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EC340 > EC340FINAL > Flashcards

EC340FINAL Flashcards

1
Q

Exchange rate

A

the price of one currency in terms of another
E(domestic/foreign)
E($/€) = American Terms

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2
Q

Fixed exchange rate (pegged, band)

A

does not fluctuate against some base currency over a period of time.
- Govt intervention in the market for foreign exchange is needed to maintain Fixed.

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3
Q

Floating exchange rate

A

fluctuating

- govt makes no attempt to peg the exchange rate against some currency

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4
Q

exchange rate crisis

A

a currency experiences a sudden and pronounced loss of value against another currency following a period in which the exchange rate had been fixed or relatively stable.

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5
Q

Exchange rate crisis may lead to gov’t declaring DEFAULT on loans.
what is a default

A

suspension on payments

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6
Q

currency crashes

A

common events - when a currency loses 30% of its value in U.S dollar terms over one year, having changed less than 20% each of the previous 2 years.

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7
Q

what does an increase in dollar - euro ($/€) exchange rate lead to?

A

an increase in wealth for americans who own eurozone assets and a decrease in wealth for europeans who own american assets

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8
Q

Gov’t expenditure

A

spending

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9
Q

current account

A

expenditure - national income

expen > income = deficit (borrowing)
expen

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10
Q

balance of payments accounts

A

imbalances are associated w/ all different kinds of international transactions and are recorded

  • NOT possible for all countries to be running deficits at the same times
  • Globally, deficits and surpluses balance
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11
Q

emerging and developing economies hold massive stock piles of what

A

foreign exchange reserves

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12
Q

how is the u.s in a current account deficit?

A
  • expenditure exceeds income
  • selling financial assets to foreigners to fund the difference
  • the surplus country buys assets w/ excess income
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13
Q

wealth =

A

assets - liabilities

what others owe you) - (what you owe them

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14
Q

borrowing

lending

A

liabilities rise, reducing net worth

assets rise, increasing net worth

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15
Q

external wealth =

A

foreign assets - foreign liabilities

what is owed by the rest of the world) - (what you owe the rest of the world

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16
Q

Changes in external wealth result from

A

borrowing and lending / changes in foreign liabilities and foreign assets

  • external wealth > 0 —> creditor
  • external wealth debtor
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17
Q

common currency

A

shared policy responsibility: Eurozone

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18
Q

dollarization

A

country unilaterally adopts the currency of another country, and has no control over the currency

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19
Q 
Appreciation 
Depreciation 
equation to determine this: 
E$/€,t = 1.06 
E$/€,t+1 = 1.28
A
  • Value has risen
  • Value has fallen
    : [(t+1) - (t)] /t
    (1.28 - 1.06) / 1.06 = 21%
    *Euro has appreciated by 21% against the dollar
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20
Q

Bilateral Exchange Rate

A

shows the price at which one currency is exchanged for another.

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21
Q

Multilateral exchange rate

Resulting in what?

A
  • calculated by aggregating bilateral exchange rates by using trade weights to construct an average over each currency in the basket.
  • The change in Effective Exchange Rate
22
Q

40% of home trades with Country A
60% is with country B
Homes country appreciates 10% against country A, and depreciates 30% against country B.
What is the effective exchange rate?

A

(.1.4) + (-.3.6) = (.04-.18) = -14%

23
Q

Trade weight

A

% that you trade with such countries

24
Q

Appreciation in home country leads to a ________ in relative price of exports to foriegners and a _______ in relative price for imports

A

increase, decrease

25
Q

managed float

A

somewhere between a fixed or float

26
Q

crawling peg

A

steadily depreciating at a constant rate

27
Q

Market for foreign exchange (forex or FX market)

A

not an organized exchange: trade is conducted “over the counter”

28
Q

Spot contract “spot exchange rate”

A

~simplest forex contract is the immediate exchange of one currency for another between 2 parties
~most common type of trade

29
Q

Derivatives

types: forwards, swaps, futures and options

A

contracts with pricing derived from the spot rate.

30
Q

forwards

A

differs from spot contract in that the contract is made today, but the settlement date for the delivery of currencies is in the future, or “forward”
- time to delivery, maturity, varies. However the price is fixed TODAY and the contract holds no risks.

31
Q

Forward premium vs discount

A
  • is forward exchange price of currency exceeds the current spot price
  • vise versa
32
Q

swaps

A

A&B agree to trade at set price today and do reverse trade at a set price in the future.
combines forwards and spot contracts into one.

33
Q

Options

A
  • provides the buyer w/ the right to buy (call) or sell (put) a currency in exchange for another at a pre-specified exchange rate. (i.e “strike price”) at a future date.
  • The buyer is under no obligation to trade and will not exercise the option if the spot price on the expiration date turns out to be more favorable.
34
Q

capital control

A

Some governments engage in policies that restrict trading, movement of forex, or restrict cross-border financial transactions
In lieu of capital controls, the central bank must stand ready to buy or sell its own currency to maintain a fixed exchange rate

35
Q

Market equilibrium

A

no-arbitrage condition = no opportunities to make a riskless profit

36
Q

arbitrage

A

Arbitrage refers to a trading strategy that exploits price differences.

37
Q

International arbitrage may lead to…
applied to a single good
applied to an entire basket of goods

A
  • equalization of goods prices in different countries (expressed in a common currency).
  • Applied to a single good, this idea is referred to as the law of one price.
  • Applied to an entire basket of goods, it is called the theory of purchasing power parity.
38
Q

Law of one Price (LOOP) assumptions

A

no transaction costs
no barriers to trade
identical goods in each location
no barriers to price adjustment
-Under above assumptions, we expect:
*prices must be equal in all locations for any good expressed in a common currency
*otherwise, there would be a profit opportunity from buying low and selling high

39
Q

If LOOP holds for every good in CPI basket then

A

the prices of the entire baskets must be the same in each locations.

40
Q

The purchasing power parity (PPP) theory states

A

that a basket of goods purchased in two countries should cost the same in a common currency.
*Absolute PPP:
(E $/€ * P eur) = P u.s
*both sides expressed in dollar amounts

41
Q

The absolute PPP implies

A

that the exchange rate at which two currencies trade is equal to the relative price levels of the two countries:
*can be used to predict exchange rate movements

42
Q

The PPP theory, whether in absolute or relative form, suggests

A

that price levels in different countries and exchange rates are tightly linked, either in levels or in rates of change.

43
Q

real exchange rate

A

relative price of the baskets

44
Q

Absolute PPP states that the real exchange rate is equal to

A

1.

45
Q

If the real exchange rate qUS/EUR is below 1

A
  • Foreign goods are relatively cheap.

- In this case, we say the euro is undervalued.

46
Q

If the real exchange rate qUS/EUR is above 1,

A
  • Foreign goods are relatively expensive.

- In this case, we say the euro is overvalued.

47
Q

If the real exchange rate qUS/EUR rises

A
  • more home goods needed in exchange for foreign goods

- intuitively called a real depreciation of the dollar.

48
Q

If the real exchange rate qUS/EUR falls

A
  • fewer home goods needed in exchange for foreign goods

- Intuitively called a real appreciation of the dollar.

49
Q

what explains deviations from PPP

A

transaction costs

  • transportation costs may add about 20% to the cost of goods moving internationally.
  • Tariffs (and other policy barriers) may add another 10%, with variation across goods and across countries.
  • Further costs arise due to the time taken to ship goods.

nontraded goods

  • Some goods are inherently nontradable;
  • Most goods fall somewhere in between freely tradable and purely nontradable.
50
Q

what explains deviations from PPP conti

A

Imperfect competition and legal obstacles

  • Many goods are differentiated products, often with brand names, copyrights, and legal protection.
  • Firms can engage in price discrimination across countries, using legal protection to prevent arbitrage
  • E.g., if you try to import large quantities of pharmaceuticals, and resell them, you may hear from the firm’s lawyers.

Price Stickiness

  • One of the most common assumptions of macroeconomics is that prices are “sticky” prices in the short run.
  • PPP assumes that arbitrage can force prices to adjust, but adjustment will be slowed down by price stickiness.
51
Q

This adjusted index addresses

A

the criticism that you would expect average burger prices to be cheaper in poor countries than in rich ones because labor costs are lower

EC340 (3 decks)

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