Week 6: Foreign Exchange Markets Flashcards
(37 cards)
What is the Foreign Exchange Market?
Where individuals, firms and banks buy and sell foreign currencies for foreign exchange
What are the 3 functions of the foreign exchange market?
- Transfer purchasing power from one country to another
- Provide credit for foreign transactions
- Provide the facilities for hedging/speculation
Who participates in foreign exchange markets?
-Those needing currency to fund transactions
-Commercial banks
-Foreign exchange brokers
-Central banks
What 3 aggregative prices are significant?
-Home price measured as P
-Foreign price measured as P*
-Relative price of foreign exchange denote as S converting P(£) to P*($)
How would you denote the exchange rate for the amount of dollars to equal gbp?
S = $/£
How is S determined under a flexible exchange system?
Intersection of market demand and supply
What is a fixed exchange rate system?
Exchange rates are held constant or allowed to fluctuate between narrow bands
What is an example of a fixed rate system?
Bretton Woods era (1944-1971)
What are some positive features of a floating exchange rate system?
-Countries more insulated from economic problems of other nations
-No central bank intervention required
-Policy is not constrained to maintain exchange rates
-Less capital flow restrictions- enhancing market efficiency
What are some negatives of a floating market system
-Countries with existing problems may have its’ issues compounded
-Resources devoted to managing exposure from fluctuations
What is a managed float exchange rate system?
When governments intervene to prevent rates moving too much in a certain direction
What is a pegged exchange rate system?
When a currency’s value is pegged to a foreign currency and moves in line with it
What is an example of a pegged currency?
Mexico’s peso peg to US dollar (1994)
What is dollarisation?
The replacement of a country’s currency with US dollars?
What are the impacts of dollarisation?
-Avoids the possibility of speculative attacks on domestic currency
-Loss of independent monetary policy
-Increase exposure to shocks from anchor country
-Inability to create money
What’s an example of dollarisation?
Ecuador (2006)
What is the difference between direct and indirect quotations?
Direct- Represent the value of a foreign currency in terms of a home currency
Indirect- Represent the number of units of foreign currency per unit of home currency
What is the bit spread formula?
(ask rate-bid rate)/ask rate
What is the cross exchange rate?
The exchange rate between 2 countries that can’t directly be traded
Whats the formula for cross exchange rate?
S= Euro/£ = $ value of £/$ value of euro
What is the effective exchange rate?
A weighted average of exchange rates between domestic currency and the nation’s most important trading partners
What is arbitrage?
The purchase of currency in one market for immediate resell in another market
What is a spot rate?
The exchange rate that calls for payment and reciept of foreign exchange within two business days
What is the forward rate?
The exchange rate that calls for the foreign exchange months after the date the contract is signed
