Week 4

Question 1

What is arbitrage?

Answer 1

If the exchange rate between two currencies differ in different locations, one can make a profit by buying a currency where it is cheap and selling it where it is expensive

Question 2

What is a fixed exchange rate?

Answer 2

The central bank determines a target rate and a band arount it.
By intervening in foreign exchange markets the CB can keep the exchange rate fixed

Question 3

What is a flexible exchange rate?

Answer 3

The relative value of a currency is market-driven, thus by supply and demand

Question 4

What does and increase in the real exchange rate imply?

Answer 4

Foreign prices have increased relative to domestic prices and/or the foreign currency has become more expensive.

This implies that the home country’s products have become more competitive compared to the foreign country’s products

Fall E= the other way around

Question 5

What if the real exchange rate (epsilon) > 1

And what if < 1

Answer 5

> 1: foreign products are more expensive than domestic products
< 1: foreign products are cheaper than domestic products

Question 6

What is the real exchange rate? (epsilon)

Answer 6

The relative value of two currencies adjusted for differences in prices in the two countries. (check formula)

Question 7

What happens if spot rate < forward rate

Answer 7

Foreign currency is more expensive in the future than today

Foreign currency is selling at a forward premium

Question 8

What happens if the spot rate > forward rate

Answer 8

The foreign currency is cheaper in the future than today

Foreign currency is selling at a forward discount

Question 9

What is the forward rate?

Answer 9

The price of buying or selling a currency at a specific date in the future

Question 10

What is the spot rate?

Answer 10

The price of buying or selling a currency at this moment

Question 11

What is the effective exchange rate

Answer 11

The weighted average of the values of a country’s currency relative to various (major) currencies

Question 12

What happens if the exchange rate goes up? HCU/FCU

Answer 12

A rise in the exchange rate implies an appreciation of the foreign currency and a depreciation of the home currency

Question 13

What is the exchange rate

Answer 13

The price of one currency in terms of another (relative value of two currencies)

Question 14

B + OR = 0 What happend if B > 0 and OR < 0

Answer 14

Official reserve asset holdings of a country have fallen or foreign official holdings of country’s assets have increased

Question 15

The official settlement balance (B):

B + OR = 0 What happend if B >0 and OR<0

Answer 15

Official reserve asset holdings of a country have increased or foreign official holdings of country’s assets have fallen

Question 16

What does the official reserves account (OR) show? What is debit and what is credit

Answer 16

The OR shows the transactions with financial assets undertaken by central banks

CB sells foreign currency/buys domestic (+)
CB buys foreign currency/sells domestic (-)

Question 17

Debit and credit items of the financial account (FA)

Answer 17

Credit:
(+) Capital import: increase in foreign holdings of domestic assets/reduction in domestic holdings of foreign assets
Foreigners buy domestic assets
selling foreign assets

Debit:
(-) Capital outflow: Increase in domestic holdings of foreign assets / reduction in foreign holdings of domestic assets
Purchasing foreign assets
Foreigners sell domestic assets

Question 18

Name the current account (CA) debit and credit items

Answer 18

Debit:

• imports of goods and services
• income paid to foreigners (also captial income > interest, dividends etc.)
• unilateral transfers (gifts, remittances)

Credit:
+ export of goods and services
+ income received from foreigners (see above)

Question 19

What is a debit item

Answer 19

(-) Creates an obligation to make a payment to a foreigner

This creates demand for the foreign currency and supply of the domestic currency

Question 20

What is a credit item?

Answer 20

(+) create an entitlement to receive a payment from a foreigner
This creates demand for the domestic currency and supply of the foreign currency