Economics

Question 1

Forward FX Calculation

Answer 1

Find matching cash inflow of original position, determine forward needed to offset this
(FP_t x FP0) x size
Discount back to PV

Question 2

Covered interest rate parity

Answer 2

Spot x (1+r_price x days/360) /(1+r_base x days/360)

Question 3

Uncovered interest rate parity

Answer 3

Δ%s = r_A - r_B
Not bound by arbitrage

Question 4

Carry trade

Answer 4

Return =
Interest earned
(-) Funding cost
(+) Appreciation in currency A vs B

Question 5

Flow supply demand mechanism

Answer 5

Foreign exporters paid in domestic currency, they sell the domestic currency to buy the foreign currency, the selling pressure causes the domestic country to depreciate.

Question 6

Portfolio Balance Mechanism

Answer 6

Foreign exporters will eventually hold too much of domestic countries debt/equity and so to reduce concentration risk they will sell domestic bonds and cause the currency to depreciate

Question 7

Debt sustainability mechanism

Answer 7

If people think the debt is unsustainable will increase selling of debt / currency leading to a devaluation

Question 10

How do you calculate the bid-offer spread?

Answer 10

Offer Rate - Bid Rate.

Question 11

What factors affect the bid-offer spread?

Answer 11

Transaction size (larger size -> wider spread), Client relationship, Interbank vs. dealer market (interbank narrower), Currency pair volume (higher volume -> narrower spread), Time of day (market overlap -> narrower spread), Volatility (higher vol -> wider spread).

Question 12

How do you identify and calculate profit from triangular arbitrage?

Answer 12

Compare the implied cross rate (calculated from two pairs) with the quoted cross rate. If different, arbitrage exists. Execute trades clockwise or anticlockwise to lock in profit, remembering “up the bid and multiply” or “down the ask and divide”.

Question 13

What is the difference between spot and forward exchange rates?

Answer 13

Spot rate is for immediate delivery (usually T+2 days). Forward rate is for delivery at a specified future date.

Question 14

How do you calculate the forward premium/discount?

Answer 14

(Forward Rate / Spot Rate) - 1. Annualized = Premium/Discount x (360 / Forward Period).

Question 15

What is Covered Interest Rate Parity (CIRP)?

Answer 15

A no-arbitrage condition where the forward exchange rate equals the spot rate adjusted by the interest rate differential: Forward=Spot×(1+rbase​×360days​)(1+rprice​×360days​)​. Bound by arbitrage.

Question 16

What is Uncovered Interest Rate Parity (UIRP)?

Answer 16

An expectation-based condition where the expected percentage change in the spot exchange rate equals the interest rate differential: E(Δ%s)=rprice​−rbase​. Not bound by arbitrage; holds better in the long run.

Question 17

What is Purchasing Power Parity (PPP)?

Answer 17

Exchange rates should adjust to equalize the price of a basket of goods across countries. Relative PPP: %ΔSA/B​≈InflationA​−InflationB​. Violations common in the short run.

Question 18

What is the International Fisher Effect?

Answer 18

Real interest rates should converge across countries, meaning the nominal interest rate differential equals the expected inflation differential: rA​−rB​≈E(InflationA​)−E(InflationB​).

Question 19

What is the Carry Trade?

Answer 19

Borrowing in a low-interest-rate currency and investing in a high-interest-rate currency, betting against UIRP. Profit depends on interest earned minus funding cost plus/minus currency appreciation/depreciation. Performs well in low volatility but has negative skew (crash risk).

Question 20

How do current account deficits affect exchange rates (long term)?

Answer 20

Can lead to depreciation via: 1) Flow Supply/Demand (selling domestic currency received for exports), 2) Portfolio Balance (reducing concentration risk of holding domestic assets), 3) Debt Sustainability (selling assets if debt deemed unsustainable).

Question 21

Explain the Mundell-Fleming model’s predictions (flexible FX, short-term).

Answer 21

High Capital Mobility: Monetary Expansion -> Lower IR -> Outflows -> Depreciation. Fiscal Expansion -> Higher IR -> Inflows -> Appreciation. Low Capital Mobility: Monetary Expansion -> Higher Imports -> Trade Deficit -> Depreciation. Fiscal Expansion -> Higher Imports -> Trade Deficit -> Depreciation.

Question 22

Contrast the Mundell-Fleming, Portfolio Balance, and Monetary approaches.

Answer 22

Mundell-Fleming: Short-term, ignores inflation. Portfolio Balance: Long-term impact of fiscal policy; deficits lead to depreciation eventually. Monetary: Focuses on inflation (PPP); Monetary expansion leads to inflation and depreciation. Dornbusch overshooting considers sticky prices, leading to initial over-depreciation.

Question 23

What are warning signs of a currency crisis?

Answer 23

Liberalized markets, excessive foreign currency bank borrowing, large capital inflows relative to economy size, high M2/Reserves ratio, fixed exchange rate regimes.

Question 24

What are preconditions for economic growth?

Answer 24

Savings/Investment, Financial markets/intermediaries, Free trade/capital flows, Political stability/rule of law/property rights, Education/healthcare, Favorable tax/regulation.

Question 25

What is the Cobb-Douglas Production Function?

Answer 25

Y=A×F(K,L), often Y=AKαL1−α, where Y=Output, A=Technology (TFP), K=Capital, L=Labor. Assumes constant returns to scale and diminishing marginal productivity of inputs.

Question 26

How is potential GDP growth decomposed using the production function approach?

Answer 26

Growth Rate in Potential GDP = Long-term growth rate of technology (TFP) + (α× Long-term growth rate of capital) + ((1−α)× Long-term growth rate of labor).

Question 27

How is potential GDP growth decomposed using the labor productivity approach?

Answer 27

Potential GDP Growth = Long-term labor force growth rate + Long-term labor productivity growth rate.

Question 28

What factors contribute to labor supply growth?

Answer 28

Population growth, Labor force participation rate, Net migration, Average hours worked.

Question 29

What factors contribute to labor productivity growth?

Answer 29

Capital deepening (increasing capital per worker, K/L) and Technological progress (TFP growth, A).

Question 30

How does capital deepening affect growth in developed vs. developing economies?

Answer 30

Due to diminishing marginal productivity of capital, capital deepening has a weaker effect on growth in developed economies (which have high K/L) compared to developing economies (low K/L).

Question 31

Contrast Classical, Neoclassical, and Endogenous Growth Theories.

Answer 31

Classical: Growth limited by population outpacing resources; income reverts to subsistence. Neoclassical: Growth driven by capital deepening, labor growth, and exogenous technology; convergence expected. Endogenous: Technological progress is endogenous, driven by investment in human capital/R&D; growth can be permanent.

Question 32

What is the difference between absolute and conditional convergence?

Answer 32

Absolute: Poorer countries will eventually catch up to richer ones (same steady state). Conditional: Countries converge to their own steady states, which depend on factors like savings rate, population growth. Club: Convergence occurs within groups ("clubs") of countries with similar institutional features.

Question 33

How does opening an economy affect growth?

Answer 33

Can increase growth via: increased investment (FDI), larger markets (economies of scale), technology transfer (TFP gain), increased competition (efficiency), focus on comparative advantage.