module 8 specifed info Flashcards
The international monetary system: a brief history (whats the Gold Standard, Bretton Woods, Central Reserve/National Currency Conflict)
gold: A monetary system that defines the value of its currency in terms of a fixed amount of gold.
Established in Britain by Sir Isaac Newton in 1717.
Government does not have monetary flexibility.
Gold often serves as a way to store value during crises.
Bretton:The international monetary system in place from 1945 to 1971, with par value based on gold and the U.S. dollar.
Fixed exchange rates: currency’s value is tied to the value of another currency or gold.
Par value: stated value based on gold.
Reserves: Assets held by a nation’s central bank, used to back up government liabilities.
Triffin paradox: National currency that is also a reserve currency will eventually run a deficit, leading to lack of confidence in the reserve currency and a financial crisis.
Special drawing rights (S D R): the unit of account for the I M F and other international organizations.
Central Reserve: U.S. dollar is the most used central reserve since end of WW II.
Holding large amounts of U.S. dollars eventually means they will lose value (Triffin paradox).
I M F would like a non-national asset to become main reserve (the S D R).
Exchange rate systems (describe floating exchange rates, current currency arrangements, Bank for int settlements
floating: Determined by supply and demand that allow currency values to float against one another. Smithsonian Agreements attempted to agree on fixed currency exchange rates.
Jamaica Agreement established flexible exchange rates among I M F members and demonetized gold.
Current currency arrangements:
Exchange arrangement with no separate legal tender.
Currency board arrangement.
Conventional fixed-peg arrangement.
Stabilized arrangement:
Crawling peg.
Crawling band.
Managed floating.
Free floating exchange rates.
Bank for International settlements (BIS):
Institution for central bankers.
Operates to build cooperation in order to foster monetary and financial stability.
Known as most discrete financial institution in the world.
The central reserve/national currency conflict
U.S. dollar is the most used central reserve since end of WW II.
Holding large amounts of U.S. dollars eventually means they will lose value (Triffin paradox).
I M F would like a non-national asset to become main reserve (the S D R).
Summary of the monetary system (theres 3 systems Gold/Bretton/Floating)(pros/cons/controlling mechanisms)
Gold standard:
Pros: simple, widely trusted, mandated, monetary dicipline
Cons: impractical with large trade flows, costly to hold
Controlling mechanism: gold flows- price-specie-flow mechanism (Hume)
Bretton woods fixed gold exchange:
Pros: fixed rate, good for trade growth
Cons:Led to US balance of payment deficit, Led to US gov liability to foreign central bank, Reduced US gold reserve
Controlling mechanism: govt adjusted rates against dollar, dollar constant against gold
Floating system
Pros: flexible (Free/managed float, peg), responsive to market forces, good for huge volume
Cons: causes widely swinging currency values
Controlling mechanism: market forces with some govt interventio
Financial forces: fluctuating currency values (IMPORTANT)
1. what are 4 major currencies that allowed by their central banks to fluctuate freely against each other.
2.Why Foreign Currency Exchange Occurs.
3.Exchange Rate Quotations and the FX Market.
4.Causes of Exchange Rate Movement.
5.Exchange Rate Forecasting
Fluctuating Currency Values.
1.The major currencies are allowed by their central banks to fluctuate freely against each other.
U.S. dollar.
British pound sterling.
Japanese yen.
Euro.
Financial Forces: Fluctuating Currency Values
2.Why Foreign Currency Exchange Occurs.
-Buyers and sellers want to do business in own currency to avoid risk that accompanies currency exchange.
-Vehicle currency is used as a vehicle for international trade or investment, such as diamond market uses U.S. dollar.
-Intervention currency is used to intervene in the foreign currency exchange markets.
3.Exchange Rate Quotations and the FX Market.
Reciprocal currency is quoted as dollars per unit of currency instead of in units of currency per dollar.
Spot rate is the exchange rate between two currencies for delivery within two business days.
Forward currency market allows managers to lock in contracts to purchase currencies at known rates for delivery in the future.
Forward rate is the exchange rate, the cost today, of a commitment to buy or sell an agreed amount of a currency at a fixed future date, usually 30, 60, 90, or 180 days from now .
Bid price is highest-priced buy order currently in the market.
Ask price is lowest-priced sell order currently in the market.
4.Causes of Exchange Rate Movement.
Monetary policies control the amount of money in circulation and its growth rate.
Fiscal policies address the collecting and spending of money by the government.
Law of one price concept says that in an efficient market, like products will have like prices.
Arbitrage is the process of buying and selling instantaneously to make profit with no risk.
Fisher effect shows relationship between real and nominal interest rates.
The real interest rate will be the nominal interest rate minus the expected rate of inflation.
International Fisher effect says the interest rate differentials for any two currencies will reflect the expected change in their exchange rates.
Purchasing power parity is the amount of adjustment that must be made in the exchange rates for two currencies for them to have equivalent purchasing power.
5.Exchange Rate Forecasting.
Efficient market approach is assumption that current market prices fully reflect all available relevant information.
Random walk hypothesis is assumption that the unpredictability of factors suggests that the best predictor of tomorrow’s prices is today’s prices.
Fundamental approach is based on econometric models that attempt to capture the variables and their correct relationships.
Technical analysis analyzes date for trends and then projects these trends forward.
The Fisher Effect (what is it also called?, real v nominal interest rates, what does the int fisher effect say in terms of exchange rates?)
-Also known as interest rate parity
-The relationship between real and nominal interest rates: the real interest rate will be the nominal interest rate minus the expected rate of inflation.
-International Fisher effect says the interest rate differentials for any two currencies will reflect the expected change in their exchange rates.
Purchasing Power Parity
the amount of adjustment that must be made in the exchange rates for two currencies for them to have equivalent purchasing power.
Financial forces government can exert (currency exchange controls) (how can govt control it? why does it matter? what does this do with open market rates?)
Currency Exchange Controls.
Governments can control currency exchange of their currency and other currencies within their borders.
Motivation is to manage foreign reserves.
With currency controls, exchange rates usually above open market rates.
Convertible Currencies v Non-convertible
Convertible currencies can be exchanged for other currencies without restrictions.
Nonconvertible currencies value is arbitrarily fixed typically at a rate higher than its value in the free market and government imposes exchange controls.
Balance of payment (what is it? what does it reveal? name of bookkeeping method? what are payments to other countries? from countries?what does current account track? what does capital account track?
B O P.
A record of a country’s transactions with the rest of the world.
Shows flow of capital in and out of the country.
Reveals demand for a country’s currency.
B O P Accounts.
Use double-entry bookkeeping.
Payments to other countries are debits.
Payments from other countries are credits.
Deficits and Surpluses in B O P Accounts.
Current account tracks tangible goods such as services and intangibles such as aid.
Capital account tracks financial assets and liabilities, direct investment, portfolio investment, short-term capital flows.
Official reserves reflect gold imports and exports.
Current account deficit may mean economic problems such as inflation OR that demand into the country exceeds outward flows.
To understand deficit, you must look at total picture.
The relationship between inflation and interest
(How does inflation impact the real cost of borrowing in capital markets? What effect does rising inflation have on interest rates?)
Inflation and Interest Rates.
Inflation is a sustained increase in prices.
Determines real cost of borrowing in capital markets.
Rising rates encourage borrowing.
Inflated currencies tend to weaken.
Interest rates rise with inflation.
Inflation rates cause the cost of the goods and services to rise, so they become less competitive globally
