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| The amount of local or domestic currency required to purchase one unit of foreign currency. |
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| An exchange rate quotation that gives the value of domestic currency in terms or units of the foreign currency. |
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Affect
Foreign Currency Appreciation |
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Increases the direct quote
Decreases the indirect quote |
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| The exchange rate between two currencies, derived from their exchange rates with a third currency. |
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Foreign Exchange Market
Over the counter
-1 Market between major banks
-2 Retail market
-Currencies ranked in decreasing order of seniority |
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| Exchange rate at which the dealer is willing to buy the quoted currency in exchange for the second currency. |
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| Exchange rate at which the dealer is willing to sell the quoted currency in exchange for the second currency. |
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Definition
The smallest incremental move an exchange rate can make.
i.e. the last decimal of the quote |
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| The difference between the quoted ask and big prices |
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| The simultaneous purchase of an undervalued asset or portfolio and sale of an overvalued but equivalent asset or portfolio, in order to obtain a riskless profit on the price differential. Taking advantage of a market inefficiency in a risk free matter. |
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| Covered Interest Rate Arbitrage |
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Definition
| The process of simultaneously borrowing the domestic currency, transferring it into the foreign currency at the spot exchange rate, lending it, and buying a forward exchange rate contract to repatriate the foreign currency into domestic currency at a known forward exchange rate. The net result should be nil. |
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Definition
| The forward discount/premium equals the interest rate differential between the two currencies. |
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Exports and Imports
Services
Income
Current Transfers |
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| A component of the balance of payments covering investments by residents abroad and investments by nonresidents in the home country. |
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Definition
A component of the balance of payments that reflects unrequited or unilateral transfers corresponding to capital flows entailing no compensation.
debt forgiveness
expropriation losses |
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| Desired Attributes of Economic Performance |
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Definition
Stable Political System
Rigorous but fair legal system
Fair Tax System
Free Movements of Capital |
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Definition
The regulation of the money supply and interest rates by a central bank, such as the Federal Reserve Board in the U.S., in order to control inflation and stabilize currency
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| The use of government expenditure and revenue collection (taxation) to influence the economy. |
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| Flexible/Floating Exchange Rates |
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Definition
| Exchange rates between two currencies fluctuates freely in the foreign exchange market. |
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Definition
Exchange Rate between two currencies remains fixed at a present level.
Known as Official Parity. |
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Definition
- Compromise between Fixed & Float
Exchange rate is allowed to fluctuate within a band around a target exchange rate (peg) and the target exchange rate is periodically revised to reflect changes in the economic fundamentals. |
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Definition
| Spot exchange rate adjusts perfectly to inflation differentials between two countries. |
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Definition
| Claims that the exchange rate should be equal to the ratio of the average prices levels in the two economies. |
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Definition
| Focuses on the general across the board inflation rates. |
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Definition
LAW OF ONE PRICE
In an efficient market all goods must have only 1 price |
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Term
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Definition
| This approach claims that the exchange rate is the relative price of two currencies, determined by investors expectations about the future, not by current trade flows. |
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Definition
Econometric Models make it feasible to take complex correlations between variable into account explicitly
-Produces forcast's |
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| Draw Backs of Econometric Appraoch |
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Definition
1-Most rely on predictions for certain key variables that are not easy for forecast
-money supply
-interest rates
2. Structural Correlation estimated by the parameters of the equation can change over time |
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Definition
Predictions based solely on price information.
Looks at repetition of specific price patterns.
Short Run Outlook |
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Definition
| Goal is to smooth erratic daily swings of exchange rates in order to signal major trends. |
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Definition
| The phenomena in which exchange rates revert to their fundamental PPP value over the long run is known as "mean reversion" of the real XR |
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Term
| Integrated International Market |
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Definition
| Efficient in the sense that securities with the same risk characteristics have the same expected return wherever in the world they are traded. |
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Term
| Segmented International Market |
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Definition
Inefficient in a sense that securities with the same risk characteristics sell at different exchange rate adjusted prices in different countries.
More apparent with emerging markets |
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Definition
The ability of money to cross borders
The free flow of money in and out of a country. |
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| Impediments of Capital Mobility |
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Definition
-psychological barriers
-Legal Restrictions
-Transaction Costs
-Discriminatory Taxation
-Political Risks
-Foreign currency risks |
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Definition
| An equilibrium theory that relates the expected return of an asset to its market risk. |
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Term
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Definition
| When riskfree borrowing and lending are possible, the decision of which portfolio of risky assets to hold is separated from the decision of how much risk to assume. |
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Definition
A conclusion of CAPM where the optimal investment strategy for any investor is a combination of two portfolios:
The market portfolio and the risk free asset |
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Term
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Definition
| CAPM conclusion is an equilibrium risk-pricing expression where the expected return on an asset (i) is the the sum of the risk free rate plus the market risk premium. |
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Term
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Definition
| All investors determine their demand for each asset by a mean-variance optimization using their domestic currency as base currency. |
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Term
Foreign Currency Risk Premium
SRP |
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Definition
The expected movement in the direct exchange rate minus the interest rate differential.
Domestic rfr - foreign rfr |
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