Lecture set 2

Question 1

What is E defined as?

Answer 1

Nominal exchange rate between two currencies

Question 2

Changes in E can have effects on global trade and capital flows. Changes can arise to 3 factors, which are they?

Answer 2

1. Domestic interest rate R
2. Foreign interest rate R*
3. Expected future exchange rate E^e

Question 3

If E goes up what happens to foreign currency?

Answer 3

Foreign currency appreciates and domestic currency depreciates relative to foreign.

Question 4

WHat happens to the price of imports if E goes up for domestic?

Answer 4

Imports are more expensive

Question 5

Who are the primary traders?

Answer 5

Large international banks
Large international coorperations
Large international investment groups
Central banks

Question 6

What are market characteristics?

Answer 6

Global currency markets are “over the counter”
Markets for large currencies operate 24/7-liquid markets.
Different finance centers
There are Veichle currencies. *

Question 7

There are 3 types of markets, which?

Answer 7

1. Spot markets (it’s here E is)
2. Forward markets
3. Swap markets

Question 8

If you trade two currencies against the same you can calculate the cross-currency, how?

Answer 8

Ecc=E2/E1

Question 9

The demand for an asset is a function of?

Answer 9

1. Expected return
2. Risk
3. Liquidity

Question 10

When the risk of an asset goes up, the demand goes?

Answer 10

Down

Question 11

The longer it takes to sell an asset, i e the less liquid it is, the more

Answer 11

Increased risk.

Question 12

We assume that assets has the same liquidity and risk, thus becoming perfect substitutes except for what?

Answer 12

Currency denomination.

Question 13

If these two assets are identical, what will be true in equilibrium?

Answer 13

The LOOR, R=R*+Ee-E/E which is the UIPC

Identical assets offer identical return

Question 14

How is the CIPC showed?

Answer 14

R=R*+F-E/E risk is killed off with forward contract.

Question 15

What will increase expected return on foreign investments?

Answer 15

R* and/or Ee goes up

Question 16

What if R increase and total return on a domestic investment. Say Money Supply Ms goes down via CB that push up domestic interest rates, then R>R*+Ee-E/E, what does this trigger?

Answer 16

Thris will trigger capital movement out of foregin in to domestic, there is immediate pressure for E do go down.

Question 17

If R goes up, E goes?

Answer 17

Down

Question 18

If R* goes up, E goes?

Answer 18

Up, this because if foreign assets more attractive, foreign currency is too.

Question 19

If Roi is equal to zero, what does it mean about how risky the asset is?

Answer 19

Means that the assets are equally risky if roi=0, they are perfect substitutes and UIPC holds

Question 20

If roi is bigger than zero

Answer 20

The domestic asset is riskier

Question 21

If roi is less than zero

Answer 21

Domestic asset is less risky.

Question 22

If roi increase, what happens to demand and E?

Answer 22

Demand goes down, E goes up.

Question 23

Why might roi change?

Answer 23

S-I=X-M
Investment activity
Changes in terms of risk ie. investment risk corrupt govt

Question 24

CIPC is not an?

Answer 24

Arbirage condition

Question 25

What does CIPC assume?

Answer 25

1. High capital mobility
2. active spot(E) and forward(F) markets, that are liquid
3. No taxes
4. Identical assets

Question 26

What if the CIPC assumptions does not hold, what will too not hold?

Answer 26

The LOOR

Question 27

If F>E then what is true for R and R*?

Answer 27

R>R*

Question 28

If F

Answer 28

R