IMF Chapter 8

Question 1

What is a open market operation (OMO)?

Answer 1

The exchange of the domestic money base for domestic bonds or vise verse as a means of influencing the exchange rate.

Question 2

What is a foreign exchange operation (FXO)?

Answer 2

The exchange of the domestic money base for foreign bonds

Question 3

What is (non) sterilized intervention in the foreign exchange market?

Answer 3

(not) Affecting the domestic money supply as a means of influencing the exchange rate (by sterilization)

Question 4

What is a sterilized foreign exchange operation (SFXO)?

Answer 4

Exchanging domestic bonds for foreign bonds and leaving the domestic base unchanged. Represents the difference between FXO and OMO

Question 5

What is Risk premium?

Answer 5

It is the additional expected return on relatively risky as compared to the less risky variety

Question 6

What are the conditions such that risk premium exists?

Answer 6

1. Perceived differences in risks between domestic and foreign bonds
2. Risk aversion on the part of economic agents to the perceived differences in risk
3. There should be a theoretical portfolio known as the risk-minimizing portfolio that minimizes the risks facing private agents

Question 7

Will the UIP hold in the existence of risk premium?

Answer 7

No

Question 8

What are the two types of risks?

Answer 8

Currency risk and country risk

Question 9

What are the different types of risks associated with currency risk?

Answer 9

inflation risk and exchange risk

Question 10

What are the different types of risks associated with country risk?

Answer 10

Exchange control risk, default risk and political risk

Question 11

What is the formula for risk premium?

Answer 11

RP = f - Es