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Econ 202 Macroeconomics > Chapter 16: Foreign Exchange Rates > Flashcards

Chapter 16: Foreign Exchange Rates Flashcards

1
Q

Dollarize

A

Non-US countries using the US Dollar as their currency due to it being an economically larger neighbor

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2
Q

Foreign Exchange Market

A

The market in which people or firms use one currency to purchase another currency

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3
Q

Largest market in the world economy, and approximate daily amount traded on it.

A

Foreign exchange markets

$5.3 trillion per day

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4
Q

4 groups that participate in the foreign exchange market

A
  1. Firms involved in international trade
  2. Tourists
  3. International investors buying ownership in foreign firms
  4. International investors making other financial investments
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5
Q

2 financial investment categories that cross international boundaries and require currency exchange

A
  1. FDI - Foreign direct investment

2. Portfolio Investment

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6
Q

Foreign Direct Investment (FDI)

A

Purchasing at least 10% of a firm in another country, or starting a new enterprise in another country

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7
Q

Portfolio Investment

A

Purely financial investment that does not involve management responsibility

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8
Q

Hedge

A

using a financial transaction to protect yourself against a risk from one of your investments (such as currency exchange risk)

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9
Q

Is Foreign Direct Investment (FDI) long-run or short-run investment?

A

Long Run

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10
Q

Is Portfolio Investment (FDI) long-run or short-run investment?

A

Short Run

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11
Q

Interbank Market

A

Banks provide foreign exchange as a service to customers, and then trade on the foreign exchange

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12
Q

Dealers

A

Banks and other firms that trade foreign exchange and provide it as a service to others

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13
Q

What makes the foreign exchange market so big?

A

Portfolio investment transactions

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14
Q

Appreciating Currency

A

Strengthening

The currency exchanges for more of other currencies

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15
Q

Depreciating Currency

A

Weakening

The currency exchanges for less of other currencies

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16
Q

For a US firm selling abroad, do they prefer a strong USD or weak USD?

A

Weak USD, because the firm will earn revenues in the foreign currency and then exchange it for USD

17
Q

For a foreign firm selling in the US, do they prefer a strong USD or weak USD?

A

Strong USD, because the firm will earn revenues in USD and then exchange it for a greater amount of weaker foreign currencies

18
Q

For a US tourist abroad, do they prefer a strong USD or weak USD?

A

Strong USD, because they will make purchases in the foreign currency, and have more foreign currency is the USD is strong

19
Q

For a US financial investor that has already invested money in another country, do they prefer a strong USD or weak USD?

A

Weak USD, because they will be converting foreign currency earned to USD

20
Q

How does a relatively high interest rate/rate of return affect a nation’s currency?

A

Makes it desirable, so demand goes for the nation’s currency goes up (so people can invest in that nation’s transactions), and the currency appreciates

21
Q

How does a relatively high inflation rate affect a nation’s currency?

A

Buying power of the currency is eroding, discouraging its desirability. The exchange rate falls, currency depreciates.

22
Q

Arbitrage

A

Buying/selling goods or currencies across international borders at a profit

23
Q

PPP/Purchasing Power Parity Exchange Rate

A

Exchange rate that equalizes the prices of internationally traded goods across countries

24
Q

What is the PPP Exchange Rate used for? (2)

A
  1. Comparing GDP size and other economic metrics between nations
  2. Know the PPP allows you to track and predict exchange rate relationships
25
Q

Why are central banks concerned about the exchange rate?

A
  1. Exchange rate affects quantity of aggregate demand in an economy
  2. Frequent substantial fluctuations can disrupt international trade and cause problems in a nation’s banking system
26
Q

How do exchange rates affect aggregate demand in a nation’s economy?

A

It has a powerful effect on incentives to import and export

27
Q

How does a weak USD affect the motivation to export?

A

Encourages exports

28
Q

4 Exchange Rate Policies

A
  1. Floating exchange rate
  2. Soft exchange rate pegs
  3. Hard exchange rate pegs
  4. Merging currencies
29
Q

Floating Exchange Rate

A

Policy that allows the foreign exchange market to set exchange rates.
Example: USD.
Con: exchange rates can move a great deal in a short. time.

30
Q

Soft Peg

A

Exchange rate policy where the government usually allows the rate to be set by the market, but in some cases will intervene

31
Q

Hard Peg

A

Exchange rate policy where the government sets a fixed and unchanging value for the exchange rate

32
Q

Merged Currency

A

Nations choose to share a common currency. Eliminates foreign exchange risk altogether. Gives up its own national control over monetary policy. Example: Euro.

Econ 202 Macroeconomics (15 decks)

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