money: foreign exchange Flashcards by Arianna Anderson

is foreign exchange itself exchange

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what is foreign exchange

financial market in which currencies are traded

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exchange rate

the price at which a aprtivular currency is traded

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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

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what is the world’s largest financial market by trading volume

foreign exchage

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what was the average daily trading volume for FX

7.5 trillion for over the counter exchange market

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makret for USD is _____. Why?

it is thick because people want it and people sell it

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why does the bar for foreign exhcnage currencies add up to 200%

because there are two currencies (each add to 100)

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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

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although certain statistics have been on a decline, whats odifferent about teh dollar

the dollar continues to occupy a positively dominant international position

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what are the two exchange taye regimes arhcetypes

free floating and fixed

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free floating

exchange rate is entriely market determined without any sort of governemnt intevention

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fixed

the exchange rate is entirely fixed (with respect to some other commodity)

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where does most countries rate regime fall in terms of archetypes

between the two archetypes

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does any currency float in an entriely unmanaged fashion

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is there movement with fixed exchange rate

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what type of archetype did US use to be

fixed

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where are most currency leaning twoards in terms of archetypes

today - free flaoting

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union

(currency)

multiple countries use same currency

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dollarization

adoption, legal (driven by govnt) or factual of a forieg currency

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what currency is most commonly aodopted

USD because USD is everywhere and market for it is larger on global scale

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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

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peg

currency baord but not 100% backed. trust central bank to maintain fixed exchange rate

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band

specify certain goal (ie 1:7) but accept movement in either direction

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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

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