Economics Flashcards
Real Exchange rate q FC/DC
The real exchange rate qFC/DC equals the ratio of the domestic price level expressed in the foreign currency to the foreign price level. qFC/DC = SFC/DC × (PDC/PFC)
The real exchange rate qFC/DC is an increasing function of the domestic price level. If the domestic price level rises, domestic income will also increase (assumption), so domestic citizens will be able to purchase more foreign goods.
The distribution of carry trade returns most closely resembles:
The “crash risk” of carry trades implies a fat-tailed distribution skewed toward a higher probability of large losses (compared with a normal distribution).
The negative skew and fat tails indicate that carry trades have tended to have more frequent and larger losses than would have been experienced had the return distribution been normal.
A negative risk reversal quote on the USD/GBP exchange rate would most likely confirm which of the following trends?
A negative risk reversal quote indicates that put options on the base currency are more expensive than call options. This indicates that the market is attaching a higher probability to a large depreciation of the base currency.
Weakening GBP
An emerging-market country with a fairly-valued currency faces an unwanted surge in capital inflows. If inflation is a concern in the emerging market, which of the following policy responses by the central bank is most likely to be appropriate?
Sterilizing intervention
Since the currency is not deemed to be undervalued, policymakers will want to intervene to avoid strengthening the currency to overvalued levels and a subsequent potential crash. Hence, the first option is incorrect. The central bank should intervene by loosening monetary policy to lower interest rates and discourage capital flow into the country. Given that inflation is a concern, the central bank should carry out sterilization of the excess liquidity introduced to the market by selling domestic securities to the private sector so that excess liquidity does not stoke inflation.
Information Frictions
Information frictions include adverse selection (private information in the hands of some, but not all market participants) and moral hazard (incentive conflict from the delegation of duties that will affect the behavior of one party to the detriment of another party)
Externalities
The benefits of the production of a public good can affect regulatory policy, they are not issues with information frictions
Regulations are necessary and are extensive due to the consequences of failures in the financial system that can include what?
financial losses, loss of confidence, and disruption of markets, among other outcomes
independent regulator
it is recognized by government regulator but is not a government agency itself.
Self regulating organization
it is an independent body that represents and regulates its members
Regulatory competition
it results in competition between regulators to attract specific entities
Macroeconomic balance
estimates by how much the exchange rate must adjust to close the difference between the country expected current account imbalance and the country’s sustainable current account imbalance
Reduced form economic model
estimates that equilibrium path of exchange rate movements based on the trends of several key macroeconomies variables, such as trade balance, net foreign asset/liability, and relative productivity
Regulations can be classified as: Statutes, administrative regulations, judicial law
Statutes: are laws made by legislative bodies
Administrative regulations: are rules issued by government agencies or other bodies authorized by the government
Judicial law: are the findings of the court
Sunset provision
it provides for the automatics removal of an implemented regulation after a number of years. A sunset provision requires to undertaken a new cost and benefit analysis to justify the continuation of the regulations
