Currency

Question 0

What is the mark-to-market value of a currency forward contract (equation)?

Answer 0

Vt=(FPt - FP)(contract size)/(1+r(days/360))

Question 1

Compute the cross rate for MXN/USD when the quotes are:
USD/AUD 0.6000-0.6015
USD/MXN 0.0933-0.0935

Answer 1

6.42-6.4481

Question 2

What is covered interest rate parity? What is the equation?

Answer 2

Holds when any forward premium or discount exactly offsets difference in interest rates.

F=(1 + Ra(days/360))/(1 +Rb(days/360))

Question 3

What is uncovered interest rate parity?

Answer 3

If forward contracts are not available, or if capital flows are restricted arbitrage may not hold. Uncovered interest rate refers to when the currency will move in the same direction indicated by the forward.

E(%changeS)(A/B) = Ra - Rb

Question 4

What is the difference between absolute PPP and relative PPP?

Answer 4

Absolute: S(A/B) = CPI(A) / CPI(B)

Relative: Change in spot price (A/B) = inflation(A) - inflation(B)

Question 5

What is the ex-ante version if PPP?

Answer 5

Same as relative PPP except that it uses expected inflation rather than actual.

Question 6

What is the real exchange rate equation?

Answer 6

Real exchange rate = Spot(CPI(B)/CPI(A))

This is an exception to the numerator-denominator rule

Question 7

Investment income is in which BOP account?

Answer 7

Current Account

Question 8

Unilateral transfers is in which BOP account?

Answer 8

Current account

Question 9

Flow of funds for debt and equity investment is in which BOP account?

Answer 9

Financial account (capital account)

Question 10

What are the three current account influences?

Answer 10

1) Flow mechanism
2) Portfolio composition mechanism
3) Debt sustainability mechanism

Question 11

What does the portfolio mechanism refer to under current account influences?

Answer 11

When Investor countries usual invest in other countries with current account deficits. When investor countries decide to rebalance their investment portfolio it can have a significant negative impact on the value if those investee country currencies.

Question 12

Regarding capital account influences what is the equation that explains real exchange rate fluctuations?

Answer 12

Real exchange rate (A/B) = equilibrium real exchange rate (A/B) + (real interest rate B - real interest rate A) - (risk premium B - risk premium A)

Question 13

How is the real value of a currency related to the following (+ve or -ve relation)?

1) Neutral real interest rate
2) Inflation gap
3) Output gap
4) Risk premium investors demand for investing in that currency.

Answer 13

Neutral real interest rate, inflation gap and output gap positively related.

Risk premium negatively related

Question 14

For the Mundell-Fleming model, with high capital mobility, how does expansionary fiscal and monetary policy affect exchange rates?

Answer 14

Monetary expansion reduces the interest rate and consequently the inflow of capital investment. This reduced the demand for domestic currency and results in depreciation of the currency.

Fiscal expansion will increase government borrowing and consequently real interest rates. Resulting in a appreciation of the currency.

Question 15

For low capital mobility in the Mundell-Fleming model what is the effect of restrictive monetary and fiscal policy?

Answer 15

Restrictive policy reduces net imports and leads to appreciation of the currency.

Question 16

What is the model when PPP holds at any point in time and output is held constant? Thus meaning expansionary monetary or fiscal policy increases the price of goods and thus depreciates the currency.

Answer 16

Pure monetary model

Question 17

What model assumes prices are sticky in the short term and exchange rates overshoot the long-run PPP implied values?

Answer 17

Dornbusch overshooting model.