep selling)
How might the central bank tackle deflation?
Abenomics in 2012: aims to weaken the yen to spur inflation and boost exports. Method: printing money to buy government bonds, inflation target from 1% to 2%. Market foresaw these policies 1-2 months before, so the value of the yen vs. the dollar decreased shortly before inflation rose.
Did the two oil crises in the 1970s lead to inflation or deflation?
Inflation: key oil-producing nations demanded higher prices for oil, raising overall price levels through industrialized economies.
What are two ways to assess currency risk?
Historic volatility of currency pair values + analyst forecasts of currency pairs. Teams estimate based on interest rates, trades, etc.
What does it mean for the ¥ to strengthen against the €?
That it will soon take more ¥ to buy one €
What does it mean to hedge? To speculate?
Hedge: reduce risk
Speculate: to seek risk
Lock currency exposure using the currency-forward market. Can agree to exchange eg. € for $ at a specified rate ten years from now.
FX forward contract
Good and bad qualities of gold?
Safe-haven asset to store value.
- Gold: Unyielding asset that pays no dividends or interest. Storage costs – gold effectively pays a negative dividend as you have to pay people to guard it. Also difficult to store.
+ Durable, rare, unable to be manipulated by any government, so is an inflation hedge. Government can’t create more.
However, price of gold does change – reached an all-time high with the debt-crisis of 2012. $35 in 1971 would have become $214 in 2017 if compounded with inflation (CPI), but would have become $1249 if stored in gold.
What happens to samsung revenue in the US when the won weakens against the u.s dollar?
It provides a tailwind to the revenues from the US when translated back into Won, leading to higher revenues.
Gold bug?
Loves gold
Good ways for investors to manage currency risk?
By locking in forward rates for known foreign payments. Investing in pegged currencies is dangerous because they may crash.
