Exam 2 part 2 Flashcards
Uncovered/Covered Interest Rate Parity
UIRP/CIP
Interest rate differentials determine spot exchange rate
Forward rate should be a good predictor of the future exchange rate
Results only hold when countries are similar in political risk
-If assets denominated in a foreign currency are viewed as risky, they will carry relatively higher interest rates
-Capital mobility is also required
Properties of Random walks
The value of the series at a particular time is the sum of its errors
Constant mean, since the errors have a 0 mean.
Variance grows over time
Distribution changes over time
Nothing can be gleaned regarding future conditions
Random walk
-A time series that is determined solely by its previous value and some random error.
-Yt = Yt-1 + Et
-Movements appear to be random, and it is impossible to predict future values.
-RW’s have no deterministic component and are driven entirely by stochastic forces.
-Examples:Prices and Stock Market
Exchange rates are like a what?
random walk
Forex Market
Foreign currencies are traded against each other in the foreign exchange market.
The exchange rate is commonly presented as (e or s)=DC/FC.
-So if s increases, There is more DC per unit of FC, and the DC depreciates relative to the FC.
-If s decreases, the DC has appreciated relative to the FC.
Floating Exchange Rates
the relative value of fiat monies are determined by the foreign exchange market, where they are traded.
Fixed Exchange Rates
anchor the value of currencies
Under commodity standards currencies were traded according to their precious metal content.
How are current account deficits possible?
If income exceeds spending, the nation is saving more than is needed to finance investment spending. It can lend internationally.
If spending exceeds income, the nation is saving less than is needed to finance investment spending. It must borrow internationally.
What does current account deficits mean?
The current account measures the difference between spending and income.
The current account allows us to see whether the country is “living beyond its means” in any period.
Trade Deficit
exports < imports
net exports < 0
Y < C + I + G
saving < investment
net capital outflow < 0
Balanced Trade
exports = imports
net exports = 0
Y = C + I + G
saving = investment
net capital outflow = 0
Trade Surplus
exports > imports
net exports > 0
Y > C + I + G
saving > investment
net capital outflow > 0
If there is a trade deficit…
CA<0
Then there must be capital inflows from the ROW to equalize BOP
If there is a trade surplus…
CA>0
Then there must be capital outflows to the ROW to equalize BOP
