Economics Flashcards
Module 6.1, LOS 6.a
What are the determining factors of dealer’s exchange rate spreads?
1) The spread in an interbank market for the same currency pair
2) The size of the transaction (larger - higher spread)
3) The relationship between the dealer and client
Module 6.1, LOS 6.a
What are the determining factors of exchange rate interbank market spreads?
1) Currencies involved (high-volume currency pairs - lower spread)
2) Time of day (most liquid time - lower spread)
3) Market volatility (higher volatility - higher spread)
4) Maturity (higher maturity - higher spread)
Module 6.1, LOS 6.a
In a triangle arbitrage, can you earn profit in both directions?
No, this is never possible
Module 6.2, LOS 6.e
What is the difference between covered and uncovered interest rate parity?
Covered interest rate parity derives the no-arbitrage forward rate, while uncovered interest rate parity derives the expected future spot rate (which is not market traded)
Uncovered interest rate parity assumes that the investor is risk-neutral
Module 6.2, LOS 6.e
In which case a forward rate is an unbiased predictor of the future spot rate?
If the forward rate is equal to the future spot rate
Then when covered interest rate parity holds, uncovered interest rate parity would also hold (and vice versa)
Module 6.2, LOS 6.e
Descibe International fisher relation
1) The difference between two countries’ nominal interest rates should be equal to the difference between their expected inflation rates.
2) Equality of real interest rates across countries is based on the idea that with free capital flows, funds will move to the country with a higher real rate until real rates are equalized
Module 6.2, LOS 6.e
Descibe Absolute purchasing power parity
S(A/B) = CPI(A) / CPI(B)
measured by consumption baskets
Module 6.2, LOS 6.e
Descibe Relative purchasing power parity
%ΔS(A/B) = Inflation(A) − Inflation(B)
where:
%ΔS(A/B) = change in spot price (A/B)
Module 6.2, LOS 6.e
What is ex-ante purchasing power parity?
The ex-ante version of purchasing power parity is the same as relative purchasing power parity except that it uses expected inflation instead of actual inflation.
Module 6.3, LOS 6.i
What is FX carry-trade?
An investor invests in a higher yielding currency using funds borrowed in a lower yielding currency (funding currency).
The FX carry trade attempts to capture an interest rate differential and is a bet against uncovered interest rate parity
Module 6.3, LOS 6.i
What is crash risk of FX carry-trade?
A high probability of a large loss in carry trade.
During turbulent times, as investors exit their positions (i.e., a flight to safety), the high-yielding currency can experience a steep decline in value, generating large losses for traders pursuing FX carry trades
Module 6.3, LOS 6.j
In BOP which factor mostly impacts FX rate?
Capital flows tend to be the dominant factor influencing exchange rates in the short term, as capital flows tend to be larger and more rapidly changing than goods flows
Module 6.3, LOS 6.j
What are the main mechanisms of current account influence on exchange rate?
Current account deficits -> depreciation of domestic currency:
1) Flow supply/demand mechanism - Current account deficits -> increase the supply of that currency in the markets (as exporters to that country convert their revenues into their own local currency)
2) Portfolio balance mechanism - investor countries decide to rebalance their investment portfolios (not to have to much investments into country with CA deficit
3) Debt sustainability mechanism - a country running a current account deficit -> may be running a capital account surplus by borrowing from abroad -> high D/GDP -> investors reduce their investments to borrower
Module 6.3, LOS 6.j
Under which conditions it is easier to restore current account deficit through exchange rate depreciation?
1) smaller initial deficit
2) increase in cost to larger extend passed on to consumers
3) most important imports are price elastic
Module 6.3, LOS 6.j
What are the main mechanisms of capital account influence on exchange rate?
Differences in real rates of return tend to be a major determinant of the flow of capital
Module 6.3, LOS 6.k
What is the key assumption of the Mundell-Fleming model?
It does consider inflation - uncovered parity doesn’t hold
Module 6.3, LOS 6.k
For countries with flexible exchange rate regimes, how does expansionary monetary and fiscal policy impact (under Mundell-Fleming model) countries with:
1) high capital mobility?
2) low capital mobility?
1) high capital mobility
expansionary monetary -> depreciation local
expansionary fiscal -> appreciation local
2) low capital mobility
expansionary monetary -> depreciation local
expansionary fiscal -> depreciationlocal
Module 6.3, LOS 6.k
What are the major types ofmonetary approach to exchange rate determination and their assumptions?
1) Pure monetary model
- PPP holds ST
- constant output
- does not take into account expectations about future monetary expansion or contraction
- expansionary monetary policy -> increase in prices, decrease in the value of the domestic currency
2) Dornbusch overshooting model
- prices are sticky (inflexible) in the short term -> ST PPP doesn’t hold
- exchange rates will overshoot the long-run PPP value in the short term
Module 6.3, LOS 6.k
Which exchange rate model focuses on long term fiscal policy impacts?
Portfolio balance approach
Module 6.3, LOS 6.l
What are the objectives of central banks or government intervention and capital controls when dealing with exchange rates?
- ensure that the domestic currency does not appreciate excessively
- allow the pursuit of independent monetary policies without being hindered by their impact on currency values
- reduce the aggregate volume of inflow of foreign capital
Module 6.3, LOS 6.l
In which countries - developed or developing - are government and central banks interventions more efficient?
Evidence has shown that for developed markets, central banks are relatively ineffective at intervening in the foreign exchange markets due to lack of sufficient resources
Module 6.3, LOS 6.i
Which distribution do carry trade returns have?
With negative skewness and excess kurtosis
Module 7.1, LOS 7.a
What are the main factors that boost GDP growth and GDP level?
1) Savings and investment
2) Financial markets and intermediaries
3) Political stability, rule of law, and property rights
4) Investment in human capital
5) Tax and regulatory systems
6) Free trade and unrestricted capital flows
Module 7.1, LOS 7.b
Which formula describes determinants of equity stock market growth? What is the limit for its growth?
ΔP = ΔGDP + Δ(E/GDP) + Δ(P/E)
In LT Δ(E/GDP) and Δ(P/E) is 0, potential GDP is a limit to equity market growth
Module 7.1, LOS 7.c
What is the relation between current interest rate, fiscal and monetary policy and potential and actual GDP growth?
1) If actual GDP growth is higher than potential - expected inflation - restrictive monetary policy
2) If actual GDP growth is lower than potential - fiscal deficit will be run
3) If potential GDP growth is positive - consumers save less - financial intermidiaries ask for higher yield to encourage savings
4) The higher the potential GDP - the lower credit risk in financial and government sector is assumed
Module 7.1, LOS 7.d
What is the difference between marginal product of capital and marginal productivity of capital?
Marginal product of capital is the additional output for one additional unit of capital (constant returns on scale). Marginal productivity of capital is the increase in output per worker for one additional unit of capital per labor (i.e., increasing capital while keeping labor constant) - decreasing
Module 7.3, LOS 7.i
What is the key assumption of classical growth theory? Does this theory hold?
Key assumption - when GPD/capita increases above subsistance level -> burst in population growth -> diminishing marginal returns to labor -> GPD/capita driven back to subsistance level.
Theory is not supported by evidence
Module 7.3, LOS 7.i
What are the key assumptions of neoclassical growth theory?
1) Capital deepening affects Y but not the g in LR. Capital deepening may temporarily increase g, but it will revert back w/o A growth
2) An economy’s g will move towards its steady state regardless of the initial C/L or A.
3) In the steady state, g is a function only of the growth rate of technology (θ) and labor’s share of total output (1 − α)
4) In the steady state, MPK = αY/K is constant, but marginal productivity is diminishing
5) An increase in savings will only temporarily raise G. However, countries with higher savings rates will enjoy higher C/L and higher productivity.
6) Developing countries (with a lower level of C/L) will be impacted less by diminishing MPK, and have higher g; there will be eventual convergence of g
7) every country has access to the same technology
8) benefit of open markets is temporary
Module 7.3, LOS 7.i
What are the key assumptions of endogenous growth theory?
1) technological growth emerges as a result of investment in both physical and human capital
2) returns to capital are constant -> increase in savings will permanently increase g
3) R&D may have external benefits and should be subsidized by government
4) open markets lead to higher rate of growth permanently for all markets
5) knowledge is not subject to diminishing returns
Module 7.3, LOS 7.j
Which convergance theories exist and what they assume?
1) absolute convergence - less-developed countries will converge to the growth rate (but not the level of per capita output) of more-developed countries
2) conditional convergence hypothesis - convergence in living standards will only occur for countries with the same savings rates, population growth rates, and production functions.
3) club convergence - poorer countries that are part of the club will grow rapidly to catch up with their richer peers
Module 8.1, LOS 8.e
In which law system SRO are more officially recognized?
In common law systems (rather than civil law)
Module 8.1, LOS 8.f
What does regulatory capture theory state?
Regardless of the original purpose behind its establishment, a regulatory body will, at some point in time, be influenced or even possibly controlled by the industry that is being regulated
Module 8.1, LOS 8.f
What is regulatory competition?
Regulators compete to provide the most business-friendly regulatory environment
Module 8.1, LOS 8.f
What is regulatory arbitrage?
Businesses shop for a country that allows a specific behavior rather than changing the behavior
Module 8.1, LOS 8.f
What is net regulatory burden?
Cost of compliance for the regulated entity (regulatory burden) minus the private benefits of regulation
