Ir 292 Exam #2 Ch. 10

Front 1

exchange rate

Back 1

the price of a currency stated in terms of another currency

Front 2

3 most frequently traded currencies:
-all 3 are ______ exchange rates.

Back 2

1. EU's Euro
2. Japanese Yen
3. British Pound
-flexible exchange rates

Front 3

As of end 2010, daily volume of trade:

Back 3

$4 trillion (over 1/4 US GDP)

Front 4

appreciation/ revaluation of a currency:

Back 4

the currency's becoming more valuable (or able to buy more units of another currency)
-$1 for 10 pesos (2005)
-$1 for 14 pesos (2008)

Front 5

depreciation/ devaluation of a currency:

Back 5

the currency's becoming less valuable in relation to another currency
-$1.25 for 1 pound (2002)
-$1.97 for 1 pound (2008)

Front 6

3 reasons to hold foreign currencies

Back 6

1. trade and investment
2. interest rate arbitrage
3. speculation

Front 7

speculation

Back 7

buying and selling of currency in anticipation of changes in the currency's exchange rate; speculators sell overvalued currencies and buy undervalued currencies

Front 8

interest rate arbitrage:

Back 8

taking advantage of interest rate differentials b/w countries; arbitrageurs borrow money where interest rates are low and sell it where interest rates are high

Front 9

4 main actors involved in foreign currency markets:

Back 9

1. retail customers: firms and individuals that hold foreign currency in order to trade, engage in arbitrage, or speculate
2. **commercial banks: hold inventories of foreign currencies as part of their services to customer
3. foreign exchange brokers: middlemen b/w buyers (banks) and sellers of foreign currency
4. central banks: a country's bank of banks

Front 10

where do exchange rate risks come from?

Back 10

the fact that currencies are constantly changing in value
-expected future payments in a foreign currency will likely be a different domestic currency amount from when the contract was signed

Front 11

5 Financial Instruments:

Back 11

1. spot
2. Forward
3. Swap
4. Future
5. Option

Front 12

What is a "Spot" transaction?

Back 12

It is a 2-day delivery transaction, as opposed to futures contracts, which are usually 3 months.
-represents a "direct exchange" b/w 2 currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction

Front 13

What is a "forward" transaction?

Back 13

In this transaction, money doesn't actually change hands until some agreed-upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then.

Front 14

What is a "swap" transaction?

Back 14

the most COMMON type of forward transaction. In this, 2 parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded thru an exchange. A deposit is often required in order to hold the position open until the transaction is completed

Front 15

What is "future" transaction?

Back 15

These are standardized forward contracts and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. They are usually incluseive of any interest amounts

Front 16

What is an "option" (FX option) transaction?

Back 16

this type of foreign exchange is a the deepest, largest, and most liquid market for options of any kind in the world.

Front 17

forward exchange rate

Back 17

the price of currency that will be delivered in the future. This allows an exporter or importer to sign a currency contract that guarantees a set price for the foreign currency in either 30, 90, 0r 180 days into the future

Front 18

forward market:

Back 18

a market in which the buying and selling of currencies for future delivery takes place; important mechanism for exporters, importers, financial investors, and speculators

Front 19

Spot market:

Back 19

buying and selling of foreign currencies in the present

Front 20

hedging:

Back 20

an interest rate arbitrageur's insuring against exchange rate risk thru buying a forward contract to sell foreign currency at the same time that the bonds or other financial assets owned by the arbitrageur mature

Front 21

covered interest arbitrage:

Back 21

the use of forward market by an interest rate arbitrageur against exchange rate risk

Front 22

a currency's value is determined by its _________ and ________, regardless of which exchange rate system is adopted.

Back 22

supply and demand

Front 23

under a ___________ exchange rate system, an increase in the demand for the dollar will cause it to ___________, while an increase in the supply of the dollar will cause it to __________.

Back 23

flexible/ appreciate/ depreciate

Front 24

Under a _________ exchange rate system, the central bank counteracts the demand and supply forces of the dollar, holding its value constant

Back 24

fixed

Front 25

USD / pound downward sloping demand curves indicate that as the USD$ appreciates on the pound, the quantity of pounds demanded by Americans (increases/ decreases)?

Back 25

increases
(the cheaper the pound, the more we demand it)

Front 26

Interest parity:
(* = foreign)
-if i = i*, investors are _____ b/w countries
-if i > i*, investors prefer (home / foreign) market
-if i < i*, investors prefer (home/ foreign) market

Back 26

the difference b/w any 2 countries' interest rates is equal to the expected change in the exchange rate
-if i = i*, investors are indifferent b/w countries
-if i>i*, investors prefer home to foreign market
-if i<i*, investors prefer foreign to home market

Front 27

purchasing power parity:

Back 27

the equilibrium value of an exchange rate is at the level that allows a given amount of money to buy the same quantity of goods abroad as it will buy at home

Front 28

Gold standards:

Back 28

they are a form of fixed exchange rates. Under this, nations keep gold as their international reserve

Front 29

Bretton Woods exchange rate system:

Back 29

a type of gold standard in 1947-1971 where USD and British pound were fixed to each other and to gold; a modified Gold standard exchange rate system

Front 30

(3) types of exchange rate systems:

Back 30

1. flexible (floating) system
2. pegged exchange rate system
3. crawling peg

Front 31

flexible (floating) system:

Back 31

the value of the currency is allowed to float up and down in market forces

Front 32

pegged exchange rate system:

Back 32

one currency is anchored to another currency
-first a country fixes its nominal exchange rate relative to a foreign currency
-the supply and demand for the foreign currency may vary but the nominal exchange rate does not. It is the responsibility of the monetary authority to keep the excahgne rate fixed by intervening in the market

Front 33

crawling peg:

Back 33

fixed (pegged) exchange rates that are periodically adjusted
-allows for dealing with real depreciations or appreciations better than a pegged system

Front 34

4 reasons for countries to adopt common currency:

Back 34

1. reduces currency conversions and transaction costs
2. eliminates price fluctuations
3. increases in inter-state political trust
4. provides exchange rate greater credibility

Front 35

4 things countries must share in order for common currency to be viable:

Back 35

1. synchronized business cycles
2. a 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