Introduction to IB chapter 7

Question 1

Purchasing Power Parity hypothesis (PPP)

Answer 1

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)

Question 2

Relative PPP hypothesis

Answer 2

The idea that changes in exchange rates will reflect the difference in inflation rates between two countries

Question 3

interest rate parity

Answer 3

The idea that after considering exchange rates, the interest rates in two different currencies should be equal

Question 4

Spot market rate

Answer 4

Exchange rate used for immediate currency exchanges

Question 5

Forward transaction

Answer 5

Currency exchange typically set for future delivery e.g. 30, 60, 90 days

Question 6

Balance of payments (BoP)

Answer 6

A record of all the financial transaction a country makes with other countries, including trade in goods, services and capital

Question 7

Current account (of the BoP)

Answer 7

A part of the BoP that tracks a country’s exports and imports of goods and services

Question 8

Capital and financial account (of the BoP)

Answer 8

The part of the BoP that tracks the buying and selling of financial assets like stocks, bonds and investments

Question 9

Bandwagon effect

Answer 9

A phenomenon in which investors move together as a herd in the same direction at the same time

Question 10

Capital flight

Answer 10

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

Question 11

Gold standard

Answer 11

a system where the value of most major currencies was linked to a specific amount of gold, making gold the common measure of value

Question 12

Bretton Woods system

Answer 12

A system where all currencies were fixed at a set rate to the US dollar, which was itself tied to gold

Question 13

World Bank

Answer 13

Provides loans for specific projects in developing countries to support their economic development

Question 14

International Monetary Fund (IMF)

Answer 14

An international organization that helps countries with financial problems by providing monetary support and promoting economic stability

Question 15

Floating (or flexible) exchange rate policy

Answer 15

A government’s choice to allow the value of its currency to be determined by supply and demand in the market

Question 16

Managed float

Answer 16

A common approach where the government occasionally intervenes in the market to influence exchange rates

Question 17

Free float

Answer 17

A system where exchange rates are set entirely by market forces, without any government interference

Question 18

Pegged exchange rate

Answer 18

An exchange rate where a currency’s value is tied to another currency’s value

Question 19

Crawling band

Answer 19

A policy that keeps the exchange rate within a certain range that can change over time

Question 20

Currency board

Answer 20

An authority that issues money that can be exchanged for a key foreign currency at a fixed rate

Question 21

Strategic hedging

Answer 21

Arranging business activities so that the currencies used for income and expenses are aligned

Question 22

Currency hedging

Answer 22

A transaction that protects traders and investors from losses caused by changes in exchange rates

Question 23

Currency risk diversification

Answer 23

Lowering overall financial risk by using multiple different currencies in transactions

Question 24

Currency swap

Answer 24

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

Question 25

Spread

Answer 25

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)