Introduction to IB chapter 7 Flashcards
Purchasing Power Parity hypothesis (PPP)
The idea that, in the long run, the same basket of goods should cost the same in different countries when prices are adjusted for exchange rates (law of one price)
Relative PPP hypothesis
The idea that changes in exchange rates will reflect the difference in inflation rates between two countries
interest rate parity
The idea that after considering exchange rates, the interest rates in two different currencies should be equal
Spot market rate
Exchange rate used for immediate currency exchanges
Forward transaction
Currency exchange typically set for future delivery e.g. 30, 60, 90 days
Balance of payments (BoP)
A record of all the financial transaction a country makes with other countries, including trade in goods, services and capital
Current account (of the BoP)
A part of the BoP that tracks a country’s exports and imports of goods and services
Capital and financial account (of the BoP)
The part of the BoP that tracks the buying and selling of financial assets like stocks, bonds and investments
Bandwagon effect
A phenomenon in which investors move together as a herd in the same direction at the same time
Capital flight
When a large number of people and companies move their money out of a country by exchanging their local currency for a foreign currency, often due to economic instability or fears of losing value
Gold standard
a system where the value of most major currencies was linked to a specific amount of gold, making gold the common measure of value
Bretton Woods system
A system where all currencies were fixed at a set rate to the US dollar, which was itself tied to gold
World Bank
Provides loans for specific projects in developing countries to support their economic development
International Monetary Fund (IMF)
An international organization that helps countries with financial problems by providing monetary support and promoting economic stability
Floating (or flexible) exchange rate policy
A government’s choice to allow the value of its currency to be determined by supply and demand in the market
Managed float
A common approach where the government occasionally intervenes in the market to influence exchange rates
Free float
A system where exchange rates are set entirely by market forces, without any government interference
Pegged exchange rate
An exchange rate where a currency’s value is tied to another currency’s value
Crawling band
A policy that keeps the exchange rate within a certain range that can change over time
Currency board
An authority that issues money that can be exchanged for a key foreign currency at a fixed rate
Strategic hedging
Arranging business activities so that the currencies used for income and expenses are aligned
Currency hedging
A transaction that protects traders and investors from losses caused by changes in exchange rates
Currency risk diversification
Lowering overall financial risk by using multiple different currencies in transactions
Currency swap
A deal between two companies to exchange currencies now and agree to switch back to the original currency at a specific time in the future
Spread
The difference between the price at which a currency can be bought (bid rate) and the price at which it can be sold (offer rate)
