Module 3 - Key words Flashcards
Rational expectations is the assumption that…
that people, firms
and participants in financial markets form expectations of
the future by assessing the course of future expected policy
and then working out the implications for future output,
future interest rates, and so on.
Expected present discount value
Value today of an expected sequence of payments that are constructed from information of expected payments & Interest rates
Market recession
A recession is a period of declining economic performance across an entire economy that lasts for several months
Give two examples of non-human wealth
Housing wealth: The value of the house subtracted by mortage due.
Financial wealth: Stocks, bonds and saving accounts
Describe human- and total wealth
Human wealth: After tax labour income over working life
Total wealth: Calculated in terms of present value
Can be affected by our expectations;
-indirectly trough non-human wealth (Expected yields and dividends)
-Directly trough human wealth (Expectance of a high-paid job)
Future expected interest rate
Expected real interest rates are calculated based on nominal yields and inflation expectations
Private spending in the goods market depends on…
current and expected future output and on current and expected future real interest rates.
It’s the total money spent on final goods and services by individuals and households for personal use.
Expectations affect..
demand and, in turn, affect output.
Changes in expected future output or in the expected
future real interest rate lead to…..
changes in spending and
in output today.
By implication, the effects of fiscal and monetary policy
on spending and output depend on….
how the policy affects
expectations of future output and real interest rates.
How are bonds priced?
Since there can be no arbitrage, bonds are priced such that they take into account future expected interest rate.
The price of a 2-year bond takes into account two interest rates.
What does the yield-curve predict?
Recessions
Which two channels does firms finance through?
- Internal Finance
- External Finance
- Debt finance
- Equity Finance
A budget deficit reduction may lead to an increase rather than a decrease in..
output.
Internal Finance
Financial sources that exists within the business itself (earnings)
Credibility, which is the…
e perceived probability that the government will do
what it has promised when the time comes to do it.
Coupon bonds
Bonds that promise multiple payments before maturity and one payment at maturity
Coupon payments
Payments before maturity
Current yield
the ratio of the coupon payment to the price of the bond
What happens if the depreciation rate increases?
The expected present value of profits will fall
Treasury bills (T-bills)
Bonds with maturity of up to a year when they are issued
Treasury bonds
Bonds with maturity of 10 years of more
Discount factor/discount rate i
the rate at which you discount the interest rate
openness in goods
markets is the…
ability of consumers and firms to choose between
domestic goods and foreign goods.
Openness in financial markets
is the ability of financial investors to choose
between domestic assets and foreign assets.
Nominal Exchange rate
The price of domestic currency in terms of foreign
Maturity
The maturity of a bond is the length of time over which the bond promises to make payments to the holder of the bond
capital controls
are restrictions on the foreign assets their domestic residents could hold and
the domestic assets foreigners could hold.
Openness in factor markets
is the ability of firms to choose where to locate
production, and of workers to choose where to work.
NAFTA stands for…..
North American Free Trade Agreement (NAFTA)
Yield to maturity (Yield)
The price and interest rate associated with bonds of different maturities
Tradable goods, are goods that
compete with foreign goods in either domestic markets or foreign markets. Ex cars, computers, etc.
government bonds
bonds issued by the government or government agencies
Non tradable goods are goods like…
housing, most
medical services, haircuts, etc.
corporate bonds
Bonds issued by firms
Fixed exchange rates
When a country decides to fix their currency to another, for example the dollar.
risk premium
A risk premium is a measure of excess return that is required by an individual to compensate them for being subjected to an increased level of risk.
Real exchange rate is…
the price of
domestic goods relative to foreign goods
junk bond
Bonds with high default risk
Balance of payments
The difference in how much money that flows into the country compared to the outflow of money.
Nominal exchange rates is…
the price of the
domestic currency in terms of foreign currency, which is denoted by E.
Discount Bond
Bonds that promise a single payment at maturity
Expectations hypothesis
When you and other investors assume and only care about the expected return and NOT the risk
When you eat breakfast and drink your first cup of coffee of the day, you can easily read about nominal exchange rates in…
newspapers.
n-year interest rate
that constant annual interest rate that makes bond price equal to the present value of future payments of the bond
Current account
Transactions “above the line”
Record payments to & from the rest of the world (imports and exports)
External finance
the main channel for small firms (bank loans)
Debt finance
bonds and loans
Equity finance
issuing stocks/shares
An appreciation of the domestic currency….
is an increase in the price of the domestic currency in terms of a foreign currency.
Dividends
A dividend is a distribution of profits by a corporation to its shareholders.
An amount decided by the firm from the firm’s profit.
Given our definition of the exchange rate, an appreciation corresponds to an …….. in the exchange rate.
increase in the exchange rate.
ex-dividend price
the price of a stock after the dividend has been paid
Equity premium
Risk premium, in case of stocks
A depreciation of the domestic currency is a…..
decrease in the price of the domestic currency
in terms of a foreign currency.
Rational Speculative bubbles
The process suggest that stock prices may increase just because investors expect them to
So given our definition of the exchange rate, a depreciation
of the domestic currency corresponds to a ….?…. in the exchange rate, E.
decrease
Default risk
The uncertainty about the price of which you can sell the bond, before maturity
Fixed exchange rates is a
a system in which two or more countries maintain a constant
exchange rate between their currencies.
a safe haven
A country which is seen to be safe to move funds
Under a fixed exchange rate system, increases in the exchange rate – which are infrequent by definition – are called …?…
revaluations (rather than appreciations).
Statistical discrepancy
difference between the numbers in the current account compared to the capital account.
Peg the currency to another
Crawling Peg
Countries choose a predetermined rate of depreciation against another currency (instead of fixing their exchange rate to another currency) - often countries with high inflation rates
Decreases in the exchange rate under a fixed exchange rate system are called …?..
devaluations (rather than depreciations).
European Monetary system (EMS)
A system that determined the movements of exchange rates within the EU from 1978 to 1998
Central parity
A given value for the exchange rate
Foreign exchange reserves
Assets denominated in a foreign currency that are held by a central bank. · These may include foreign currencies, bonds etc.
What does the capital account consist of?
Foreign direct investments
Net portfolio investments
Derivatives
Other investments
Real appreciation is…
an increase in the real exchange rate – that is, an increase in the relative price of domestic
goods in terms of foreign goods
Interest parity condition
Arbitrage by investors implies that the domestic interest rate must be equal to the foreign interest rate minus the
expected appreciation rate of the domestic currency.
Note that the expected appreciation rate of the domestic currency
How can a country run a trade deficit?
By borrowing from the rest of the world
Driving factors of trade
1. Geography (distance to other markets 2 Size (ex. small countries might need to specialize)
real depreciation is a
decrease in the real exchange rate – that is, a decrease in the relative price of domestic
goods in terms of foreign goods.
Opportunity cost
The cost of producing a good, in terms of “lost” production of another good
Absolute advantage
When a country is better than another country at producing a certain good or service
Comparative advantage
A country has comparative advantage in production of a good if the opportunity cost is lower than for another country
MRT (marginal rate of transformation)
An opportunity cost denoting the amount fo wine to be forgone in order to produce one more cheese
Positive effects of free trade
- Increases competition
- Causes ineffective industries to die out
- More?
Stock prices depend on:
Current and future movements
more?
How stock prices respond to change in output depends on:
- what the market expected in the first place
- the source of the shocks behind the change in output
- how the stock market expects the CB to react to the output change
What indicates a downward sloping yield curve?
A downward sloping yield curve indicates people think that interest rates (and thus bond yields) will be lower in the future than they currently are. Typically, central banks cut interest rates to encourage economic growth.
What factors affects the IS curve to shift?
A change in G or T or Y* or i*
What happens with the IS/LM curve if the interest rate is increased by the CB? At a given level of output
The LM-curve shifts upward, the IS curve does not change
What does a monetary contraction lead to in terms of the IS/LM curve?
A monetary contraction shifts the LM curve up. It shifts neither the IS curve nor the interest parity curve.
So, in the open economy, monetary policy works through two channels. Describe.
first, as in the closed economy, it works through the effect of the interest rate on spending; second, it works through the effect of the interest rate on the exchange rate and the effect of the exchange rate on exports and imports.
Net income balance, current account
Income received from the rest of the world & income paid to foreigners (given and received)
Net transfer received
Difference in foreign aid (given and received)
GNP stands for?
Gross national product - which measures the value added by domestic factors of production
How can we measure openness?
Through imports and exports (% of GDP)
Through tradable goods
How does the IS curve change in in an open economy compared to a closed economy?
It gets steeper
Imports (IM) depend on?
Domestic income (Y) and real exchange rate (e) - epsilon However, in the short run it depends on the nominal exchange rate (E)
Exports depend on?
Foreign income (Y*) and the real exchange rate (e) - Nominal exchange rate in the short run (E)
In the open economy the interest rate (i) affects demand through two channels, which two and how?
- directly through Investments (I) - higher i -> more expensive loans -> less investments
- Indirectly through Net Exports (NX)
Can nominal & real exchange rate move in different directions?
Yes, since there is a difference in interest rate across countries (long time period)
Can a country have exports larger than its GDP?
Yes, since imports and exports may include intermediate goods which they transform to final goods by using labor
Ex. small countries like Luxembourg
The LM curve only shifts in the short run if….?
The CB changes the interest rate today
