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29 Cards in this Set

  • Front
  • Back
Functions of Exchange Rate Markets
Transfer purchasing power between currencies
Provide credit for foreign transactions
Who participates in the forex markets?
1. Those needing currency to fund transactions
2. Commercial Banks
3. Foreign Exchange Brokers
4. Central Banks
An increase in the domestic currency price of a foreign currency

Suppose that the supply of yen falls due to a decrease in the role of the dollar as the “international currency.”
Since more dollars are required to buy yen, the dollar has weakened or depreciated.
An decrease in the domestic currency price of a foreign currency.

Suppose that the supply of yen increases from an increased desire to purchase U.S. goods.
Since fewer dollars are required to buy yen, the dollar has strengthened or appreciated.
Nominal Exchange Rate
- Exchange rate without any adjustment for a change in price level.
Real Exchange Rate
Nominal exchange rate adjusted for change in price level. This rate is often used to examine changes in the purchasing power of currencies over time.
Spot Exchange Rate
Spot Exchange Rate
The exchange rate that calls for payment and receipt of the foreign exchange within two business days from the date when the transaction was made.
Forward Exchange Rate
30 60 or 90 days into the future, it can be either at a premium or a discount
Cross Exchange Rate
The exchange rate between currencies A and B, given the exchange rate between currency A and C and between B and C.
Effective Exchange Rate
The effective exchange rate is a weighted average of the exchange rates between the domestic currency and the nation’s most important trading partners.
Fixed Exchange Rate
An exchange rate which is fixed and constant, relative to another currency or group of currencies.
Flexible Exchange Rate
An exchange rate which is determined by the forces of demand and supply without government intervention in foreign exchange markets.
Managed Flexible Rate
A flexible exchange rate in which the monetary authority occasionally intervenes to cause an increase or decrease in the value of the country’s currency.
What are the 3 reasons for holding foreign currency?
1. Trade and investment
2. Interest rate arbitrage
3. Speculation
Foreign Exchange Risk
Risk which occurs when a person or firm holds assets denominated in a foreign currency. The risk refers to the potential unexpected losses or gains that can occur because of unforeseen changes in the value of the foreign currency. (This risk is also sometimes called Exchange Rate Risk.)
In our context, arbitrage refers to the activity of buying a currency in a monetary center where it is cheaper for immediate resale in a place where it is more expensive with the intention of making a profit.
Covered Interest Arbitrage
The transfer of short-term liquid funds abroad to earn higher returns with the foreign exchange risk covered by the spot purchase of the foreign currency and a simultaneous offsetting forward sale.
Interest Parity
The idea that the interest rate differential between two countries is approximately equal to the percentage difference between the forward and spot exchange rates.
Purchasing Power Parity
The notion that a currency should buy the same quantity of goods when converted to another currency as it can buy at home.
Medium run forces affecting exchange rate
The country’s economic growth: produces an increase in imports and an outward shift in the demand for foreign currency.
Growth abroad: results in an increase of exports from the home country and an increase in the supply of foreign currency.
The Short run forces that affect exchange rates are: (there are 2 of them)
1. interest rates
2. expectations of future rates
Real exchange rate -
[(nominal exchange rate) * (foreign prices)] / (domestic prices) = Rr = Rn(P*/ P)
4 reasons for countries to adopt a common currency:
Reduces currency conversions and transaction costs.
Eliminates price fluctuations.
Leads to an increase in inter-state political trust.
Provides greater credibility to the exchange rate.
For a common currency to work, it must:
(1) synchronized business cycles;
(2) high degree of labor and capital mobility;
(3) regional policies to deal with economic imbalances;
(4) an integration effort that goes beyond mere free trade.
Price – Specie – Flow Mechanism
The automatic adjustment mechanism under the gold standard. It operates according to the rule that a country which has a deficit in its external accounts loses gold and experiences a decrease in its money supply. This reduces domestic prices, which stimulates the nation’s exports and discourages its imports until the deficit is eliminated. A surplus in external accounts is corrected by the opposite process.
What is the difference between appreciation and revaluation?
appreciation is when the value of a currency increases in a flexible exchange rate system, while revaluation is an increase in the value of a fixed rate system.
what did the smithsonian agreement say?
It marked the beginning of the end for the Bretton Woods exchange rate system. The major provisions of the Agreement were: (1) The U.S. dollar was devalued by about 9 percent (by increasing the dollar price of gold from $35 to $38 an ounce); (2) Other strong currencies were revalued by various amounts with respect to the dollar; (3) The convertibility of dollar into gold remained suspended; and (4) Exchange rates were allowed to fluctuate by 2.25 percent on either side of the new par values.
Dollar Standard
The international monetary system that emerged out of the Smithsonian Agreement in 1971 under which the U.S. dollar remained an important currency and reserve without any gold backing.
What happened at the PLaza and Louvre Accords?
At the Plaza, other currency's values were appreciated in relation to the dollar. It got out of hand, and at the Louvre accords, they had to stablize the value of the dollarz.