IMF

Question 1

Participants at forward market

Answer 1

1. Hedgers - trade to get rid of risky position
   - Trader needs some $ next month so he invests right now in forwards market to avoid risk
   
   2. Arbitrageurs - trade in riskless assets
      
      • Try to exploit the differences between S(t) and F(t) -> Ensure CIP
   3. Speculators - trade to create risky position
      
      • They are willing to take on risk
      • The want to exploit differences in expected S(t) and F(t)
        Sell expensive $ forward and expect to buy cheap $ at spot market at t+1

Question 2

Cip formula (and approximation formula)

Answer 2

1+r = 1/S(1+r)F
pproximation:
R (home interest rate) = R* (foreign) +(F-S)/S where (F-S)/S is the forward discount on EURO

Question 3

IN CIP what happens when r* goes uo

Answer 3

If R* goes up then r<r+(F-S)/S
- Both sides of this equasion are the returns on investments: Domestic and foreign
- U can see that returns on foreign are higher so investors invest abroad -> arbitrageurs invest abroad
- To invest abroad investors buy $ with their EUR to invest aborad -> Spot demand incrases for $ -> S increases (as dollard become more valueable so u need more EUR to buy 1$)
- Then investors invest in foregin market -> the SUPPLY the $ on the forward market of foreign currency (to avoid risk). As supply increases F goes down due to injected excess demand.
- As F decreases in brings the original equasion back to equilibrium and CIP is restored bc the (F-S)/S = F/(S-1) falls in value. As it is on the right side of the equasion in compensates for the increase of r that is on the right as weel so L=R again

Question 3

CIP crucial condition and what does it mean

Answer 3

Crucial condition: Perfect capital mobility: meaning you can freely buy/sell other currencies and invest in them. Otherwise, arbitrage CANNOT ensure equality.

Question 4

Formula for F

Answer 4

F=S(1+r)/(1+r) -> This suggests that S somehow comes before F. (its not realistic as F affects S and vice versa)
Banks use this to compute F

Question 5

Is S determined before F?

Answer 5

no

Question 6

What happens when we drop F? (CIP)

Answer 6

If we drop F -> r>r*+(F-S)/S (reminder: Drop in F means that (on forward market) foreign currency’s price in home currency falls. This means foreign currency depreciates and home currency appreciates
- This means that its more attractive to invest at home that abroad
If its better to invest at home(NL so Euro) then the demand on the spot market for EUR increases as ppl invest here now. This increase in demand makes euro more valuable so it appreciates on spot market as well -> S decrease (remember continental definition)

Question 7

Measures of national activity?

Answer 7

1. National income accounts
   ○ Composition of country’s income/production - national focus
   ○ GNP, GDP, consumption
   
   2. Balance of Payments (BoP)
      ○ Flow between domestic and foreign country: international focus
      
      • Exports, importns, investments abroad, official reserves

Question 8

Current account (and its subaccounts) - 4 of them - name them.

Answer 8

○ Goods accounts - merchandise trade or visible trade (goods export/import)
○ Services accounts - services E/I
○ Income account - Interest, profits, dividends
○ Unilateral transfers account - Current transfers of income likek gifts and contributions (from EU expl)
○ As u see in there 4 categories: this is jsut income/money but these are not assets

Question 9

Capital and financial account (K)
(mainly 2 name them)

Answer 9

○ Portfolio investments (stocks and bonds)
○ Foreign direct investments (FDIs): physical capital like properties and factories
○ Non-financial non-produced assets: copyrights andd patents
○ Capital transfers: assets ownership transfer, debt forgivness
(First 2 are most important)

Question 10

Official reserves account (ORA)
what is it, types of transactions

Answer 10

○ This account is for CB only -> if CB does not act on the iternational market then ORA=0
○ Forex Interventions (OMO)
○ Selling Gold
○ Borrwoing from IMF and foreign CBs
Concerns offcial reserves of a country (aka international reserves)

Question 11

What are official reserves held for

Answer 11

They are foreign assets held by CB to cushion against financial instability. -> accumulation of official reserves by CB particularly emerging markets, serves as a buffer against financial instability. It allowes CB to menage their currencys value, provide liquidity in times of need and maintain confidence in their financial system

Question 12

How do we book entries from imports and exports?

Answer 12

• Priciple: double entry bookkeeping (error detenction tool) - in BOP
  
  • BoP is measured in home currency
  • Export is a credit entry (+)
  • Import is a debit entry (-)

Question 13

NIIP - meaning

Answer 13

NIIP -net international investment position
- Total value of H-owned assets (real and financial) in F minus F-owned assets is H country
- Net international Debt//Surplus is NOT THE SAME as public debt
Japan for example is very rich internationally as it has a OSB positive yet its public debt is huge

Question 14

What happens when CA<0 ( just BoP case)

Answer 14

if CA<0 than K>0 : asset outflow, H borrows from F. Net foreign debt goes up.

Question 16

What is the key in external debt increase?

Answer 16

CA deficit