International finance prep. Flashcards
what is Foreign exchange reserves?
assets held on reserve by a central bank in foreign currencies.
size of Foreign exchange reserves?
In 2019, global currency reserves amounted to approximately 11.8 trillion U.S. dollars.
composition of Foreign exchange reserves?
1- US, 2-Euro, 3-Chinese renminbi
first Foreign exchange reserves?
sterling pound
problem with a dominant Foreign exchange reserves?
The term exorbitant privilege refers to the benefits the United States has due to its own currency being the international reserve currency.
what does Foreign exchange reserves tell about a country? 2
1- ability to pay foreign debt
2- defend their national currency
what is Financial globalization?
—the phenomenon of rising cross-border financial flows
When did Financial globalization originate?
the Bretton Woods System and liberalization of capital
Effects of Financial globalization? 3
1- removal of government restrictions on the mobility of capital
2- The importance of the financial sector in all national economies that participate in the global financial markets has increased
3- the scale and frequency of financial crises especially banking crises have increased
Pros of financial globalization? 4
1- “deeper degree of financial integration”
2- further market stability and regulation, strengthening investors’ trust in a given country’s market
3- larger pool of investors and businesses
4- Advances the financial infrastructure
Cons of financial globalization? 4
1- Even if capital inflows have been related with substantial growth rates in several developing nations, most of them have faced periodic collapses in growth rates and critical financial crunches → significant macroeconomic and social costs
2- Higher risk of global financial crisis (World crisis 2008)
3- Division that can be created between those capable of participating in the world financial system and those that must depend on local segments
4- Despite the fact that globalization boosts free tarde amidst nations, some nations attempt to save their countrywide markets
what is capital flight
is a large-scale exodus of financial assets and capital from a nation due to events such as political or economic instability, currency devaluation or the imposition of capital controls.
Effects of capital flight? 3
1-Lower investment
2-Lower tax revenue
3-Weakened currency
Strategies to deal with capital flight?
1- Instituting capital controls restricting the flow of their currency outside the country.
2- making it expensive to transfer large sums of cash across borders
3- Raising interest rates to make local currency attractive for investors.
Example of capital flight
In 2014, Russia annexed Crimea. The result was a list of heavy sanctions imposed by the West which cost Russia billions. The economic uncertainty and political risk meant that investors left the country in their droves, with $150 billion lost in capital flight in 2014 alone.
what is Illicit financial flows
a form of illegal capital flight that occurs when money is illegally earned, transferred, or spent.
what is monetary policy?
policy pursued by the central bank
what are the two monetary policies?
Expansionary monetary policy - to increase economic growth.
Contractionary monetary policy - slow growth of money, cool down economy
tools of monetary policies? 4
1- Interest rates
2- Foreign Reserves
3- Reserve requirements: when requirements are strict then banks are less able to provide money.
4- Sale of bonds ( buying bonds injects money into the economy)
what is fiscal policy?
policy pursued by the government to keep econ healthy
goal of fiscal policy?
stimulate demand, increase production, create jobs, increase GDP, avoid recessions, control inflation, and stabilise economic growth.
what are the two fiscal policies?
1- Expansionary fiscal policy - designed to stimulate the economy, is most often used during a recession, times of high unemployment or other low periods of the business cycle. It entails the government spending more money, lowering taxes or both.
2- Contractionary fiscal policy - used to slow economic growth, such as when inflation is growing too rapidly. The opposite of expansionary fiscal policy, contractionary fiscal policy raises taxes and cuts spending. As consumers pay more taxes, they have less money to spend, and economic stimulation and growth slow.
what are the fiscal tools?
Taxes influence the economy by determining how much money the government has to spend in certain areas and how much money individuals should spend. For example, if the government is trying to spur spending among consumers, it can decrease taxes. A cut in taxes provides families with extra money, which the government hopes will, in turn, be spent on goods and services, thus spurring the economy as a whole.
Spending is used as a tool for fiscal policy to drive government money to certain sectors needing an economic boost. Whoever receives those dollars will have extra money to spend – and, as with taxes, the government hopes that money will be spent on other goods and services.
what is the gold standard about?
all paper money can be converted into gold;
who was the strongest under gold standard?
UK COS THEY MINED A LOT
WHEN DID GOLD STANDARD BEGIN?
EARLY 1870
When did the rest of the world start using gold standard?
19th. century
what was the period called after gold standard and during war period?
transition period
when did Bretton wood system emerge?
1944 after the Great Depression
what was Bretton system about?
The Bretton Woods System required a currency peg to the U.S. dollar which was in turn pegged to the price of gold.
when did Bretton system go to shit?
in the 1960s the economy slowed down and in 1971 collapsed
what was after Bretton wood system?
Jamaican agreement
when was the Jamaican agreement
1976
what was the when was the Jamaican agreement about?
Since 1974, all major currencies (the dollar, the pound sterling, the German mark, the yen, the French franc) have floated freely in relation to each other. In the same year, “Special Drawing Rights” (the “SDR basket”) has become the new standard of value of the currency.
what are free floating currencies
is a regime where the currency price of a nation is set by the forex market based on supply and demand relative to other currencies.
what is risky about pegging?
Pegging currency to limited resources is risky and to another currency as well due to dependency on other economies you have no influence on.
advantages of gold standard? 3
1- Allows for long-term price stability
2- indepence from pegging to a currency
3- Reducing the uncertainty of international trade.
disadvantages of gold standard? 3
1- Benefiting countries that produce gold. Gold is rare. Not all countries have gold mines.
2- Limits the economy’s ability to grow. demand is not met
3- Monetary policy is useless for stabilizing the economy. Under the standard, the gold supply determines the money supply.
Why did the attempt to restore the gold standard in the interwar period fail? 3
1- the 1920s and 30s saw frequent recessions and banking crises
2- there was a leadership vacuum in the international regime
3- absence of policy cooperation, each country became selfish.
Why was the gold standard abandoned?
Too much demand for gold and not enough of it enough during the great depression
Major Types of Financial Institutions? 6 + 1
- Central Banks: are the financial institutions responsible for the oversight and management of all other banks.
- Retail and Commercial Banks: worked directly with businesses. Currently, the majority of large banks offer deposit accounts, lending.
- Internet Banks: A newer entrant to the financial institution market is internet banks, which work similarly to retail banks.
- Investment Banks: inancial institutions that provide services and act as an intermediary in complex transactions, for instance, when a startup is preparing for an initial public offering (IPO), or in merges. Goldman Sachs,
- Brokerage Firms: assist individuals and institutions in buying and selling securities among available investors.
- Insurance Companies: help individuals transfer the risk of loss are known as insurance companies.
- Mortgage Companies specialized in originating or funding mortgage loans are mortgage companies.
10 - European Union and others
What it is a financial crises?
is a situation when asset prices decrease, businesses and consumers are unable to pay their debts, and financial institutions experience liquidity shortages. the bursting of a speculative financial bubble, a stock market crash, a sovereign default, or a currency crisis.
Types of financial crises?
1- banking crisis
2- sudden stop
3- currency crisis
4- debt crisis
what is banking crises
occurs when many banks in a country are in serious solvency or liquidity problems at the same time
what is sudden stop
an abrupt reduction in net capital flows into an economy, especially an emerging economy.
what is currency crisis
any situation in the foreign exchange markets where a currency suddenly and/or unexpectedly loses substantial value relative to other currencies.
what is debt crisis
occurs when a country is unable to pay its bills
why does banking crises happen? 4
1- Bank Run: occurs when many people try to withdraw their deposits at the same time, due to different reasons.
2-Stock Market Loops: One particularly interesting cause of banking disasters is a similar positive feedback loop effect in the stock markets, which was a much more dynamic factor in more recent banking crises (i.e. 2007-2009 sub-prime mortgage disaster).
3- Regulatory Failure: One of the simplest ways in which bank crises can occur is a lack of governmental oversight.
4- Contagion: Due to globalization and international interdependence, the failure of one economy can create something of a domino effect.
Consequences of banking crises domestically ? 2
- reduce economic output and growth.
- investment suffers
Consequences of banking crises globally ? 2
- Imports and exports
- domino effect
example of banking crisis?
Great Depression
reasons for sudden stop?
1- political
2- economic
example of sudden stop?
investors and creditors who had for years financed large balance-of-payment deficits in Portugal, Ireland, Italy, Greece, and Spain (PIIGS)—lost confidence in the fiscal
example of currency crises?
between 2010 and the first quarter of 2018, the Turkish economy grew at a steady pace, and the country’s economy experienced a sustained period of ever-increasing inflation. In addition, during the same period, inflation expectations – i.e., what people thought Turkey’s inflation rate would be in the future – increased significantly as well.
example of debt crises?
when Iceland took over the country’s bank debt, causing the value of its currency to plummet.
How do countries overcome financial crises? 4
- interest rates have to be cut in order to stimulate the economy
- central bank should implement a policy of quantitative easing
- central bank should publicly encourage people and companies to invest money and ensure that they do not lose faith in the system.
- the central bank will have to bail out important financial institutions in crisis to prevent further erosion of the banking system and the economy.
What is the role of WB and IMF in terms of coordinating financial crises? 7
1- increased lending 2- Provide policy advice, 3- provide financing 4- Provide technical assistance to governments 5- Support packages 6- facilitate dialogue 7- identify contingent risks
what is financial reporting?
is the process of documenting and communicating financial activities and performance over specific time periods, typically on a quarterly or yearly basis.
