Foreign Exchange Market Flashcards
what is Nominal exchange rate (e)?
- price of one unit of a currency in terms of another currency
Trading Markets of currencies: (currency exchange)
- The Interbank Market (large commercial banks)
- The Retail Market (commercial bank act as a broker)
- small-scale currency markets (airports, etc)
what Appreciation mean in the finance world?
- rise in a currency’s price in terms of foreign currency
what is Depreciation ? (currency exchange rate)
- fall in a currency’s price in terms of foreign currency
when dollar appreciate, what happens? (economy)
When the dollar Appreciates:
- Import become less expensive
- Benefits U.S consumers
- Hurts U.S firms that compete with imports
U.S goods became more expensive to foreigners
- Hurts U.S firms that export
Foreign assets became less valuable in dollars
- Hurts U.S owners of foreign assets
Currency Futures and Hedging
- Currency futures work in a way similar to futures contracts for stocks and bonds
- Currency futures are traded on the Reuters and EBS networks
- Same function of risk reduction or “betting”
- Hedgers can’t eliminate exchange rate risk entirely.The use of currency futures is limited because contracts rarely have delivery dates more than 6 months in the future.
Real exchange rate (€)
- measure of the relative prices of domestic and foreign goods ( € = eP/P* )
- This requires that we measure these prices in the same currency.
Trade-weighted real exchange rate :
- weighted average of a country’s real exchange rates, with weights proportional to levels of trade
- A way of evaluating the strength of a country’s currency by weighting its value according to the relative amount of trade carried out with each of its trading partners.
Purchasing power parity (PPP)
- theory of exchange rates based on the idea that a currency purchases the same quantities of goods and services in different countries; implies that real exchange rates are constant over time
The Law of One Price
- theory that an identical good or service has the same price in all locations.
- The theory count trade only across national borders.
definition of arbitrage ?( Law of one price)
- The difference in price between different location creates opportunities for people to make money by buying and selling.
Nominal Exchange Rate formula:
e = P*/P
P = national price (what you want)
P*= Foreign price (compering to )
foreign inflation rate formula :
percentage change in e = pi* - pi
- “pi” stands for the inflation rate
- “pi*“ stand for the percentage change in the inflation rate
supply of dollars formula: (trade)
supply of dollars = imports + capital outflows
Definition Net exports (NX):
- exports minus imports
Definition of Net capital outflows (NCO):
- capital outflows minus capital inflows
Net exports (NX) and Net capital outflows (NCO):
NX = NCO
- NX is positive if exports exceed imports, creating a trade surplus, and negative if imports exceed exports, creating a trade deficit.
- net capital outflows can be either positive or negative
- net exports and net capital outflows must be equal to balance the supply and demand for dollars. (to avoid distorsions)
graph that shows the relationships:
- net exports,
- net capital outflows
- the real exchange rate
Why Do Real Exchange Rates Fluctuate?
- Shifts in net capital outflows because of . . .
- Changes in real interest rates (causes include changes in monetary policy or in budget deficits)
- Changes in confidence
- Changes in expected future exchange rates
- Shifts in net exports because of . . .
- Foreign recessions
- Changes in commodity prices
Shifts in Net Capital Outflows (graph)
How the Changes in Interest Rates affect the exchange rate ?
- factors that influence the real interest rate also affect the real exchange rate
- Examples : government budget deficits, tightening of monetary policy, etc.
Shifts in Net Exports:
what is Order flow ? (dealer markets)
- in a dealer market, the difference between total buy orders and sell orders over some period
Meaning of “Technical analysis”? (Forecast Methods)
- Set of methods for forecasting prices in financial markets based on the past behavior of prices
- more popular in currency markets
- Comparing Averages
- Support and Resistance Levels (mantain between a range above and below its current level)
