Currencies

Question 1

Currency Main Currency Traders

Answer 1

1. Financial Investors (45%) – banks, security firms, institutional investors
2. Corporations – global business selling goods and services
3. Travelers

Question 2

What are pegged currencies?

Answer 2

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?)

Question 3

Currency crises (pegging)

Answer 3

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

Question 4

How many currencies are traded every day?

Answer 4

Over $5T

Question 5

What date market the dawn of the modern currency market?

Answer 5

1971

Question 6

Why do countries still peg their currencies to other currencies?

Answer 6

To foster stability and contain inflation

Question 7

Are locked exchange rates set in stone?

Answer 7

No, they are government aspirations

Question 8

Why do 85% of all FX trades involve US dollars?

Answer 8

One reason is that the US dollar is frequently used as a currency through which two less liquid currencies are converted

Question 9

To determine the overall strength/ weakness of a certain currency?

Answer 9

Trade-weighted basket: indices that calculate the aggregate value of one currency against it’s main trading partners, with larger partners weighted more heavily.

Question 10

What is the law of one price?

Answer 10

With enough time, the same product should cost the same anywhere (cue big mac index – proxy on currency under- and over-valuation).

Question 11

What are the three main short-term currency drivers?

Answer 11

Surprise changes in interest rates
Surprise changes in inflation
Surprise changes in trade

Question 12

What happens when Country A finds Country B’s bonds appetizing?

Answer 12

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.

Question 13

What happens when interest rates rise?

Answer 13

Interest rate hikes generally cause a currency to strengthen

Question 14

What happens when a central bank unexpectedly decreases interest rates?

Answer 14

Govt bond yields go down, deterring investment from around the world. This reduces demand for the currency which therefore weakens.

Question 15

What happens when the supply of one currency expands more rapidly compared to another?

Answer 15

The exchange rate of the country that has higher inflation will tend to weaken against the other.

Question 16

Example of a country where inflation weakened the currency?

Answer 16

India: inflation rose, Rupee weakened against the dollar.

Question 17

Import and export – currency?

Answer 17

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.

Question 18

Surprise decline in net exports leading to collapse in currency?

Answer 18

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.

Question 19

What happens when a currency is overvalued?

Answer 19

Domestic products appear more expensive so exports decrease. Foreign products become cheaper, leading to more imports. Risks deflation.

Question 20

Net exports higher?

Answer 20

Generally more attractive currency

Question 21

Mark of a developed economy?

Answer 21

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

Question 22

What is the inflation vicious cycle?

Answer 22

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

Question 23

How might the central bank tackle inflation?

Answer 23

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.

Question 24

Deflation vicious cycle?

Answer 24

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)

Question 25

How might the central bank tackle deflation?

Answer 25

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.

Question 26

Did the two oil crises in the 1970s lead to inflation or deflation?

Answer 26

Inflation: key oil-producing nations demanded higher prices for oil, raising overall price levels through industrialized economies.

Question 27

What are two ways to assess currency risk?

Answer 27

Historic volatility of currency pair values + analyst forecasts of currency pairs. Teams estimate based on interest rates, trades, etc.

Question 28

What does it mean for the ¥ to strengthen against the €?

Answer 28

That it will soon take more ¥ to buy one €

Question 29

What does it mean to hedge? To speculate?

Answer 29

Hedge: reduce risk
Speculate: to seek risk

Answer 30

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

Question 31

Good and bad qualities of gold?

Answer 31

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.

Question 32

What happens to samsung revenue in the US when the won weakens against the u.s dollar?

Answer 32

It provides a tailwind to the revenues from the US when translated back into Won, leading to higher revenues.

Question 33

Gold bug?

Answer 33

Loves gold

Question 34

Good ways for investors to manage currency risk?

Answer 34

By locking in forward rates for known foreign payments. Investing in pegged currencies is dangerous because they may crash.