Chapter 5 - FX (2/3)

Question 1

What is a FX market?

Answer 1

Where converting currencies takes place

Question 2

What is a SPOT XR?

Answer 2

AN XR which is quoted for immediate delivery of currency

Question 3

What is a FORWARD XR

Answer 3

agreed on now for delivery of currency on a future date

Question 4

What is a DIRECT quote?

Answer 4

How many of the home currency can be obtained from a single unit of the foreign currency
£/$

Question 5

What is a INDIRECT quote

Answer 5

how many of the foreign currency can be obtained from a single unit of the foreign currency
$/£

Question 6

What is the mathematical relationship between Direct and Indirect?

Answer 6

Direct = 1/Indirect

Question 7

How are XR’s reported

Answer 7

As a bid - offer range

$/£ N1 - N2

the bank buys high and sells low

Question 8

In a free market, how is XR established?

Answer 8

In a free market, XR is set by interaction by demand-supply

XR ($/£) vs Q

FOr UK, If £ is converted to other S is shifted out
If other converted to £, D is shifted out

Question 9

What does £ strengthening mean?

Answer 9

INCREASE in $/£
cheaper for UK to buy US goods
more expensive for US to buy UK

Question 10

What does £ weakening mean?

Answer 10

DECREASE in $/£
More expensive for UK to buy US goods
Cheaper for US to buy UK

Question 11

What influences XR?

Answer 11

1) Interest Rates - UP UP
2) Inflation Rates UP DOWN
3) Balance of Payments M>X DOWN
4) Speculation

Question 12

How does Interest Rate influence XR?

Answer 12

If interest rates INCREASE in UK more than US
Increase in demand for UK, increase in spot rate
Forward rate $/£ adjusted

Forward rate ($/£) = spot rate ($/£) * (1+Interest rate $/1+Interest rate £)

Question 13

How does inflation rate influence XR?

Answer 13

Inflation erodes purchasing power
One country has Higher inflaction to another

weakens currency of Higher Inflation
LI/HI DECREASE

Future spot rate(a/b) = spot rate (a/b)* (1 + inf rate a/1+inf rate b)

Question 14

How does balance of payments influence XR?

Answer 14

If imports > exports

-weakens the currency = DECREASE F/H

Question 15

How does Speculation influence XR?

Answer 15

People try to make gains by trading in currencies
If this happens in large quantities, this can influence the whole market

Question 16

How can XR be controlled by government?

Answer 16

1) Directly - Buring and selling currency using foreign currenct reserves
(shifts supply and demand)
2) Indirectly via the ability to change the level of domestic interest rates

Question 17

What are the 4 management levels of XR?

Answer 17

1) Floating rate
2) Managed floating rate
3) Fixed rate
4) Moving peg

Question 18

What is a floating rate system?

Answer 18

No intervention from government at all - only market dictates

Question 19

What is a managed floating rate system?

Answer 19

To keep the XR within an acceptable range, gov may intervene by using currency reserves

Question 20

What is a fixed rate system?

Answer 20

XR is fixed, gov use currency reserves to maintain
XR will be benchmarked against something e.g. gold/another stable currency

Question 21

What is a moveable peg system?

Answer 21

Fixed rate but with periodic revaluation/devaluation

Question 22

ADVANTAGES: Floating rate system?

Answer 22

No gov intervention required

Question 23

DISADVANTAGE: Floating rate system?

Answer 23

Increased potential volatility Increased risj

Increased swings -> increased movement in Balance of Payments
= instability

Question 24

ADVANTAGE: Fixed rate system?

Answer 24

Certainty for international trade

Question 25

DISADVANTAGE: Fixed rate system?

Answer 25

GOv has to set policies solely to maintain XR

Question 26

What is a Currency board?

Answer 26

Fixes XR with a stronger currency -> member currenct has to have 100% reserve of less stable currency

Question 27

What is a Currency bloc

Answer 27

number of countries fix XR against a major currency
Increase stability and Increase trading

Question 28

What is a single currency zone?

Answer 28

All members adopt a single currency (e.g. EU)

Must have similar economic outlook and goalds

Decrease in flexibile economic policies are major TURNOFF

Question 29

Advantages: Single currency zone?

Answer 29

1) Eliminates XR risk
2) decrease conversion costs
3) increase avail of financing

Question 30

Disadvantages: Single currenct zone?

Answer 30

1) hard to ensure monetary policy fits all
2) cant adopt individual policies