Lecture 9 Flashcards
(22 cards)
When did fixed exchange rates end?
1971 (weakened)
1973 (abandoned)
What does a stronger £ mean for UK exporters?
They become less competitive
What does a weaker £ mean?
- Imports are more expensive
- Increases inflation
What does EMU stand for?
Economic & Monetary Union
What are the main activities in FX markets?
- Trade transactions (1%)
- International investment flows
- Hedging
- Speculation
What does PPP stand for?
Purchasing power parity
What is purchasing power parity?
An attempt to determine if currencies are over- or under-valued
The underlying concept of purchasing power parity is…
the law of one price
True or false: absolute PPP generally holds
False - exchange rates consistently diverge from absolute PPP values
What is relative PPP?
Calculates ‘real exchange rate’
What is the ‘real exchange rate’?
Market exchange rate adjusted for differences in inflation
How effective is relative PPP?
Somewhat helpful in long term, not very helpful in short term
What accounts for the ineffectiveness of PPP?
Imports & exports account for a very small proportion of FX turnover
What are risks associated with FX?
- Transaction risk
- Translation risk
- Economic exposure
What is transaction risk?
Exchange rate movements alter price of buying / selling abroad
What is translation risk?
£ value of assets / liabilities changes on balance sheet
What is the risk of economic exposure to FX markets?
Even if you don’t import/export, shifts can make foreign competitors more competitive
What are some examples of behavioural biases?
- Overconfidence
- Confirmation bias
- Hindsight bias
- Attribution bias
How does the disposition effect manifest?
Closing profitable positions, keeping loss-making positions open
What is the endowment effect?
Overvaluing assets you already own
What is prospect theory?
Investors are sensitive to framing / use acquisition price as reference value
What are examples of heuristics?
- Anchoring
- Social proof
- Halo effect
- Availability bias
