Term
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Definition
| To not repay a debt on time |
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Term
| Nominal Effective Exchange Rate (NEER) |
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Definition
| Sum of (Trade Shares*Exchange Rate) in each country |
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Definition
| Danish crone maintains a + or – 2% exchange rate band to euro |
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Definition
| ER follows a trend rather than a strict peg |
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| ER follows a trend rather than a strict peg |
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Term
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Definition
| 1) A and B agree to trade on currency for another for delivery on the spot at a set price. 2) 90% of transactions |
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Definition
| Risking Reduction/Risk Taking |
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Term
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Definition
| 1) A and B agree to trade currencies at a set price on a settlement date. 2) Contract cannot be traded to third parties. |
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Definition
| 1) A and B agree to trade at a set price today and do reverse trade at a set price in the future. 2) Combine two contracts → a spot and a forward |
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Term
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Definition
- An agreement between a holder (buyer) and a writer (seller) that gives the holder the right, but not the obligation, to buy or sell foreign currency at a prearranged price, within a few days or a couple of years
- CALL OPTION: Gives the holder the right to buy foreign currency at a specified price
-PUT OPTION: Gives the holder the right to sell foreign currency at a specified price
- STRIKE PRICE: The price at which the option can be bought or sold at |
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Term
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Definition
| EX. Suppose a U.S. importer is buying equipment from a German manufacturer with a € 1,000,000 payment due in 3 months. The importer can hedge against an euro appreciation by buying a call option that confers the right to purchase Euros over the next 3 months at a specific price. |
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Term
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Definition
1) A and B agree to trade currencies at a set price in the future.
2) Can be traded to third parties. |
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Term
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Definition
| Taking advantage of price differences in different markets. The purest form involves making a risk less profit through trading. |
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Term
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Definition
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Term
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Definition
- Price of good g in europe over U.S. price = 1!
- If greater than 1, GOODS EXPENSIVE IN EU |
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Term
| Purchasing Power Parity (PPP) |
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Definition
- Theory that overall price levels in each market must be the same
- Also called Absolute PPP
- Exchange rate = Relative Price Levels (Price EU/U.S.) |
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Term
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Definition
- Relative price of basket is Eu vs. US = EU basket expressed in $ / Price of basket in US
- Tells us how many U.S. Baskets are needed to buy one European |
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Term
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Definition
| If the real exchange rate rises (less home goods needed in exchange for foreign goods) |
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Term
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Definition
| Foreign goods are relatively expensive so currency is overvalued by x% |
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Term
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Definition
| Rate of depreciation of the nominal ER = Inflation Differential |
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Term
| Speed of Price and Exchange Rate Convergence |
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Definition
1) 15% per year
2) 4 year half life |
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Term
| Forecasting Exchange Rates |
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Definition
- Change in ER = Change in Real ER + (Inflation US - Inflation EU)
- When PPP holds, no change in Real ER so that terms = 0 |
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Term
| Forecasting Exchange Rates EXAMPLE |
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Definition
- You find that US inflation is 3%, Eurozone inflation is 2%
- Based on the inflation differential you predict a 1% rate of depreciation of the US dollar, or E to rise by 1%
- Then you also discover that the US dollar is 10% overvalued against the euro (q=0.90), relative to a PPP value of 1
- You expect 15% of that deviation of –0.1 to vanish in one year, so you expect q to rise (real depreciation) by 1.5%
- Adding the inflation differential, you now expect E to rise by 2.5% |
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Term
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Definition
- Created by economist Pam Woodall
- Prices of big macs are consistently lower in developing countries than in developed |
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Term
| Why are the deviations from PPP? |
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Definition
1) Transaction Costs
2) Non-Traded Goods
3) Imperfect Competition and Legal Obstacles
4) Price Stickiness |
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Term
| Covered Interest Partiy (CIP) |
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Definition
- Investor covers the risk of the exchange rate changing in the future by using a forward contract
- RISKLESS ARBITRAGE
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Term
| Are there arbitrage profits? |
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Definition
| We observed that once capital controls were removed, riskless arbitrage opportunities have disappeared |
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Term
| Uncovered Interest Parity (UIP) |
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Definition
- Investor does not cover the risk and invests according to the current and expected future exchange rate
- RISKY ARBITRAGE |
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Term
| Asset Approach to finding the interest rate on $ deposit |
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Definition
| = Interest Rate on EU deposit + Expected Rate of Depreciation |
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Term
| What Happens When We Increase Domestic Interest Rates? |
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Definition
| E$/€ decreases (home currency appreciates) |
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Term
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Definition
- When UIP does not hold (home interest rate doesn't equal foreign plus interest), investors can earn profits from borrowing in one currency and investing in another
- = Int. R Foreign + Expected Depreciation Home Currency - Int. R Home |
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Term
| Leverage and Margin Example |
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Definition
Example: You have $2,000 and borrow an additional $48,000 in yen from a bank in Japan.
- You have borrowed 25 times your own $2,000 capital, a leverage ratio of 25. You conduct carry trade, investing $50,000 in the Australian dollar.
- If you lose 4% on the trade, you’ve lost your initial capital investment. This initial capital put up by the investor of 4% of the total investment is known as a margin |
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Term
| GNE (Gross National Expenditure) |
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Definition
- Total national spending on final goods and services
- = (C + I + G)
- In closed economy, GNE = GDP |
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Term
| Trade Balance (net exports) |
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Definition
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Term
| GDP (Gross Domestic Product) |
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Definition
- Total value of goods and services produced
- GDP = GNE + TB = (C + I + G) + (EX – IM) |
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Term
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Definition
- Occurs when one country is paid income by another, in compensation for labor, capital and land!
- A country exports factor services and receive factor income in return
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Term
| GNI (Gross National Income) |
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Definition
- Income earned by home factors only
- Subtract factor service imports and add factor service exports to GDP
- GNI = GDP + (EXFS – IMFS) |
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Term
| GNDI (Gross National Disposable Income) |
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Definition
- Income available including transfers
- EX: Foreign aid, charity, income remittances by migrants to families back home
- GNDI = GNI + (UTin – Utout) |
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Term
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Definition
- Cross-border movement (trade) in ownership of a financial claim
- FA = EXa – IMa = Asset Exports – Asset Imports |
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Term
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Definition
- Transfer/receive assets as gifts
- KA = KAin – KAout |
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Term
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Definition
- GNDI = (C + I + G) + CA
- CA = TB + NFIA + NUT
- The sum of TB, NFIA and NUT is the difference between expenditure and income
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Term
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Definition
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Term
| When GNDI > GNE (C + I + G)... |
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Definition
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Term
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Definition
= (GNDI – C - G)
- S = I + CA
- S is > 0 only if CA >0 |
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Term
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Definition
= CA + KA + FA = 0
- If CA > 0, then KA + FA is < 0 and country is a net lender
- If CA < 0, then KA + FA is > 0 and country is a net borrower |
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