FX Markets and Exchange Rates

Question 1

What is the FX market?

Answer 1

Forward-looking traders with rational expectations who attempt to profit from arbitrage opportunities.

Question 2

What does the FX market do?

Answer 2

Connects interest rates and exchange rates, and affects the economy’s reaction to shocks.

Question 3

Define Nominal Exchange

Rate

Answer 3

The rate at which one currency is traded with that of another.

e= number of units of home currency/ 1 unit of foreign currency.

Question 4

What does a rise in e mean?

Answer 4

A nominal home currency depreciation.

Question 5

Define Real Rate

Answer 5

Takes into account price differences between countries.

Q= price of foreign goods in home currency/ price of home goods.

p*e/p

Question 6

What does Q measure?

Answer 6

Q measures price competitiveness.

If Q rises, then this will boost net exports as home goods become cheaper relative to foreign goods.

Caused by a fall in P, rise in P* or a rise in e