BOP

Question 1

Distinguish between indirect + direct quotation

Answer 1

Indirect = cost of domestic currency expressed in units of foreign

Direct = cost of foreign currency expressed in units of domestic

Question 2

Appreciation

Answer 2

Currency becomes more valuable

Question 3

Depreciation

Answer 3

Currency becomes less valuable

Question 4

What’re the categories that affect the forex market?

Answer 4

Real flows (trade in goods + services, e.g. exports + imports)

Financial flows (trade on capital markets, e.g. FDI, foreign aid)

Question 5

What’re the different types of ER?

Answer 5

Floating (determined by market force)

Fixed (set by central bank)

Managed (dirty) float (ER allowed to float freely within predetermined band but central bank intervenes to prevent from leaving)

Nominal (domestic currency expressed as foreign)

Real (the rate at which one country’s goods can be traded for another country’s goods)

Effective ER (Bilateral/multilateral) (price of one currency/price of a basket of currencies)

Spot (exchange takes place today)

Forward (exchange takes place in future (at ER agreed today))

Question 6

Give the pro’s and cons of floating ER

Answer 6

Floating (P): can freely respond to changes in economy

Floating (C): can be very volatile (ER risk)

Question 7

Give the pro’s and con’s of forward ERs

Answer 7

P: useful in eliminating ER risk

C: requires to pay a premium

Question 8

What are the 2 main theories of ERs?

Answer 8

Purchasing Power Parity (PPP) > more LT

Uncovered Interest Parity (UIP) > ST

Question 9

What is the ‘law of one price’?

Answer 9

The same good should cost the same in all countries when cost is expressed in a single currency

Question 10

What are the problems of the ‘law of one price’?

Answer 10

A good available in one country might not be available in the other

Question 11

Balance of Payments

Answer 11

A record of a country’s transactions with the rest of the world

Question 12

What are the 2 main parts of the BoP and explain

Answer 12

Current account - records international flows of goods/services + income + transfer payments

Capital + financial accounts - records transactions involving a change in the ownership of assets

Question 13

Describe Adam Smith’s theory of trade (absolute advantage)

Answer 13

1 region has an absolute advantage (AA) over another in prod. of good X when equal Q of resources can produce more of good X in 1st region than in 2nd (lower COP)

Total prod. can be increased if each country specialises in producing the product for which it has an absolute advantage (gains from specialisation > gains from trade)

Countries then import between goods they specialise in

Question 14

Opportunity cost

Answer 14

How much of one good we have to give up to produce 1 more unit of the other good

Question 15

Comparative advantage

Answer 15

Lower opportunity cost to produce a good in one country in comparison to producing the same good in another region

Question 16

Terms of Trade (TOT) + how would this look on a diagram?

Answer 16

The ratio of the P of goods exported to those imported > determines the Q of imports that can be obtained per unit of exports

On diagram, it’s the slope of the International Trade Line

Question 17

Formula for TOT?

Answer 17

Px/Pm * 100

Question 18

Give the pro’s and con’s of the fixed ER

Answer 18

Pros: anchors (stabilises) expectations, eliminates ER risk (promotes trade, eases borrowing abroad)

Cons: may be misaligned with state of economy (not appropriate parity > equality)