Econ Flashcards
international Fisher relation - inflation forecasts
R nominal a - R nominal b = E(inflation a) - E(inflation b)
R = real
E = expected
relative PPP formula for spot rates
JPY/EUR example - expected sport rate t years from now Spot rate (1 + inflationJPY)^t/(1 + inflationEUR)^t
uncovered interest rate parity forecast
JPY/USD example
spotjpy *( 1 +RFjpy)/(1+RFusd)
forward premium
just means F (the forward price) is greater that So the current Spot price
F- So
or
[[1 + Ra(days/360)]/ [1 + Ra(days/360)] - 1]*So
The value of a forward contract at maturity time T
Vt= (FPt-FP) * contract size Vt - Value T - maturity of forward contract FP - forward price FPt - forward price to sell
Value Prior to Expiration of a forward currency contract
(FPt-FP)*contract size /
[1+R(days/360)]
Covered interest rate parity (given A/B structure)
F = So * [1 + Ra(days/360)] / [1 + Rb(days/360)]
given A/B structure
F - forward rate
So - spot rate
Purchasing Power Parity
The law of one price states that identical good should have the same price in all locations (adjusted for exchange rates)
Doesn’t hold however due to the effects of frictions such tariffs and transportation costs.
Real exchange rate between a currency pair includes an adjustment for inflation differentials between two companies: formula
real exchange rate = St* (CPIb/CPIa)
St sport rate at time t for A/B
CPI consumer price index
Balance of Payments equation
current account + financial account + official reserve account = 0
Current account measures the exchange of good, services, exchange of investment income and unilateral transfers.
Financial account aka capital account - measures the flow of funds for debt and equity investments into and out of the country
Official reserve - account transactions are those made from the reserves held by the official monetary authorities of the country. Normally doesn’t change much year over year
Current account deficits in BOP
Capital account Inflhttps://www.brainscape.com/packsuences
depreciation in CA - leads to a deprecation of domestic currency
Capital account flows are one of the major determinations of exchange rates. As capital flows into a country demand for the currency increases resulting in appreciation.
Taylor Rule
Central banks are usually charged with setting policy interest rates so as to 1. maintain price stability (inflation target) and 2 achieve the maximum sustainable level of employment.
The IMF assess long term equilibrium real exchange rate based on 3 complementary approaches
Macroeconomic balance approach - balance CA accounts
External sustainability approach - force external debt relative to GDP to sustainable level
Reduced-form econometric model - based on several key macro economic variables such as trade balance, net foreign asset, and relative productivity. - to equalize exchange rates
Calculate profit on a carry trade
return = interest earned on investment - funding cost - currency deprecation
Mundell - Fleming Model
evaluates the impact of monetary policies on interest rates and consequently on exchanges rates.
Changes in inflation rates due to changes in monetary or fiscal policy are not explicitly modeled by this.
Monetary/Fiscal policy and exchange rates
high - low capital mobility pg 258
Mon/Fin High - low capital mobility
Expansionary / Expansionary Uncertain - Dep
Expansionary / Restrictive Dep - Uncertain
Restrictive / Expansionary Appre - Uncertain
Restrictive / Restrictive Uncertain - Appre
Dornbusch overshooting model
The model assumes that prices are sticky in the short term and no not immediately reflect changes in monetary policy.
a restrictive monetary policy leads to excessive appreciation of the domestic currency in the short term and then a slow depreciation towards the long term PPP value
Growth rate in potential GDP
= long term growth rate “tech”
+ alpha * (long term growth rate of capital)
+ (1- alpha) * long term growth rate of labor
Classical Growth vs Neo Classical
Classical: real GDP/person reverts to subsistence level.
Neo: Sustainable growth rate is a function of the population growth, labor share in income, and the rates of technological advances.
Growth late in labout productivity driven only by improvement in technology
Endogenous growth
Investment in capital can have constant returns
Forward Exchange Rate from Spot
= Spot * [(1 + rate1) / (1+rate2)]
Cross rates with bid-ask spreads
Use bid/ cross to get bid
Use cross/bid to cross
X
formula to test if arbitrage opportunity exist
+ borrow foreign
- borrow domestic
(1 + rdomestic) − [((1 + rforeign) × ForwardDC/FC) / SpotDC/FC] = 0
Calculate how much something will depreciate
= (1/spot - 1/forward) / (1/spot)
