Week 7: FX Market Flashcards
What are the 2 types of FX market transactions?
Spot Transactions
Forward Transactions
What happens to businesses and domestic consumers when your country’s currency appreciates compared to another?
Prices relatively higher in your country than abroad. Businesses are now less competitive, but consumers are better off as they can enjoy foreign goods for lower prices.
What market is Foreign Exchange traded on?
OTC
What are Exchange rates determined by?
Supply & Demand
What are Exchange rates determined by?
Supply & Demand
What is the Law of one price?
States that identical goods should cost the same throughout the world regardless of where they are produced. LOOP drives supply and demand.
What is the theory of Purchasing Power Parity?
States that exchange rates between 2 currencies will adjust to reflect changes in price levels
According to PPP, how does domestic currency react to a fall in domestic prices?
Domestic currency will appreciate
According to PPP, how does domestic currency react to a fall in domestic prices?
Domestic currency will appreciate
What are some problems with PPP?
- Not all goods are identical in each country
- many goods cannot be traded (e.g. haircuts, restaurant meals, etc.)
What factors affect exchange rates in the long run?
- Relative price levels
- tariffs & Quotas
- Productivity
- Preferences (domestic demand)
What happens to ER if domesetic real interest rates increase?
Domestic currency appreciates
What happens to ER when domestic inflation expectations increase?
Domestic currency depreciates
