Economics Flashcards
Spot exchange rate settlement time
T + 2 settlement
Currency prices quotations
The base currency is the one being bought or sold in units of the price currency
Price / Basebid (seller)
- Sells price @
- Buys base @
Price / Basebid (buyer)
- Buys price @
- Sells base @
Price / Baseoffer (seller)
- Buys price @
- Sells base @
Price / Baseoffer (buyer)
- Sells price @
- Buys base @
Covered interest rate parity - formula a
Covered interest rate parity - formula b
Forward premium/discount - formula
Forward premium on the domestic currency
The domestic currency will trade at a forward premium (Ff/d > Sf/d) if, and only if, the foreign risk-free interest rate exceeds the domestic risk-free interest rate (if > id)
Mid-market spot rate
Used for FX transactions
Uncovered interest rate parity expected return
The expected return on an uncovered foreign currency investment should equal the return on a comparable domestic investment
Uncovered interest rate parity condition in terms of the expected change in the exchange rate
Return on a uncovered investment formula
- PPP
- Absolute
- Relative
- Ex ante
- Purchasing power parity
- Reflects national price levels
- Reflects actual inflation levels (observed for 3 to 5 years horizons)
- Reflects expected inflation levels
Relative version of PPP
- The percentage change in the spot exchange rate (%ΔSf/d) will be completely determined by the difference between the foreign and domestic inflation rates (πf – πd)
- %ΔSf/d ≅ πf − πd
The ex ante version of PPP
The ex ante version of PPP focuses on expected changes in the spot exchange rate being entirely driven by expected differences in national inflation rates
%ΔSef/d = πef − πed
International Fisher effect
- The nominal interest rate (i ) in a given country is composed of two parts: (1) the real interest rate in that particular country (r) and (2) the expected inflation rate (πε) in that country
- The f/d yield will be solely determined by f/d expected inflation differential
- if − id = πεf − πεd
The international Fisher effect must satisfy this relation
Real exchange rate - formula
Real exchange rate with explicit risk premium formula
- ( q overline)f/d = long-run equilibrium value
- r = real exchange rate
- phi = risk premium
Real interest rate parity condition
Real interest rates will converge to the same level across different markets
Long-term exchange rate convergence
Gravitate toward their PPP equilibirum value
If uncovered interest rate parity holds, then the nominal interest rate spread (if – id) equals the expected change in the exchange rate ( %ΔSef/d). Similarly, if ex ante PPP holds, the difference in expected inflation rates ( πεf−πεd) also equals the expected change in the exchange rate. Assuming that both uncovered interest rate parity and ex ante PPP hold leads to
- Covered interest rate parity (forward exchange rates are a function of)
- Uncovered interest rate parity (the expected future spot rate is a function of)
- Forward exchange rates are a function of current spot rates. Abitrage locks the foward price
- The expected future spot rate is a function of the current spot rate and the interest rates of each currency
Under low capital mobility
- Uniformly restrictive fiscal / monetary policy
- Uniformly expansionary fiscal / monetary policy
- Bullish - tends to lead to an improvement in the trade balance
- Bearish - tends to lead to a deterioration of the trade balance
Under high capital mobility
- Restrictive fiscal policy / expansionary monetary policy
- Expansionary fiscal policy / restrictive monetary policy
- Bearish - capital will flow out
- Bullish - capital will flow in
The Dornbusch Overshooting Model
A modified monetary model of the exchange rate that assumes output prices exhibit limited flexibility in the short run but are fully flexible in the long run
Mundell - Fleming theory
- The Mundell–Fleming model portrays the short-run relationship between an economy’s nominal exchange rate, interest rate, and output (in contrast to the closed-economy IS-LM model, which focuses only on the relationship between the interest rate and output)
- The model focuses only on aggregate demand. Thus, the implicit assumption is that there is sufficient slack in the economy to allow changes in output without significant price level or inflation rate adjustments
Monetary–Fiscal Policy Mix and the Determination of Exchange Rates under Conditions of Low Capital Mobility
Monetary–Fiscal Policy Mix and the Determination of Exchange Rates under Conditions of High Capital Mobility
Quantity theory
Money supply changes are the primary determinant of price level changes
Taylor’s rule - formula
Taylor’s rule - notation
- i = the Taylor rule prescribed central bank policy rate
- rn = the neutral real policy rate
- π = the current inflation rate
- π* = the central bank’s target inflation rate
- y = the log of the current level of output
- y* = the log of the economy’s potential/sustainable level of output
Taylor’s rule - response coefficients
- Alpha (α) and beta (β)
- As long as alpha and beta are both positive—Taylor proposed that alpha and beta each equal 0.5—the Taylor rule prescribes that the policy rate should rise in real terms relative to its neutral setting in response to positive inflation and output gaps (and fall in response to negative inflation and output gaps)
Portfolio balance approach
Global investors are assumed to hold a diversified portfolio of domestic and foreign assets, including bonds. Their desired allocation is assumed to vary in response to changes in expected return and risk considerations
The Short- and Long-Run Response of Exchange Rates to Changes in Fiscal Policy
ERM
European rate mechanism
- ERM crisis
- Mexican peso crisis
- Asian financial and currency crisis
- Fall of 1992
- Late 1994
- 1997 - 1998
Unsterilized Foreign Exchange Intervention
- An attempt by a country’s monetary authorities to influence the domestic currency exchange rate by not buying or selling domestic or foreign currencies
- The monetary base is allowed to change
- Is used when inflation is not a concern
Sterilized Foreign Exchange Intervention
- An attempt by a country’s monetary authorities to influence the domestic currency exchange rate
- There is no change in the monetary base
- Is used when inflation is a concern
Risk reversal
A risk reversal is a currency option position that consists of the purchase of an out-of-the-money (25 delta) call and the simultaneous sale of an out-of-the-money (25 delta) put, both on the base currency in the P/B exchange rate quote and both with the same expiration date
CFTC
Commodity Futures Trading Commission
Carry trade
- Borrow in the lower yielding currency and invest in the higher one
- The leverage magnifies the effect of gains and losses
OECD
Organisation of Economic Co-Operation Development
Aggregate value of equity
- P represents aggregate value (price) of equities
- E represent aggregate earnings
Logarithmic rates of change of aggregate value of equity
Two-factor aggregate production function
- Y = AF(K,L)
- A = Total factor productivity (TFP)
- Y = Level of aggregate output
Cobb-Douglas production function
Marginal production of capital (MPK) for the Cobb-Douglas function
The marginal product of capital is simply the derivative of output with respect to capital
It can be approximated as ΔY/ΔK ≈ [A(K + ΔK)αL1–α – AKαL1–α] / ΔK ≈ [AαKα–1ΔKL1–α] / ΔK = AαKα–1L1-α = αY/K. The approximation becomes exact for very small increments of ΔK
Profit maximization requires that:
- the marginal product of capital equals
- the marginal product of labor equals
- the rental price of capital
- the real wage rate
Constant returns to scale
- The condition that if all inputs into the production process are increased by a given percentage, then output rises by that same percentage
- The Cobb-Douglas function exhibits constant return to scale
Capital deepening
Increase in the capital-to-labor ratio
The Solow growth accounting equation
- alpha = output elasticity of capital
- 1 - alpha = output elasticity of labor
- ΔA/A = growth in total factor productivity
GDP growth rate (growth accounting equation)
= growth rate in TFP + alpha (long-term growth rate of capital) + (1 - alpha) (long-term growth rate of labor)
Human capital
The accumulated knowledge and skills that workers acquire from education, training, or life experience
- Labor force
- Labor force participation rate
- The working age population (ages 16 to 64) that is either employed or available for work but not working (i.e., unemployed)
- The percentage of the working age population in the labor force
Labor productivity growth accounting equation
Growth rate in potential GDP = Long-term growth rate of labor force + Long-term growth rate in labor productivity
Dutch disease
The currency appreciation driven by strong export demand for resources makes other segments of the economy globally uncompetitive
Neoclassical model
- Based on the Cobb-Douglas production function
- Equilibrium position → steady state rate of growth
- Theorised by Robert Solow
- Exogenous model
- Assumes that all countries have access to the same technology and per capital income shoud eventually grow at the same rate in every country
ICT
Information and communication technologies
Steady state rate of growth
Solow model - equilibrium toward wich the economy will move when the output-to-capital ratio is constant
Sustainable growth rate of output
Equilibrium output-to-capital ratio
- theta - growth of TFP
- delta - rate of depreciation of the physical capital stock
- n - ΔL/L
Equilibrium output-to-capital ratio - savings/investment formula
alpha (proportion of GDP paid to the supplier capital; income share of capital)
1 - alpha (proportion of income paid to labour; income share of labour )
Endogenous models
- These models focus on explaining technological progress rather than treating it as exogenous
- Self-sustaining growth emerges as a natural consequence of the model and the economy does not necessarily converge to a steady state rate of growth
- Unlike the neoclassical model, there are no diminishing marginal returns to capital for the economy as a whole
Endogenous production function
c = constant marginal product of capital
Endogenous growth model function
Absolute convergence
Developping countries will eventually catch up with developped countries
Conditionnal convergence
Only developping countries with the same saving rate, population growth rate and production function will eventually catch up with developped cou
Club convergences
Only certains countries will converged to the level of developped countries
Non-convergence trap
Policies that with cause a failure to converve
Financial Industry Regulatory Authority (FINRA)
Independant regulator of securities firm doing business in the US
- Substantive laws: focus on the rights and responsabilities of entities and relationships among entities
- Procedural laws: focus on the protection and enforcement of the substantive laws
Statute: Law enacted by a legislative body (Dodd-Frank Act)
Regulatory capture
Theory that regulation often arises to enhance the interests of the regulated
Informational frictions
Forces that restrict availability, quality, and/or flow of information and its use
Classical model
- GDP will settle at subsistence level
- Population growth will cause decreased return to labor and decreased labor productivity
Neoclassical capital deepening effects
- Increase the level of output but not the growth rate in the long run
- Once an economy reaches the steady-state rate of growth, only technological progress will increase the growth rate
Mark-to-market
- Take the spot rate and add/subtract the forward basis points difference
- Take the initial forward rate and subtract the result found above
- Multiply by the notional of the forward and actualize the difference
Growth due to total factor productivity (TFP)
= growth in labor productivity - growth in capital deepening
FX carry trades closing signals
- The volatility implied by market prices of options on equities or currencies is high
- Signals given by trading rules trend
GDP and interest rates
An increase in real GDP will cause an increase in interest rates and vice versa
Self-regulating organizations most important characteristic (SRO)
They should be properly supervised by the government
