ECO 2121, FINAL Flashcards
What is the BOP ?
The balance of payments (BOP) is an accounting of a country’s transactions for a particular time.
POSITIVE = SURPLUS / NEGATIVE = DEFICIT
- Each transaction between a country + ROW involves an exchange of value for value
- Each transaction has 2 items (1 positive + 1 negative)
- BOP = accounting principle for double-bookkeping
- If we add up all the positive (credits) + negative (debits) = ZERO
How can we define a CREDIT?
An item that would cause funds/money to FLOW INTO a country = positive value
It’s an item for with the country MUST BE PAID (claim on a foreigner)
E.g., a country’s export-of-goods, purchases by foreign tourists traveling the country, foreign investers
How can we define a DEBIT?
An item that would cause funds/money to FLOW OUT = negative value
It’s an item for which the country MUST PAY (claim owed to a foreigner)
E.g., a country’s imports-of-goods, purchases by firms in this country, purchases by investors in this country of the equity shares, etc.
What is included in the CA ?
- Trade balance (exports - imports)
- Net foreign income (what we receive from abroad - what we pay foreigner, e.g., rents, loans, profits, dividends, loyalties, interests, etc.)
- Net unilateral transfers (governement, individuals, private)
INCLUDES ALL DEBIT/CREDIT
- Exports/imports of goods = flows of raw materials/manufactured goods out/into the country
- Exports/imports of services (e.g., tourism, transportation, insurance, education, etc.)
- Income flows = mainly receipts and payments to holders of foreign financial assets
- Unilateral transfers = are gifts that the country receives and that the country makes
———————————————————–.
Current account balance = the net value of flows of goods, services, income, and unilateral transfers
Goods and services = the number obtained by adding up exports + imports of goods and services
What is included in the financial account ?
- Net FDI (what we receive - what we invest)
- Net porfolio investment (what foreigners invest in Canada - what Canadiens invest abroad)
- Net loans
The financial account balance = net value of flows of financial assets + similar claims ==> the private net value
- Credits = funds are flowing INTO the country (positive) [exporting financial assets, capital imports)
- Debits = funds are flowing OUT of the country (negative) [importing financial asset, capital exports]
What is the official international reserves?
Money-like assets that are HELD and RECOGNIZED by governements as fully ACCEPTABLE for payments.
KEEPS TRACK OF CHANGES IN OFFICIAL HOLDINGS
Gold was used in the 19th and 20th centuries
What is a statistical discrepancy?
It’s the net result of errors + omissions on both the credit and debit sides.
If the flows were recorded properly, there would be ZERO discrepency.
E.g., for U.S = much of the discrepancy is undermeasurement of private capital flows
Explain why the CAB must equal it’s net foreign investment?
MACRO PERSPECTIVE
To calculate the CAB = the INCREASE in the country’s foreign financial assets - the INCREASE in the country’s foreign financial liabilities
- CA SURPLUS (positive) = it’s foreign assets are growing FASTER than it’s foreign liabilities = NET LENDER
- CA DEFICIT (negative) = it’s foreign liabilities are growing FASTER than it’s foreign assets = NET BORROWER
Net exports = Savings - Investments
T/F, the U.S has evolved from a net exporter to lender after the WW2 ?
FALSE, after the WW2, he’s a net importer and borrower
WHY = the U.S cut it’s rate of national savings much faster than it’s domestic investments
What does the overall balance imply?
It indicates wether a country’s balance of payments has acheived an overall pattern that is sustainable over time.
* no single indicator represent the overall balance perfectly
All items in the BOP must equal ZERO = any imbalance in the official settement balance must be finance through official reserves flows (OR)
* B + OR = ZERO
———————————————————-.
B is in surplus:
* Must equal an accumulation of official reserve assets or
* Decrease in foreign official reserve holdings of the country’s assets
B is in deficit:
* Must equal a decrease in the country’s holdings of official reserves or
* Accumulation of foreign official reserve holdings of the country’s assets
What is the math behind the official settement balance (B) ?
It measures the sum of CA + financial account balance + (plus statistical discrepency)
B = CA + FA + (stats)
What is the international investment position?
It is a statement of the stocks of a nation’s international assets + foreign liabilities at a point in time, usually the end of a year.
E.g., if the country as a CA SURPLUS = it’s net foreign investment is positive
* The country is adding to it’s holding of foreign financial assets
* The country’s position will increase
T/F, a credit + debit can go into 3 categories?
4 net balances
SURPLUS vs DEFICIT
TRUE,
1. CA
2. Private financial account
3. Changes in the official international reserve assets
These 3 categories, generate 4 net balances:
1. The goods/services balance (equals the net exports of both goods and services, often called trade balance)
2. The CA balance (equals the net credits - debits in the flows of goods, services, income, unilateral transfers)
3. The net private financial account balance (equals net credits - debits involving changes in no official foreign financial assets and liabilities)
4. The overall balance/official settlements balance (equals the sum of the current account balance and the private financial account balance + the statistical discrepancy from mismeasuring items in the current account and financial account)
———————————————————–.
If the overall is in surplus, it is counterbalanced by an increase in the country’s official reserve holdings or a decrease in its official liabilities to other countries monetary authorities
If it is in deficit, it is counterbalanced by a decrease in the country’s official reserve assets or an increase in its official liabilities
What are the basics of currency trading?
Foreign exchange = act of trading different nations’ money
Foreign exchange market = the financial market where exchange rates are determined
Exchange rate = the price of one nation’s money in terms of another nation’s money (relative price)
- Spot exchange rate = the price for immediate exchange + provides clearing services that permit payments to flow for people who prefer to use different money (max 2 working days)
- Foward exchange rate = the price set now for an exchange that will take place sometime in the future (30, 90, 180 days)
What is a vehicular currency ?
One currency is commonly exchanged for dollars and the dollars are then exchanged for other currency
U.S. dollars
- One foreign currency is exchanged for dollars
- The dollars are then exchanged for the other currency
T/F, the foreign exchange market permits customers (i.e., individuals, businesses) to acquire foreign money to make payments OR sell foreign money they received in payments ?
TRUE
Why trading increases?
- Driven by large increases in trading by hedge funds, pension funds, and other financial institutions
- They expand their foreign exchange trading as they pursue international diversification of their financial investment portfolios
- They increase their use of algorithms for computer-driven foreign exchange
What is a foreign exchange swap ?
It’s a package trade that includes both a spot exchange of 2 currencies + an agreement to the reverse foward exchange of the 2 currencies
Explain the interbank foreign exchange trading ?
Participation in the interbank (or interdealer) part of the market provides a bank with a continuous stream of information on conditions in the foreign exchange market through communications with traders at other banks and through observing quoted prices.
- Interbank allows a bank to readust it’s own position quickly + low cost.
- Permits a bank to take on a position in a foreign currency quickly if the bank and its traders want to speculate on exchange-rate movements in the near future.
Explain the demand/supply of foreign exchange ?
An exchange rate is the price of domestic assets in terms of foreign assets.
A nation’s EXPORT causes foreign moneys to be SOLD to buy that nation’s money.
* Domestic exports (capital inflow) of goods/services/financial assets create a supply of foreign currency + a demand for domestic currency.
——————————————–.
A nation’s IMPORTS tends to cause the home currency to be SOLD to buy foreign currency.
* Domestic imports (capital outflow) of goods/services create a demand for foreign currency + a supply of domestic currency.
Supply curve for domestic assets: assume amount of domestic assets is fixed (supply curve = vertical)
Demand curve for domestic assets: most important determinant is the relative expected return of domestic assets + at a lower current value of the dollar (everything else equal), the quantity of demanded of dollar assets is higher.
What is a floating exchange-rate system?
The spot price of a foreign currency is market-determined by the interaction of private demand + supply for that currency.
The market clears itself through the price mechanism.
What is a fixed exchange-rate system?
Government monetary authorities keep the exchange-rate value fixed (within a narrow band around the central/par value).
What do these terms mean?
* Depreciation
* Appreciation
* Devaluation
* Revaluation
- Depreciation = a fall in the market price
- Appreciation = a rise in the market price
- Devaluation = an official reduction in the otherwise fixed par value of a currency
- Revaluation = an official increase in the otherwise fixed par value of a currency
What is arbitrage + triangular arbitrage in currency trading ?
Arbitrage = the process of buying/selling to make a riskless pure profit
* Ensures that exchange rate values in different locations are essentially the same
Triangular arbitrage = arbitrage throught three exchange rates, typically two dollar exchange-rate values + one cross-rate value
* Ensures the two dollar exchange rates + the cross-rate are consistent amoung themselve
