Economics Flashcards
Currency Cross Rates
Bid & Asks (must uses all bid or ask inputs): (A/C) = (A/B) * (B/C)
A/B Bid/Ask
When converting currencies if A -> B use ask price, if B -> A use the bid price in your equation
Mark to Market of Forward Contract
V_t=((FP_t - FP) * Size)/(1+R(days/360))
t is the time into contract, T-t is time remaining, T is the total time on the contract. FP_t is the value of the contract a time t, use spot rate at time t plus the remaining days expected spot rate change.
Use R as of T-t, days are days remaining, should be same as rate and days used for spot rate adjustment.
Use A/B Bid/Ask, you need to lock in profit so if you long B you will want a B/A deal, so use bid price for B, if long A than use ask price.
International Parity Conditions (Covered, Uncovered, International Fisher Relation, PPP)
Covered Rate Parity: Forward = (1+R_A(days/360))/(1+R_B(days/360))*Spot Rate
This always holds as both are traded on the market and if it did not hold there would be an arbitrage opportunity.
International Fisher Relation: R_A - R_B = Expected(inflation_A) - Expected(inflation_B)
Holds when we can forecast relative PPP and inflation.
Relative Purchasing Power Parity: %△Spot_(A/B) = Inflation(A) - Inflation(B)
Holds if inflation and interest rates move in tandem
Uncovered Rate Parity: Expected(%△Spot_(A/B)) = R_A - R_B
Holds if forward rates are unbiased predictor of future rates OR if IFR and PPP hold
FX Carry Trade and Balance of Payments
FX Carry: Profits when short term uncovered rate parity fails.
Profit = Interest differential between currencies - change in spot rate between currencies
Trying to profit from taking money from a low yield currency, converting it into a high yield currency so that you get paid more interest and then hoping that the exchange rate has not moved. Risk is FS rate corrects/crashes and you lose more than you gained in interest.
Balance of payments: Exchange rates are influenced by current account and capital account.
Current Account (Income Statement Account):
Flow Mechanism: Deficit in current account so currency goes down, when currency goes down there is a change that you will export more due to your good being cheaper to the rest of the world so the deficit will correct itself.
Portfolio: Countries in a surplus invest into deficit countries can effect currency value if they sell
Debt: Country in deficit takes more debt and may signal weakness so currency may go down even more.
Capital Account (Balance Sheet Account): Inflows and Outflows of capital will cause currency to appreciate and depreciate respectively.
Exchange Rate Determination
Mundell-Fleming Model: MP will always cause currency to go down if expansionary and go up if restrictive. FP effects depends on capital mobility (the ability for capital to be able to flow from one country to another). If high capital mobility than currency will go down if restrictive FP, if low capital mobility than currency will go up if restrictive FP.
Monetary Models:
Pure Model: MP expansionary than currency will always go down and inflation up, PPP holds
Dornbusch Overshoot Model: The effect will not get the change perfect, will overshoot to start (currency will depreciate more than it should have) and adjust back to proper level in long term.
Portfolio Balance: If long term FP expansionary than currency will go down in long term due to investors being borrowed from in long term
Potential GDP & Growth
Potential GDP is maximum output an economy can have without putting upward pressure on prices, high potential = better returns on market and better credit quality
If gap between potential and actual is high that means inflation is unlikely and the government will most likely use expansionary MP and FP
Capital Deepening & Production Function & Growth of GDP
Cobb-Douglas Production Function: Y = TK^alphaL^(1-alpha)
Output = Tech * Capital^Allocation to Capital * Labor^Allocation to Labor
Output per worker = Y/L = T(K/L)^alpha
Capital Deepening will move along on production curve with diminishing returns
Technology increases will shift up the curve, allowing for better output at all levels
In equilibrium marginal product (alpha*Y/K) = Cost of capital (r)
Growth rate of potential GDP = Tech Rate + alpha(Capital Rate) + (1-alpha)(Labor Rate) OR Labor Force Growth Rate + Labor productivity growth rate
Theories of Economic Growth (Classical, Neoclassical, Endogenous)
Classical: GDP growth is temporary, will result in population boom which will cause GDP to then fall back down to the same regular level
Neoclassical: Permanent GDP growth is driven by Tech improvements, amount of income allocated to Labor, and overall labor force growth.
g* = Θ/(1-alpha) which means gdp per capita growth = tech growth / labor rate allocation, for maximum gdp per capita growth you want tech improvement while not allocation much of your income to labor
G* = g* x △L, Total GDP growth = gdp per capita growth * change in labor force
Capital deepening and saving does not affect GDP growth as they are only temporary growth factors.
Endogenous: Same as Neoclassical except Capital Deepening and savings rates (savings will increase GDP growth as it will be loaned to businesses) do affect GDP growth because the more capital deepening and saving the quicker technological advancements will occur.
Convergence Hypothesis (Absolute, Conditional, Club)
Absolute: All countries will converge to one another in terms of standard of living
Conditional: Only countries with same population growth, savings rate, and production function will converge
Club: Only countries in the same club will converge, need to have similar institutional structures (property laws, political stability)
Econ Regulations
Regulations help move info, prevent bad things, prevent monopolies
Govt may hinder or facilitate via regulations
Prudential supervision is overlooking financial institutions to reduce risk/protect investors
SROs have govt authority, SRBs do not, Outside Bodies do not have authority but provide services to help regulate
Regulatory Capture: Regulators being influenced by the industry they work in to give more favorable regulations
Regulatory Arbitrage: Company moving to most favorable place where regulations are low
Regulatory Burden = Cost of regulation - Benefit, want small burden if any
