Lecture set 2 Flashcards
What is E defined as?
Nominal exchange rate between two currencies
Changes in E can have effects on global trade and capital flows. Changes can arise to 3 factors, which are they?
- Domestic interest rate R
- Foreign interest rate R*
- Expected future exchange rate E^e
If E goes up what happens to foreign currency?
Foreign currency appreciates and domestic currency depreciates relative to foreign.
WHat happens to the price of imports if E goes up for domestic?
Imports are more expensive
Who are the primary traders?
Large international banks
Large international coorperations
Large international investment groups
Central banks
What are market characteristics?
Global currency markets are “over the counter”
Markets for large currencies operate 24/7-liquid markets.
Different finance centers
There are Veichle currencies. *
There are 3 types of markets, which?
- Spot markets (it’s here E is)
- Forward markets
- Swap markets
If you trade two currencies against the same you can calculate the cross-currency, how?
Ecc=E2/E1
The demand for an asset is a function of?
- Expected return
- Risk
- Liquidity
When the risk of an asset goes up, the demand goes?
Down
The longer it takes to sell an asset, i e the less liquid it is, the more
Increased risk.
We assume that assets has the same liquidity and risk, thus becoming perfect substitutes except for what?
Currency denomination.
If these two assets are identical, what will be true in equilibrium?
The LOOR, R=R*+Ee-E/E which is the UIPC
Identical assets offer identical return
How is the CIPC showed?
R=R*+F-E/E risk is killed off with forward contract.
What will increase expected return on foreign investments?
R* and/or Ee goes up
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?
Thris will trigger capital movement out of foregin in to domestic, there is immediate pressure for E do go down.
If R goes up, E goes?
Down
If R* goes up, E goes?
Up, this because if foreign assets more attractive, foreign currency is too.
If Roi is equal to zero, what does it mean about how risky the asset is?
Means that the assets are equally risky if roi=0, they are perfect substitutes and UIPC holds
If roi is bigger than zero
The domestic asset is riskier
If roi is less than zero
Domestic asset is less risky.
If roi increase, what happens to demand and E?
Demand goes down, E goes up.
Why might roi change?
S-I=X-M
Investment activity
Changes in terms of risk ie. investment risk corrupt govt
CIPC is not an?
Arbirage condition
What does CIPC assume?
- High capital mobility
- active spot(E) and forward(F) markets, that are liquid
- No taxes
- Identical assets
What if the CIPC assumptions does not hold, what will too not hold?
The LOOR
If F>E then what is true for R and R*?
R>R*
If F
R
