Revision 2

Question 1

What can GNP be adjusted for?

Answer 1

Depreciation of physical capital results in a loss of income to capital owners
Unilateral transfers to and from other countries can change national income

Question 2

Name the 3 broad accounts from balance of payments accounts

Answer 2

Current account (imports & exports)
financial account (flows of financial assets)
capital account (records special transfers of assets)

Question 3

Name 3 sub-categories from financial accounts

Answer 3

Official (international) reserve assets
all other assets
statistical discrepancy

Question 4

What is Depreciation?

Answer 4

a decrease in the value of a currency relative to another currency. A depreciated currency means that imports are more expensive and exports are cheaper

Question 5

What is appreciation

Answer 5

an increase in the value of a currency relative to another currency. A appreciated currency means that imports are cheaper and exports are more expensive

Question 6

What are the foreign exchange markets participants?

Answer 6

Commercial banks
corporations (non-financial businesses)
Non-bank financial institutions
Central banks

Question 7

What is arbitrage?

Answer 7

Buy at a low price and sells at higher price for a profit

Question 8

What are spot rates?

Answer 8

exchange rates for currency exchanges “on the spot”, or when trading is executed in the present

Question 9

What are forward rates?

Answer 9

exchange rates for currency exchanges that will occur at a future (“forward”) date
typically 30, 90, 180 or 360

Question 10

What is rate of return

Answer 10

% change in value that an asset offers during a time period

Question 11

What does interest parity imply?

Answer 11

It implies that deposits in all currencies are equally desirable assets. It also implies that arbitrage in the foreign exchange market is not possible

Question 12

What happens if the interest parity doesn’t hold?

Answer 12

No investor would want to hold euro deposits, driving down the demand and price of euros. Meaning all investors would want to hold dollar deposits, driving up the demand and price for dollars. The dollars would appreciate and the euro would depreciates, increasing the right side until equality is achieved.

Question 13

How do changes in the current exchange rate affect the expected rate of return of foreign currency deposits?

Answer 13

Depreciation of the domestic currency today lowers the expected rate of return on foreign currency deposits
Appreciation of the domestic currency today raises the expected return of deposits on foreign currency deposits

Question 14

What is covered interest parity?

Answer 14

It relates interest across countries and the rates of change between forward exchange rates and the spot exchange rate. It says that rates of return on dollar deposits and “covered” foreign currency deposits are the same.

Question 15

What is money supply?

Answer 15

The quantity of money that circulates in an economy.

Question 16

What is money demand?

Answer 16

It represents the amount of monetary assets that people are willing to hold

Question 17

What influences aggregate demand of money?

Answer 17

Interest rate/expected rates of return
Prices
Income

Question 18

What happens if there is an increase in the domestic money supply?

Answer 18

An increase in a country’s money supply causes interest rates to fall, rates of return on domestic currency deposits to fall, and the domestic currency to depreciate.

Question 19

What happens if there is a decrease in the domestic money supply?

Answer 19

A decrease in a country’s money supply causes interest rates to rise, rates of return on domestic currency deposits to rise, and the domestic currency to appreciate.

Question 20

How would a change in the supply of euros affect the US money market?

Answer 20

An increase in the supply of euros causes a depreciation of the euro (an appreciation of the dollar). The increase in the supply reduces interest rates in the EU, reducing the expected rate of return on euro deposits.
A decrease in the supply of euros causes an appreciation of the euros and a depreciation of the dollar.

Question 21

What happens in the short - run?

Answer 21

prices don’t have sufficient time to adjust to market conditions

Question 22

What happens in the long - run?

Answer 22

prices of factors of production and of output have sufficient time to adjust to market conditions

Question 23

How does a change in the money supply cause price of output and input to change?

Answer 23

Excess demand of goods and services
Inflationary expectations

Question 24

Exchange rates overshooting

Answer 24

The exchange rate is said to overshoot when its immediate response to a change is greater than its long - run response
Overshooting helps to explain why exchange rates are so volatile