Chapter 15

Question 1

Balance of payment

Answer 1

Record that summarizes all international transactions of a country with the rest of the world during a certain period

Question 2

Credit in components of the balance of payment

Answer 2

Money comes into Canada (exports of goods/services)

Question 3

Debit in components of the balance of payment

Answer 3

Money that goes out of Canada (imports of goods/services)

Question 4

Trade Balance

Answer 4

Exports of goods - imports of good

Question 5

Net Transfers

Answer 5

Inflow of transfers - outflow of transfers (eg. a grant or an aid)

Question 6

Unilateral Transfers

Answer 6

Transfers that flow in one direction, we take and don’t give back, or give and do not give back,. a gift.

Question 7

Net Investments income

Answer 7

The inflow of investment income(credit) - the outflow of investment income(debit) (eg. profits and interests). Both are recorded in current account, not capital.

Question 8

Current Account

Answer 8

is a record of the net exports of goods and services and net transfers and net investment income

Question 9

Capital account

Answer 9

Records flow of capital like investment and borrowing “loans”. Talking about the investment itself, (eg. me opening a restaurant in China is and outflow of capital in Canada)

Question 10

Types of investment

Answer 10

Direct: Making a project
Indirect: Investing in the stock market, portfolio investment.
Both are recorded in the capital account.

Question 11

Capital inflows

Answer 11

Recorded in the credit side

Question 12

Capital outflows

Answer 12

Recorded in the debit side

Question 13

International reserve ‘settlement; account

Answer 13

Holdings of gold and foreign currencies and foreign assets held by our central bank. This account is used to settle ‘balance’ the other two accounts so the balance of payment has to be zero=balanced.

Question 14

Exchange Rate

Answer 14

Price(cost) of 1 foreign currency. How many CD$ to buy 1 unit of foreign currency

Question 15

If the exchange rate increases

Answer 15

CD$ depreciates versus the other currency, CD$ becomes weaker. Canadian goods and services are now cheaper than foreign goods and our net exports increase.

Question 16

Fixed (peged) Exchange rate system

Answer 16

Mainly used in developing countries exchange rate is determined by the central bank which uses his reserves of foreign currency to keep the exchange rate fixed.
If there is a shortage of foreign currency in the market the exchange rate goes up, so to prevent this the central bank will sell foreign currency into the market.
If there is a surplus of foreign currency the central bank will buy this surplus and add it to its reserves to prevent the exchange rate from decreasing.

Question 17

Pure Floating(flexing)

Answer 17

the exchange rate is determined freely by the Demand and supply market. No intervention from central bank

Question 18

Impure floating

Answer 18

The exchange rate is flexible as long as it is within a certain range “limits”. However the central bank will intervene once the exchange rate gets out of the limits.

Question 19

Depreciation

Answer 19

currency becomes weaker on its own with no intervention from the central bank. This occurs due to market forces (demand and supply). It happens under a flexible exchange rate system like in Canada

Question 20

Depreciation

Answer 20

currency becomes weaker on its own with no intervention from the central bank. This occurs due to market forces (demand and supply). It happens under a flexible exchange rate system like in Canada

Question 21

Devaluation

Answer 21

Currency becomes weaker. This happens internationally by the central bank. This happens under a Fixed exchange rate system.

Question 22

Appreciation

Answer 22

Currency becomes stronger due to the market forces

Question 23

Revaluation

Answer 23

The central bank strengthens the currency internationally.

Question 24

Fixed Exchange Rate Systems Benefits and Costs

Answer 24

Benefit: Less exchange rate fluctuation (Risk) which encourages trades and investments and this helps keep inflation low.
Cost: The country will not have an independent monetary policy it has to follow the monetary policy of the country that its change rate is tired to. –> Country becomes a follower

Question 25

Pure Floating exchange rate system benefits and costs

Answer 25

Benefits: The country will have an independent monetary policy
Cost: Higher uncertainty and exchange rate risk. Negatively affects trade and investment.

Question 26

Pure Floating exchange rate system benefits and costs

Answer 26

Benefits: The country will have an independent monetary policy
Cost: Higher uncertainty and exchange rate risk. Negatively affects trade and investment.

Question 27

Balance the balance of payment

Answer 27

The balance of payment has to equal zero. This automatically happens under Floating exchange rate and the central bank has to balance it using its reserves under a Fixed exchange rate system

Question 28

Balance the balance of payment

Answer 28

The balance of payment has to equal zero. This automatically happens under Floating exchange rate and the central bank has to balance it using its reserves under a Fixed exchange rate system

Question 29

Derived Demand

Answer 29

The demand for foreign currency is a Derived demand. We demand foreign currency because we will use it to import or invest abroad. The supply of foreign currency reflects our exports to others. We export our goods and services to others to get their currency in return

Question 30

Our national income (Factors affecting demand on foreign currency)

Answer 30

If our GDP increases we are now rich and our imports will increase causing our demand on foreign currency in Canada to increase

Question 31

Our tariffs (Factors affecting demand on foreign currency)

Answer 31

If our tariffs increase then the imported items are now more expensive causing our imports to decrease because our demand on foreign currency in Canada has decreased.

Question 32

if our tastes are in favor of foreign goods (Factors affecting demand on foreign currency)

Answer 32

Our imports will increase and our demand on foreign currency in Canada will also increase

Question 33

Relative inflation rate (Factors affecting demand on foreign currency)

Answer 33

If our inflation rate increases compared to other countries, our goods and services are now more expensive so our consumers will prefer to import cheaper foreign goods causing our demand on foreign currency to increase.

Question 34

Relative interest rate (Factors affecting demand on foreign currency)

Answer 34

If the foreign interest rate Is higher than the domestic interest rate then our bonds and savings accounts are now less attractive since they offer a lower return. Many of our people will prefer to save or invest in other countries and our demand for foreign currency will increase.

Question 35

Expectations (Factors affecting demand on foreign currency)

Answer 35

If we expect the foreign currency to appreciate in the future then we will buy more of it now since we can sell it tomorrow at a higher price and our demand for foreign currency increases.

Question 36

Foreign income (Factors affecting supply of foreign currency)

Answer 36

If foreign income increases then foreigners are now rich and they will buy more of our goods and services and our exports will increase so our foreign currency in Canada will increase

Question 37

Foreign tariff (Factors affecting supply of foreign currency)

Answer 37

If our foreign tariff decreases then our foreigners will buy more of our goods and services since they are now paying less tariffs. This will cause our exports to increase and foreign currency in Canada to rise.

Question 38

Expectations (Factors affecting supply of foreign currency)

Answer 38

If we expect the foreign currency to depreciate in the future then the people in Canada will get rid of their foreign currency so foreign currency in Canada will increase.

Question 39

Relative interest rate (Factors affecting supply of foreign currency)

Answer 39

If our interest rate increases relative to other countries then foreigners will prefer to save their money in Canada or buy Canadian bonds to benefit from this higher return. This will cause foreigners to convert their currency into Canadian dollar and foreign currency in Canada will increase

Question 40

Relative inflation rate (Factors affecting supply of foreign currency)

Answer 40

If our inflation is less than in other countries then Canadians’ goods and services are cheaper and foreigners will buy more of our goods and services. They will convert their currency into Canadian $ to buy our goods and foreign currency in Canada will increase.

Question 41

In the graph, all 3 scenarios show what in common.

Answer 41

In the 3 cases, the price of foreign currency always increases and this will depreciate our currency.