Managing the Exchange Rate

Question 1

The three aspects of the trilemma

Answer 1

1. Exchange Rate stability
2. Financial Integration
3. Monetary Policy Autonomy

Question 2

Definition monetary autonomy policy

Answer 2

the independence of a country’s central bank to affect its own money supply and conditions in its domestic economy

Question 3

Monetary policy definition

Answer 3

Consists of the management of money supply (central banks)

Question 4

Fiscal policy

Answer 4

refers to the use of government spending and tax policies to influence economic conditions

Question 5

Financial integration

Answer 5

The interconnectedness between countries, businesses and economies

Question 6

How is the EMU positioned at the trilemma?

Answer 6

EMU has a stable exchange rate, and financial integration. So:

Stable exchange rate: ^S = 0
Financial integration: i = i*

No autonomy to set i independent from i*

Question 7

How is a free float positioned at the trilemma?

Answer 7

Free float has financial integration, and monetary autonomy policy. So:

Financial integration: i = i*
Monetary autonomy policy: i =/ i*

No Exchange rate stability

Question 8

How is Bretton Woods positioned at the trilemma?

Answer 8

Monetary policy autonomy and exchange rate stability. So:

^S = 0
i =/ i*

Meaning that there is no capital mobility

Question 9

The different exchange rate systems.

Answer 9

1. Fee float -> no intervention
2. Managed float -> some intervention
3. Wide target zones
4. Crawling peg
5. Unilateral fixed exchange rates
6. Fixed rates by agreement (EMS)
7. Currency board
8. Currency union (EMU)

Question 10

What is a crawling peg?

Answer 10

Crawling peg is a system where a fixed exchange rate where it is allowed to make adjustments in a certain band width. The par state is also adjusted frequently due to inflation.

Question 11

What is a soft peg?

Answer 11

The exchange rate regime applied to a currency to keep its value stable against a reserve currency or a basket of currencies

Question 12

Dollarization

Answer 12

These countries have given up their own monetary policy and adopted other countries currencies such as the dollar

Question 13

Which methods can be used to defend a currency?

Answer 13

1. Intervention 2. Interest rates

Question 14

Intervention

Answer 14

buying your own currency when its weak from the spot and forward market

Question 15

Interest rates

Answer 15

Increasing the short-term interest rate in such way that you are more attractive for investors than other countries

Question 16

Which retrospective risk is their for businesses?

Answer 16

Translation risk

Question 17

Define translation risk

Answer 17

A firm has accounting exposure when it transforms the foreign financial statements into the home currency. Translation risk relates to the effect of currency fluctuations on this conversion.

Question 18

Which prospective risks are their for businesses?

Answer 18

1. Transaction risk

2. Economic risk

Question 19

Transaction risk

Answer 19

Is currency risk focused on future cash flows on one easily identifiable transaction. Easy to measure.

Question 20

Economic risk

Answer 20

Is currency risk focused on all future cash flow necessary to determine firm value. Difficult to measure.

Question 21

How to manage transaction risk?

Answer 21

Forward contracts, future contracts, hedging with swaps and options

Question 22

How to manage economic risk?

Answer 22

On the supply side: plant location and input mix

On demand side: product and pricing strategy