Lecture 9

Question 1

When did fixed exchange rates end?

Answer 1

1971 (weakened)
1973 (abandoned)

Question 2

What does a stronger £ mean for UK exporters?

Answer 2

They become less competitive

Question 3

What does a weaker £ mean?

Answer 3

• Imports are more expensive
• Increases inflation

Question 4

What does EMU stand for?

Answer 4

Economic & Monetary Union

Question 5

What are the main activities in FX markets?

Answer 5

• Trade transactions (1%)
• International investment flows
• Hedging
• Speculation

Question 6

What does PPP stand for?

Answer 6

Purchasing power parity

Question 7

What is purchasing power parity?

Answer 7

An attempt to determine if currencies are over- or under-valued

Question 8

The underlying concept of purchasing power parity is…

Answer 8

the law of one price

Question 9

True or false: absolute PPP generally holds

Answer 9

False - exchange rates consistently diverge from absolute PPP values

Question 10

What is relative PPP?

Answer 10

Calculates ‘real exchange rate’

Question 11

What is the ‘real exchange rate’?

Answer 11

Market exchange rate adjusted for differences in inflation

Question 12

How effective is relative PPP?

Answer 12

Somewhat helpful in long term, not very helpful in short term

Question 13

What accounts for the ineffectiveness of PPP?

Answer 13

Imports & exports account for a very small proportion of FX turnover

Question 14

What are risks associated with FX?

Answer 14

• Transaction risk
• Translation risk
• Economic exposure

Question 15

What is transaction risk?

Answer 15

Exchange rate movements alter price of buying / selling abroad

Question 16

What is translation risk?

Answer 16

£ value of assets / liabilities changes on balance sheet

Question 17

What is the risk of economic exposure to FX markets?

Answer 17

Even if you don’t import/export, shifts can make foreign competitors more competitive

Question 18

What are some examples of behavioural biases?

Answer 18

• Overconfidence
• Confirmation bias
• Hindsight bias
• Attribution bias

Question 19

How does the disposition effect manifest?

Answer 19

Closing profitable positions, keeping loss-making positions open

Question 20

What is the endowment effect?

Answer 20

Overvaluing assets you already own

Question 21

What is prospect theory?

Answer 21

Investors are sensitive to framing / use acquisition price as reference value

Question 22

What are examples of heuristics?

Answer 22

• Anchoring
• Social proof
• Halo effect
• Availability bias