money: foreign exchange Flashcards
is foreign exchange itself exchange
no
what is foreign exchange
financial market in which currencies are traded
exchange rate
the price at which a aprtivular currency is traded
bid ask spend
when you go to the bank and your ask price is lower than the actual excnage rate because the bank takes a cut
what is the world’s largest financial market by trading volume
foreign exchage
what was the average daily trading volume for FX
7.5 trillion for over the counter exchange market
makret for USD is _____. Why?
it is thick because people want it and people sell it
why does the bar for foreign exhcnage currencies add up to 200%
because there are two currencies (each add to 100)
if you are trying to buy pound with euro why would you buy dollars first
because of bid-ask spend. more bang for your buck essentially
although certain statistics have been on a decline, whats odifferent about teh dollar
the dollar continues to occupy a positively dominant international position
what are the two exchange taye regimes arhcetypes
free floating and fixed
free floating
exchange rate is entriely market determined without any sort of governemnt intevention
fixed
the exchange rate is entirely fixed (with respect to some other commodity)
where does most countries rate regime fall in terms of archetypes
between the two archetypes
does any currency float in an entriely unmanaged fashion
no
is there movement with fixed exchange rate
no
what type of archetype did US use to be
fixed
where are most currency leaning twoards in terms of archetypes
today - free flaoting
union
(currency)
multiple countries use same currency
dollarization
adoption, legal (driven by govnt) or factual of a forieg currency
what currency is most commonly aodopted
USD because USD is everywhere and market for it is larger on global scale
what are the two types of dollarization
full (less common) adopt currencies
partial: purchasing power decreases so firms (best inetrest) accept foreign currency fixed exchange rate
peg
currency baord but not 100% backed. trust central bank to maintain fixed exchange rate
band
specify certain goal (ie 1:7) but accept movement in either direction
dirty float
system west has adopted, no major intervention, changes overtime
pegged golad standard is similar to what
bitcoin because amount is finite
gold standard
tie specific amount of money to certina amount of gold
goal of gold standard
don’t make too much money which helps reign in inflation
what does pegged gold standrad depend on
how many people want to exchange
what do you trust in gold standard
build trust in currency not getting too much to help purchasing power long term
what occurs under gold EXCHNAGE stanadrd
rather than holding large quantitties of gold, each (participating) country other than the gold-issuing country hold the latter’s currency in reserves
how many countries have true gold standard today
1
reserve currency
certain currency held by other govnts to stabilize their own currency
what is the reserve currency
Gold, USD and other currencies tied to USD
sum up internaitonal monetary history
Uk adopts gold standard, many other countries follow suit. to finance war, gold standard is suspended. to restebalish gold standard they substituted scarce gold for USD and pound. to achieve reflation countries suspend (abandon) gold standard. countries pegged their currency to USD. at end US abandons gold exchange standard.
in 1970s why did US abandon gold exchange standard
because we just could not print enough money (we don’t like deflation)
since 1972 US has had a monopoly on what
coinage (fix vaue to gold + silver)
BOTUS standas for
bank of the united states
how did BOTUS finance civil war
green backs (100 dollar notes)
when was FED founded
1913
would you use a green back today since it is redeemable
no because it is more of an asset since you can sell on eBay for more than $100
de facto silver standard means
silve value is lower than gold
de facto gold standard means
gold value lower than silver, but during this period people held onto gold since it is valuable
de jure means
rid of it
pure fiat
what US is today. no commodity backing. we are backed by the full faith and credit of US govnt. Fed has to hold = amount of debt for each US dollar that circulates
appreciation
increase of a currency’s price
what happens if there is a positive chock to demand and a negative shock to supply
even higher appreciation with both
why did purchasing power inc in 2008
because people everywhere lost wealth so they wanted a safe asset that would not lose vaue overtime
what is produced abroad =
more expensive locally
what happens if there is a negativeshock to demand and a positive shock to supply
deprecitaiont
depreciation
decrease of currency price
exchange rates are ____ driven
trade
two forgeign exchange models
trade based and asset based
trade based
everyone is trying to buy others goods
law of one price purpose
so purhcaisng power of one power does not inc
problem of law of one price
it assumes only exchange rate will change but price of goods will start to adjust first
example of law of one price
if a computer costs 1k in US and 500pound in UK the LOOP exchange rate is Eloop = 2$/pound
logic of LOOP
if price differed from Eloop buyers would exclusively purchase frin whereverthe good is cheaper. in turn demand for the cheaper currency mounts, it wil naturally appreciate
limitation of lOOP
-only applies to tradable goods
-tariffs
-prices adjusting
what is absolute PPP
it is LOOP but applied to all goods
are LOOP and absolute PPP the same
yes except PPP is applied to all goods
logic behind abolsute PPP
if goods are cheaper in one country, that countrys currency will appreciate because of demand
limitations of absolute PPP
same as LOOP
realtive PPP
only one with empirical bite. Assumes no change in trade barriers + transaction costs
international finance
comparing local vs international rate and current vs future excahnge rate
what is Y and X in terms of international finance
X is excange rate today and Y is exchange rate in year
what is the final step of international finance
turn back to original currency
what is arbitrage of international finance
if all conditions were known, no arbitrage conditions would hold because investors can make riskless profits
problem with international finance
the Y variable is typically not known
spot
you buying currency today
forward
comitting to buy currecny 1yr from now
swaps
combination of spot + forward
