Topic 1

Question 1

What does the international Monetary System refer too and what does it in turn have an effect on?

Answer 1

the institutions and policies that determine exchange rates. In turn has an effect on countries economies , companies need to know as determines how they do business

Question 2

What are the two main different types of exchange rate systems and how are they classified?

Answer 2

Fixed and floating
classified by the extent of the intervention from either gov or central bank controlled or by the markets.

Question 3

Explain fixed exchange rates

Answer 3

exchange rates are held constant or are allowed to fluctuate within very narrow boundaries

Question 4

devaluation is when …

Answer 4

when the currency falls in value against another currency (fixed system)

Question 5

revaluation is when …

Answer 5

when the currency rises in value against another currency (fixed system)

Question 6

what are fixed rate exchange systems controlled by?

Answer 6

governments

Question 7

what are pegged rate exchange systems controlled by?

Answer 7

central banks

Question 8

what is an example of a pegged system

Answer 8

Hong Kong dollar (HK$) /US$

Question 9

2016 Venezuelan Bolivar Example:
base rate is B10/US$
A) What happens when B9/US$?
B) What happens when B11/US$?

Answer 9

A) strengthening of B, gov/central bank sell B to bring rate back down
B) weakening of B, gov/central bank buy B to try and bring rate back down

Question 10

Under pegged or fixed systems what would the gov or central banks do if the currency moved away from base level?

Answer 10

intervene to bring back to fixed rate by selling or buying currency determining if the currency had strengthened or weakened respectively.

Question 11

Advantage of fixed rate exchange system

Answer 11

• reduces exchange rate risk for companies (little uncertainty about what it is worth)
  BUT
  there is still a risk of devaluation/revaluation, does not eliminate just reduce
• fixed exchange rate systems can export economic problems

Question 12

What happens when Argentinean goods become relatively more expensive than US products…. (Inflation)

Answer 12

• consumers will buy US products as cheaper
• move from Argentinean goods to US goods ( demand in argentina goes down and up in US. Production will have to go down in argentina and up in US.
• Move employment from argentina to US
• wage levels will fall in Argentina and rise in the US (wages in US will rise, so business costs rise in US, so prices in US rise = Inflation

Question 13

Is inflation, wages and employment linked?

Answer 13

yes

Question 14

What are floating exchange rates determined by?

Answer 14

market forces

Question 15

what is the term used when there is an increase in currency value (floating system)

Answer 15

appreciation

Question 16

what is the term used when there is an decrease in currency value (floating system)

Answer 16

depreciation

Question 17

What is an advantage of floating rate system

Answer 17

• countries are insulated from economic problems of other countries, as the exchange rate will adjust to compensate for the change in price of goods

Question 18

what is a disadvantage of floating exchange rate systems

Answer 18

companies are exposed to exchange rate risk, as rate changes all the times companies will not know what exchange rate will be when they make the transaction

Question 19

what is hedging

Answer 19

getting rid of exchange rate risk

Question 20

What are the 3 categories of of IMF’s classification of exchange rate systems 2009

Answer 20

hard pegs
soft pegs
floating arrangements

Question 21

hard pegs is when….
example…

Answer 21

where countries have to give up the control over monetary policy, eg zimbabwe dollarisation

Question 22

soft pegs is when
example…

Answer 22

covers countries with fixed exchange rate systems. subcategories differentiate between different types of fixed rate systems, e.g. extent to which variation is allowed , extent of government intervention.
eg HK$/US$ , former european exchange rate mechanism

(this category is more common)

Question 23

floating arrangements is when …
examples …

Answer 23

covers countries whose exchange rates are mainly determined by market forces.
eg Managed/ dirty floats = £, $ ,¥
eg most floating currency = CA$ (ie least gov intervention)

Question 24

What does de facto mean

Answer 24

actual behaviour / in practice

Question 25

what does de jure mean

Answer 25

based on official policy statements / theory

Question 26

Is the IMF 2009 system based on de facto or de jure

Answer 26

de facto

Question 27

what is the purpose of the foreign exchange market?

Answer 27

to enable companies, individuals etc to trade one currency for another

Question 28

Where do central banks agree to co-operate with one another

Answer 28

bank for international settlements

Question 29

What are qualities of the foreign exchange market?

Answer 29

- over 90% of FX transactions are through the interbank market (where banks trade with one aother) - an over-the-counter (OTC) market (not one physical location of trade - done via phone etc) 24hr market

Question 30

where is 78% of trading concentrated (BIS, 2022)

Answer 30

UK Singapore Hong Kong Japan US

Question 31

By what percentage does the US $ dominate the market (% of trades that involve the US$)

Answer 31

88%

Question 32

What are the percentages of trade involving the dominant currencies and the % of the emerging market currencies in 2022 (BIS)

Answer 32

US$ - 88% euro -30.5% (down from 2019) japanese yen - 17% brittish pound - 13% emerging markets: chinese renminbi - 7% south korean won - 2.2% mexican peso - 1.5%

Question 33

What are the two types of FX transactions

Answer 33

spot market forward market

Question 34

describe what happens in a spot market transaction

Answer 34

currencies are traded for immediate delivery t + 2 settlement delivery transaction is conducted on todays price

Question 35

describe the forward market

Answer 35

most popular currencies are bought and sold at prices agreed now but for future delivery at an agreed date "locking in a price" - hedging forward rate is based on what they think the price/spot rate will be

Question 36

regarding forward market transactions if the period is over 12 months what is this called

Answer 36

SWAP market

Question 37

What are the different Market participants?

Answer 37

FX dealers (marketmakers) brokers (matchmakers) retail customers speculators and arbitragers

Question 38

what to FX dealers do

Answer 38

buy and sell currencies on a continuous basis

Question 39

what is a bid price

Answer 39

bank buy price

Question 40

what is a offer/ask price

Answer 40

bank sell price

Question 41

bank needs to make a profit so what relationship must there be between bid and ask price

Answer 41

ask >bid

Question 42

what does retail customers cover

Answer 42

governments/ central banks companies eg exporting and importing smaller domestic banks

Question 43

what do speculators do

Answer 43

gamble on FX movements

Question 44

what do arbitragers do

Answer 44

exploit riskless profit opportunities

Question 45

if the companies aim is to maximize shareholder wealth what kind of market participant should they be and what should they not be

Answer 45

shouldnt be speculators, should be arbitragers as want to minimise currency risk rather than gamble

Question 46

What is a direct quote

Answer 46

the number of units of home currency needed to buy one unit of foreign currency e.g. £0.538/C$

Question 47

What is an indirect quote

Answer 47

the number of units of foreign currency needed to buy one unit of home currency e.g C$ 1.7129/£

Question 48

How do you get from indirect to direct quote and vis versa

Answer 48

1/home(direct) = foreign (indirect) 1/foreign (indirect) = home (direct)

Question 49

what is bid-ask spread

Answer 49

difference between buy and selling rate, shows how risky the currency is

Question 50

what is the impact for us of a) banks bid b) banks sell price

Answer 50

a) our sell price b) our buy price

Question 51

what are the normal first 3 digits of the currency exchange dollor

Answer 51

1.60

Question 52

difference between banks buy and sell ie buy-sell is called what

Answer 52

spread

Question 53

what does pip stand for

Answer 53

Price Interest Point Percentage In Point

Question 54

%Spread =

Answer 54

(ask-bid)/ ask x100

Question 55

what does spread reflect

Answer 55

risk

Question 56

what does wide spread mean in terms of trade qualities

Answer 56

RISKY TO TRADE Illiquid Volatile e.g. emerging markets

Question 57

what does narrow spread mean in terms of trade qualities

Answer 57

LESS RISKY TO TRADE Liquid Stable eg £,$, jap yen

Question 58

what is a cross rate

Answer 58

an exchange rate that is calculated from 2 rates, e.g. if you don't want to include dollar in rate

Question 59

How would you calculate the value of 1 unit of A in units of B

Answer 59

Value of A in $(common currency) / Value of B in $(common currency) where A = pricing currency ie RHS, expressed as one whole unit b= LHS, base currency

Question 60

what is capital flows

Answer 60

the movement of wealth across countrys

Question 61

what is capital flows an indicator of

Answer 61

financial health of global economy

Question 62

what can capital flows impact

Answer 62

countrys economic growth, development and financial stability

Question 63

what does IMF stand for

Answer 63

International Monetary Fund

Question 64

What is the impossible trinity

Answer 64

1 Exchange rate stability : value of currency is fixed in compassion to other major currencies 2. Full Financial Integration : complete freedom of monetary flows between countries 3. Monetary Independence: Domestic monetary and interest rate policies would be set by the individual countries

Question 65

what one of the impossible trinity does a) US b) China c) Europe forgo

Answer 65

a) Exchange rate stability b) Full Financial Integration c) Monetary Independence

Question 66

what are the benefits of the euro

Answer 66

cheaper transaction costs risks associated with exchange rate reduced price transparency and increased price competition

Question 67

arguments against dollarisation

Answer 67

loss in authority over monetory policy country losses the ability to profit from printing of its own money (seigniorage) central bank can no longer have the role of lender as last resort

Question 67

arguments for dollarisation

Answer 67

removes currency volatility againt the dollar elminate the possibility of future crisis's greater economic integration with other dollar based economies several countries that are highly economically integrated would benefit from dollarising together

Question 67

what is the choice that emerging market nation currency's must make

Answer 67

free-floating regime vs currency board or dollarisation

Question 67

drawback of the euro

Answer 67

loss of monetary independance

Question 68

what countries made up the euro in 1999 when it began and what country joined two years later

Answer 68

austria, belguim, finland, france, germany, ireland, italty, luxemburg, the Netherlands, Portugal, Spain 2 years later greece

Question 68

euro vs the dollar

Answer 68

2002-2008 euro appreciated vs dollar since then, it has depreciated slowly though does show significant volatility