Week 4 Flashcards
What is arbitrage?
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
What is a fixed exchange rate?
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
What is a flexible exchange rate?
The relative value of a currency is market-driven, thus by supply and demand
What does and increase in the real exchange rate imply?
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
What if the real exchange rate (epsilon) > 1
And what if < 1
> 1: foreign products are more expensive than domestic products
< 1: foreign products are cheaper than domestic products
What is the real exchange rate? (epsilon)
The relative value of two currencies adjusted for differences in prices in the two countries. (check formula)
What happens if spot rate < forward rate
Foreign currency is more expensive in the future than today
Foreign currency is selling at a forward premium
What happens if the spot rate > forward rate
The foreign currency is cheaper in the future than today
Foreign currency is selling at a forward discount
What is the forward rate?
The price of buying or selling a currency at a specific date in the future
What is the spot rate?
The price of buying or selling a currency at this moment
What is the effective exchange rate
The weighted average of the values of a country’s currency relative to various (major) currencies
What happens if the exchange rate goes up? HCU/FCU
A rise in the exchange rate implies an appreciation of the foreign currency and a depreciation of the home currency
What is the exchange rate
The price of one currency in terms of another (relative value of two currencies)
B + OR = 0 What happend if B > 0 and OR < 0
Official reserve asset holdings of a country have fallen or foreign official holdings of country’s assets have increased
The official settlement balance (B):
B + OR = 0 What happend if B >0 and OR<0
Official reserve asset holdings of a country have increased or foreign official holdings of country’s assets have fallen
What does the official reserves account (OR) show? What is debit and what is credit
The OR shows the transactions with financial assets undertaken by central banks
CB sells foreign currency/buys domestic (+)
CB buys foreign currency/sells domestic (-)
Debit and credit items of the financial account (FA)
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
Name the current account (CA) debit and credit items
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)
What is a debit item
(-) Creates an obligation to make a payment to a foreigner
This creates demand for the foreign currency and supply of the domestic currency
What is a credit item?
(+) create an entitlement to receive a payment from a foreigner
This creates demand for the domestic currency and supply of the foreign currency
