Exchange Rates, capital flows, balance of payments

Question 1

The Nominal Exchange Rate (e)

Answer 1

The price of one currency in terms of another currency

• The amount of foreign currency that can be bought with one unit of the domestic currency.
• The amount of domestic currency needed to buy one unit of foreign currency.

Question 2

The real exchange rate

Answer 2

The price of a domestic good or service relative to the price of an equivalent foreign good or service, when the prices are expressed in terms of a common currency.
(P / pf/e) or eP / Pf
- Price of domestic good in domestic currency over price of foreign good in domestic currency

Question 3

The supply of euro is upward-sloping because…

Answer 3

…an increase in the number of dollars offered for each euro makes US goods, services and assets more attractive to European buyers.

Question 4

The demand for euro is downward-sloping because…

Answer 4

…holders of dollars will be less willing to buy euro the more expensive they are in terms of dollars.

Question 5

The fundamental value of the exchange rate

Answer 5

The equilibrium rate, e*

Question 6

Reasons for an increase in supply of euro

Answer 6

1. An increased preference for American goods.
2. An increase in income in European countries.
3. An increase in the interest rate of American assets.

Question 7

Reasons for an increase in demand for euro

Answer 7

1. An increased preference for European goods.
2. An increase in income abroad.
3. An increase in the interest rate on European assets.

Question 8

Flexible Exchange Rate

Answer 8

When an exchange rate is not officially fixed but varies according to the supply of and the demand for the currency in the foreign exchange market.

Question 9

Fixed Exchange Rate

Answer 9

An exchange rate whose value is set by official government policy and maintained through interventions by the central bank.

Question 10

Foreign Exchange Market

Answer 10

The market on which currencies of various nations are traded for one another.

Question 11

Devaluation

Answer 11

• A reduction in the official value of a currency.

Question 12

Revaluation

Answer 12

• An increase in the official value of a currency.

Question 13

Overvalued Exchange Rate

Answer 13

• An exchange rate that has an officially fixed value greater than its fundamental value.
  e dash > e*

Question 14

Undervalued Exchange Rate

Answer 14

• An exchange rate that has an officially fixed value less than its fundamental value.
  e dash < e*

Question 15

A speculative attack

Answer 15

A massive selling of domestic currency assets by financial investors