AGB 302 QUIZ 5

carry trade

involves borrowing in one currency where interest rates are low and then using the proceeds to invest in another currency where interest rates are high.

Trade creation

occurs when high-cost domestic producers are replaced by low-cost pro-ducers within the free trade area. It may also occur when higher-cost external producers are replaced by lower-cost external producers within the free trade area.

A forward exchange

occurs when two parties agree to exchange currency and execute the deal at some specific date in the future

Currency speculation

typically involves the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates.

nonconvertible

when neither residents nor non-residents are allowed to convert it into a foreign currency.

externally convertible

when only nonresidents may convert it into a foreign currency without any limitations.

freely convertible

when the country's government allows both residents and nonresi-dents to purchase unlimited amounts of a foreign currency with it.

rt of Justice

which is comprised of one judge from each country, is the su-preme appeals court for EU law

purchasing power parity (PPP)

which links changes in the exchange rate between two countries' currencies to changes in the countries' price levels. By comparing the prices of identical products in different currencies, it would be possible to determine the "real" or PPP exchange rate that would exist if markets were efficient. (An efficient market has no impediments to the free flow of goods and services, such as trade barriers.)

Trade diversion

occurs when lower-cost external suppliers are replaced by higher-cost suppliers within the free trade area.

capital flight.

ost likely to occur when the value of the domestic currency is depreciating rapidly because of hyperinflation or when a country's economic prospects are shaky in other respects. Under such circumstances, both residents and nonresidents tend to believe that their money is more likely to hold its value if it is converted into a foreign currency and invested abroad.

customs union

eliminates trade barriers between member countries and adopts a common external trade policy.

European Parliament

The parliament, which meets in Strasbourg, France, is primarily a consultative rather than legislative body.

free trade area

all barriers to the trade of goods and services among member countries are removed. In the theoretically ideal free trade area, no discriminatory tariffs, quotas, subsidies, or administrative impediments are allowed to distort trade between mem-bers. Each country, however, is allowed to determine its own trade policies with regard to nonmembers. Thus, for example, the tariffs placed on the products of nonmember coun-tries may vary from member to member.

common market

has no barriers to trade among member countries, includes a common external trade policy, and allows factors of production to move freely among members. Labor and capital are free to move because there are no restrictions on immigration, emigration, or cross-border flows of capital among member countries.

law of one price

in competitive markets free of transportation costs and barriers to trade, identical products sold in different countries must sell for the same price when their price is expressed in the same currency

political union

in which a central political apparatus coordinates the economic, social, and foreign policy of the member states.

economic union

involves the free flow of products and factors of production among member countries and the adoption of a com-mon external trade policy, but it also requires a common currency, harmonization of mem-bers' tax rates, and a common monetary and fiscal policy.

Economic exposure

is the extent to which a firm's future international earning power is affected by changes in exchange rates.

Transaction exposure

is the extent to which the income from indi-vidual transactions is affected by fluctuations in foreign exchange values.

Translation exposure

is the impact of currency exchange rate changes on the reported financial statements of a company.

Countertrade

refers to a range of barter-like agreements by which goods and services can be traded for other goods and services.

European Council

represents the interests of member states. It is clearly the ulti-mate controlling authority within the EU because draft legislation from the commission can become EU law only if the council agrees. The council is composed of one representa-tive from the government of each member state. T

A currency swap

simultaneous purchase and sale of a given amount of foreign exchange for two different value dates

Fisher effect

states that a country's "nominal" interest rate (i) is the sum of the required "real" rate of interest (r) and the expected rate of inflation over the period for which the funds are to be lent (I).

international Fisher effect (IFE)

states that for any two countries, the spot exchange rate should change in an equal amount but in the opposite direction to the difference in nominal interest rates between the two coun-tries.

arbitrage,

the process of buying a currency low and selling it high

spot exchange rate

the rate at which a foreign exchange dealer converts one currency into another currency on a particular day