Economic Flashcards
m-to-m value of forward contract VT=
=(FPt- FP)(contract size)
/ (1 + r *days/360))
covered interest parity Forward =
arbitrage free value
SPOT * (1+ rp (n/360))
/(1 + rb(n/360))
linear approx: fwd/spot-1 =rp-rb
fwd>spot –premium
strong currency,
fwd < spot
weak currency
discount
forward premium/discount
forward rate - spot rate
=S0 * ([1+Rp(days/360)/(1+rb(days/360)) -1 ]
covered interest arbitrage
forward - competed forward
fwd > computed fwd:
sell the base, borrow the quoted, convert to base in spot and invest today
fwd < computed fwd
sell the quoted, borrow the base, convert to quoted in spot and invest today
purchasing power parity ppp
E(change in spot p/b) = pai p - paib
uncovered interest rate parity UIRP
E(change in spot p/b) = Rp - Rb
high interest rate should depreciation. relative to lower interest rate.
fisher effect
r = real + E(inflation)
international fisher effect
Rprice - Rbase = E(inflationoP)-E(inflation B)
forward rate is unbiased predictor of future spot
E(St) =
F
carry trade (depend on UCIP doesn't hold in ST) flat trail & negative screw
if uncovered rip does not work in st, invest in higher old currency and borrow in lower yld currency.
risk: crash risk due to non normal distribution of carry trade returns
negative screwiness and excess kurtosis
return on carry trade:
interest earned on investment
- funding cost
- investment currency depreciation
profit only if UCIP does NOT hold.
BOP - current account influences
flow mechanism
portfolio composition mechanism
debt sustainability mechanism
BOP - Capital (financial) account
higher relative real rates attract foreign capital, appreciating domestic currency
excess capital flows lead to undue appreciation of local currency - especially problematic for em mkt
monetary policy/fisher policy (mundell-fleming) ST
expansion on both, depreciation in low capital
restrictive on both, appreciation in low capital mobility
expansion on monetary, depreciation in high capital
expansion on fiscal, appreciation in high capital mobility
monetary approach -
pure monetary approach
ppp holds at any point
expansionary monetary policies lead to higher inflation and depreciation of currency
dornbusch overshooting model
output prices are sticky in the short run but fully flexible in the long run.
expansionary monetary policy increases the real money supply and prices are slow to react in the rt. This causes the nominal and real exchange rates to depreciate. exchange rates gradually increase towards their pp implied values
portfolio balance approach (LT)
IN LONG TERM, gov’t may find it increasingly difficult to fund sustained deficits, leading to depreciation of the currency.
Sp/b =
Law of one price
CPI(p) / CPI(b)
relative ppp
change in Spot(p/b) = inf(p) - inf(b) based on absolute ppp doesn’t hold
ex-ante version ppp (expected)
CIP holds > if FRP hold, UCPI hold
int. rate diff should mirror inflation diff. if IFR hold.
If ex-ante Rppp & IFR hold, UCPI holds.
warning sign of currency crisis
terms of trade deteriorate
fixed or partially fixed exchange rates
official fx reservers dramatically decrease
currency value that has risen above its historical mean
inflation increase
liberalized capital mkt, that allow for free flow of capital
MS. relative to bank reserves increase
bankrupt rises
change in price
= change in GDP + change in (E/GDP) + CHANGE IN (P/E)
COBB-DOUGLUS PRODUCTION FUNCTION Y=
constant return to scale
TK^aL^(1-a)
diminishing marginal productivity of capital
Cobb-Douglas Production Function
y=
constant return to scale
TK^aL^(1-a)
growth rate in potential GDP
=LT growth rate of tech + a(LT growth of capital) +
(1-a)(LT growth rate of Labor)
= LT growth rate of labor force + LT growth rate in labor productivity — this is capital deepening & tech progress
Dutch diese
global demand drives up currency value, making export more expensive
large endowments of natural resources
Labor supply factors
demographics
labor force participation = labor force/working age population
immigration
avg/hour worked
classical growth theory
LT
Population growth increase whenever there are increases in per capital income above substance level (population explosion occur) due to an increase in capital or tech progress.
growth in real GDP/capital is NOT permanent.
lead to diminishing marginal return to labor
reduce productivity and GDP/capital
neoclassical growth theory
focus on estimating the economic’s LT steady state growth of rate.
at equilibrium economy when output - to-capital is constant g
Neoclassical growth theory concludes that capital accumulation affects the level of output but not the long-run growth rate.
population growth is independent of economic growth
g*
= TPF/(1-a)
g*
= θgrowth rate in technology/(1-a)
G*
TFP/(1-a) + change in L
g* + ∆L
Endogenous growth theory
technological growth emerges as a result of investment in both physical and human capital
permanently increase rate of growth for increase in investment
RIO are constant
increase in savings will permanently increase the growth rate
economies of scale
convergence hypothesis - absolute
less developed countries will achieve living standard over time
convergence hypothesis - conditional
convergence in living standard will only occur for countries with the same savings rates, population growth rate, and production functions.
growth higher for less developed countries until they catch up
convergence hypothesis - club
poorer countries that are part of the club will grow rapidly to catch up with their richer peers
regulatory capture
a regulatory body be influenced or even possibly controlled by the industry the is being regulated
regulatory competition
regulators compete to provide the most business-friendly environment
regulations intervention
price mechanism(Taxes and subsidie) restricting or requiring certain activities provision of public goody on financing of private project
Self-regulatory bodies (SRBs)
do not have government recognition, and they represent as well as regulate their members.
Self-regulating organizations (SROs)
are SRBs that are given government recognition and authority.
net regulatory burden
Regulatory burden minus the private benefits of regulation
(rd − rf) > (Forward − Spot) / Spot
then Borrow Foreign
(rd − rf) < (Forward − Spot) / Spot
then Borrow Domestic
The adjustment to exchange rates to restore current accounts to a balanced position depends on:
The level of initial deficit.
The response of import and export demand to changes in import and export prices.
The response of import and export prices to changes in the exchange rate.
Regulatory arbitrage occurs when
the firms exploit the difference between the economic substance and interpretation of a regulation.
Capital deepening = labor productivity - tfp
is an increase in the capital-to-labor ratio. Due to diminishing marginal productivity of capital, increases in the capital per worker can lead to only limited increases in labor productivity if the capital-to-labor ratio is already high.
The objectives of regulators in financial markets include
prudential supervision, financial stability, market integrity, and economic growth.
High-quality cash flow is characterized by
positive OCF that is derived from sustainable sources and is adequate to cover capital expenditures, dividends, and debt repayments.
debt sustainability channel
there should be some upper limit on the ability of countries to run persistently large current account deficits.
flow supply/demand channel mechanism
focuses on the fact that purchases and sales of internationally traded goods and services require the exchange of domestic and foreign currencies in order to arrange payment for those goods and services.
Such shifts in currency demand should exert UPWARD pressure on the value of the surplus nation’s currency and downward pressure on the value of the deficit nation’s currency.
portfolio balance channel
assumes that current account imbalances shift financial wealth from deficit nations to surplus nations. Countries with trade deficits will finance their trade with increased borrowing. This behavior may lead to shifts in global asset preferences, which in turn could influence the path of exchange rates.
