International Econ Test 2

nominal bilateral exchange rates

'normal' spot exchange rate

what are two challenges for developing economies?

(1) capital markets work less efficiently in developing countries (more barriers to the lending of $ to the most productive uses; property rights less clearly defined -> less willingness to invest in new assets -> higher interest rate for good projects) (2) labor markets work less efficiently, so wage gaps between expanding and declining factors are larger (indirect clue that labor is being kept from moving to most productive use)

why are we not good at predicting exchange rates?

(1) strong immediate reaction to new information; unexpected & cant be incorporated into models (2) exchange rate expectations can be formed without reference to economic fundamentals-- investors just extrapolate trends (bandwagon) - speculative bubbles

real exchange rate

(bilateral or effective) RER = (Pt/P0)*(et/e0)/(Pft/Pf0)*100 e here = foreign currency units per unit of domestic currency [(foreign cost of home currency) x (P/Pf) x (100)]. RER = nominal rate USD/EUR * average price of good in euro area/average price in USD

what fraction of US-Mexico trade involves offshoring

1/2

what fraction of trade is within trade blocs as of 2014?

1/2

what fraction of sanctions are successful?

1/3

what fraction of world's international trade of intrafirm trade

1/3

When did the modern era of floating exchange rates take hold?

1973

it takes _ years for deviation from PPP to be reduced by 1/2 for exchange rates of major industrialized countries

4

if currency is over priced relative to PPP standard, RER is

> 100, nominal exchange rate value higher than PPP value

rules of origin

A version of domestic-content regulations in which products are certified to have been produced within a free-trade area (and so are permitted to trade without barriers in that area). Without such rules, a non-member Country X may circumvent Country Y's high external tariff by exporting its good to Y's free-trade partner, Country Z.

If you are a Chinese exporter and expect to receive $5 million at the end of 60 days, how can you best remove the risk of loss due to a potential weakening of the USD? Sell USD now in the 60-day forward exchange market. Buy USD now and sell these USD at the end of 60 days. Sell the yuan equivalent now in the forward exchange market for 60-day delivery. Keep the USD in the United States after they are delivered to you.

Sell USD now in the 60-day forward exchange market.

A foreign exchange swap involves the: Future sale of a currency. Forward repurchase of a currency. Spot sale of a currency combined with a forward repurchase of the same currency. Spot sale of a currency combined with a forward repurchase of a different currency.

Spot sale of a currency combined with a forward repurchase of the same currency.

A nation running a current account surplus is accumulating foreign assets.

T

An expectation that the yen will appreciate can cause the yen to appreciate.

T

An export embargo will backfire if the embargoing country has an inelastic export supply curve while the target country has an elastic import demand curve.

T

Customs unions are more likely to be successful among developed countries than among less-developed countries.

T

If Americans suddenly refuse to lend money to Mexico, we would expect the dollar to appreciate relative to the peso.

T

If GDP, consumption, and domestic investment are all constant, an increase in government spending will cause the country to run a trade deficit.

T

If German interest rates are higher than American interest rates, we would expect the euro to be at a forward discount relative to the dollar.

T

If a currency is undervalued in a fixed exchange rate system, officials from that country's central bank will have to sell their currency to keep it pegged.

T

If a speculator believes that the future spot rate on the British pound will be higher than the current forward rate, the speculator will buy the pound forward.

T

If the inflation rate in the United States is lower than the inflation rate in France, the euro will depreciate relative to the dollar.

T

International interest rate differentials drive exchange rates in the short run; international price differentials drive exchange rates in the long run.

T

The purchasing power parity hypothesis is unlikely to be true for countries that do not trade commodities internationally.

T

Trade discrimination is bad in the sense that separate deals with separate nations may destroy many of the gains from global markets.

T

Suppose the average price of a Big Mac in the United States is $3.50 while in Japan the average price is 400 yen. If the market exchange rate is that 1 USD is exchanged for 100 JPY, the purchasing power-parity model of exchange-rate determination suggests that: The JPY is valued correctly. The JPY is overvalued and will depreciate against the USD. The USD is overvalued and will depreciate against the JPY. None of the above.

The JPY is overvalued and will depreciate against the USD.

What could be a possible consequence in the foreign exchange market of a sudden increase in the purchase of Japanese stocks by U.S. residents? The demand for dollars (USD) will increase. The yen (JPY) will weaken. The USD will weaken. The supply curve for USD will shift to the left.

The USD will weaken.

Suppose an American speculator anticipates the spot rate on the yen in 180 days will be higher than today's 180‑day forward rate on yen ($0.0072). Which of these investments is best if she is correct? A. Sell one million yen today in the forward market for delivery in 180 days. B. Buy one million yen today in the forward market for delivery in 180 days. C. Buy dollars today in the spot market. D. Buy dollars today in the forward market for delivery in 180 days.

B

The United States was able to initiate most of the trade embargoes in the last four decades mainly because A. the U.S. is a superpower. B. the U.S. has high demand and supply elasticities in a significant number of products and can, therefore, influence trade. C. other countries cannot do without U.S. trade. D. embargoes are usually successful.

B

The optimal monopoly markup is A. higher with more elastic demand for cartel sales. B. higher with less elastic demand for cartel sales. C. lower with less elastic demand for cartel sales. D. higher with more elastic supply schedules.

B

Trade sanctions are A. usually successful as long as the imposing countries are developed countries. B. more likely to be successful when the sanctioning countries have high trade elasticities. C. more likely to be successful when the sanctioning countries have low trade elasticities. D. successful mostly due to world cooperation, not trade elasticities.

B

Which of the following causes a downward trend in the relative prices of primary products? A. Slow productivity growth in the primary sector. B. Development of synthetic substitutes for primary products. C. The nonrenewable nature of many primary products. D. A high income elasticity of demand for food. 

B

Which of the following statements is false? A. British imports of Florida oranges will create a demand for U.S. dollars. B. If all Americans buy Japanese cars, the dollar will appreciate relative to the yen. C. The American dollar is often used as a vehicle currency. D. Australia, Canada, New Zealand and Taiwan all use currencies called "dollars."

B

Borrowing from abroad is a A. capital import and therefore a debit item. B. capital export and therefore a credit item. C. capital import and therefore a credit item. D. capital export and therefore a debit item.

C

If all member nations of a customs union are fully employed before and after the formation of the union, then (assuming that trade diversion does not dominate) A. the welfare of the member nations will decrease. B. the welfare of the member nations will increase but world welfare will decrease. C. the welfare of the member nations and the world will increase. D. no member nations will have time to organize good soccer matches.

C

Suppose the exchange rate between the Canadian dollar (C$) and the American dollar (US$) changes from C$1.340/US$ to C$1.325/US$, but the Canadian government wants to maintain a fixed exchange rate of C$1.340/US$. What should the Bank of Canada do? A. Stop trading with the U.S. so that fewer U.S. dollars will flow into Canada. B. Sell U.S. dollars (buy Canadian dollars). C. Sell Canadian dollars (buy U.S. dollars). D. Purchase British pounds and sell French francs.

C

Suppose you are an established speculator with an excellent reputation, but currently without liquid funds. You believe the dollar is going to appreciate. What would you do? A. Borrow dollars in the U.S. and sell the dollars in the spot exchange market. B. Buy foreign (non-dollar) currencies forward. C. Sell foreign (non-dollar) currencies forward. D. Borrow yen in Japan and sell them on the spot market

C

Under the asset market approach, if both U.S. and British interest rates rise by three percentage points, we could expect A. the dollar to appreciate. B. the dollar to depreciate. C. the exchange rate between the dollar and the pound to remain unchanged. D. investors to move their funds to a third country.

C

When American residents buy bonds from Her Majesty's Treasury in London, in the foreign exchange market this will give rise to A. a demand for American dollars. B. a supply of British pounds. C. a supply of American dollars. D. another Boston Tea Party.

C

Which group definitely loses from international migration of labor? A. The migrants. B. The migrants' new employers in the receiving country. C. The migrants' old employers in the sending country. D. The migrants' fellow workers who did not emigrate.

C

Which of the following is not correct? A. The formation of a common market allows the free movement of factors of production between member nations. B. The 1992 EC common market overturned Italian Pasta Protection Laws, which protected higher-cost producers. C. A common market coordinates monetary and fiscal policies of members. D. Common markets have been more successful among rich countries than among poor countries.

C

equation for Current Account balance

CA = X-M = Y - E = S - Id = If

covered interest differential

CD = (1 + i(uk)) * f/e - (1 + i*(us)) approx = f + (i(uk) - (i(us) if positive, invest in UK if negative, invest in US

CMEA

Council for Mutual Economic Assistance (1949-1991), an organization of Soviet Bloc countries intended to promote and coordinate multilateral trade within the centrally-planned economies of the bloc.

OPEC

Organization of Petroleum Exporting Countries. Established in 1960, this cartel has a membership of 12 producers (from the Middle East, Africa, and South America) as of 2011. OPEC was successful in engineering enormous increases in the price of crude oil during 1973‑74 and 1979‑80. Because of supply conditions, it is unlikely that cartels in other primary products could achieve anything like OPEC's success.

As long as _______ and _______ are low enough, foreign direct investment can be used to reduce total costs by locating different stages of overall production in different countries. Foreign demand; transport costs. Transport costs; trade barriers. Trade barriers; domestic demand. Domestic taxes; foreign demand.

Transport costs; trade barriers.

covered interest arbitrage

buying country's currency spot, selling forward, profiting off combined different in interest rates and forward premium if many people do it, pressure on rates (size of covered interest differential shrinks) causes covered interest parity

current account deficit is offset/financed by equivalent amount of

capital account inflows (possibly including via drawing down of official international reserves)

If it suddenly looks like domestic interest rates are going to drop more than previously expected, while foreign interest rates and the expected future spot rate remain unchanged, then chances are that the domestic currency's exchange rate will: Strengthen. Weaken. Remain unchanged. Converge to its PPP value.

weaken

nominal effective exchange rate

weighted average spot exchange rate

does the law of one price hold?

well for heavily traded commodities if free trade is permitted (gold & other metals; crude oil; various agricultural commodities) doesn't hold for most products, nearly all manufactured goods because of transport costs, unfree trade, imperfectly competitive markets, dumping

uncovered interest parity

when EUD = 0; international fisher effect currency expected to appreciate by as much as interest rate is lower than interest rate in other country (ie, expected appreciation of GBP = ius-iuk) expected overall uncovered return on foreign currency investment = return on domestic currency investment (expected appreciation + iuk = ius)

how are business enterprises branches/affiliates considered, in terms of residency?

where they're located

speculating

willing to take net position on foreign currency

Should home country restrict FDI outflows?

workers may be harmed by temporary unemployment, decline in real wages (especially organized labor), home government loses; owners of MNE gain (increased returns to equity investments) -- gains can be > losses, can be smaller or owners can be foreign FDI may carry tech. benefits

does competition prevail in the foreign exchange market?

yes

how much of the foreign exchange activity does interbank trading make up?

~40%

CEMEX

cement company (expensive to ship) - new managers introduced extensive automation, info tech, satellite communication for quality control & detailed info on production, sales, distribution -more aggressive with exports using sea transportation -> antidumping duty - other foreign opportunity: exporting to spain, FDI in spain (minimized inherent disadvantages by investing somewhere with same language, similar culture); internal transfer of intangibles

who are the four banks that make up most trade in the foreign exchange market?

citigroup, deutsche bank, UBS, Barclays

overall covered return is approximately equal to

gain (or loss) from the spot and foreign currency exchanges PLUS interest return of pound investment itself (i(uk))

currency option

gives buyer right, not obligation, to buy foreign currency (call) or sell (put) in the future at 'exercise' or 'strike' price - pay premium for that right

advantage of speedy reform in transitioning countries

growth takes effect before interest groups can take power during recession period

does uncovered interest parity hold?

hard to test- expected appreciation rate should approximately = difference in interest rates according to survey method, doesn't hold nearly as closely looking to broad patterns, holds roughly with some important deviations because exchange-rate risk matters expectations of spot-rate are biased- inefficient market or just slow learning?

if a foreign currency appreciates while you're a tourist in that foreign country, the dollar price of those goods to you is (higher/lower)

higher

cut in money supply ->

higher exchange rate value of the currency

long positions

holding net assets in foreign currency

how is inflation measured?

household surveys determine basket of items & cost of purchasing them mainly rent/mortgage consumer price index

Does RPPP hold?

if APPP holds for both Y0 and YT, otherwise still useful guide for why exchange rates change over time.

Does APPP hold?

if LoOP holds, APPP holds - even if LoOP doesn't, APPP might (different products balance each other) In the real world, APPP doesn't work much better because of technical difficulties

Why does the foreign exchange demand curve slope downward?

if exchange rate falls, foreigners will find more to do with a currency

why does ISI fail?

ill-informed governments protecting industries that turn out to be inefficient, have self-interest conflicting with maximizing national well-being

law of one price

in perfectly competitive global market, product that is easily & freely traded should have same price everywhere P = e * Pf

what are additional gains from trade blocs? (not trade creation)

increase in competition can reduce prices (less monopolies) increase in competition can lower costs of production (pressure to implement to tech, lower costs) firms can lower costs by expanding scale of production by expanding consumer base consumers gain access to larger number of varieties/models of product increases opportunities for business investments

increased incomes --> [increased/decreased] value of currency

increased

arguments in favor of ISI

infant industry argument developing government argument for a large country, replacing imports can bring better terms of trade effects than expansion of export industries replacing imports of manufactures is a way of using cheap & convenient market information

what is hyperinflation?

inflation > 1000%

why do MNEs exist?

inherent disadvantages of being foreign firm-specific advantages to overcome inherent disadvantages location factors that favor foreign production over exporting internalization advantages (favor FDI over contracting with independent firms) oligopolistic rivalry among MNEs

financial derivatives other than reserves

instruments through which risk is traded

[short term] if expected future spot exchange rate decreases...

international financial repositioning toward domestic currency assets → spot exchange rate decreases (domestic currency appreciates)

[short term] if foreign interest rate decreases...

international financial repositioning toward domestic currency assets → spot exchange rate decreases (domestic currency appreciates)

if domestic interest rate decreases...

international financial repositioning toward foreign currency assets → exchange rate increases (domestic currency depreciates)

[short term] if expected future spot exchange rate increases...

international financial repositioning toward foreign currency assets → spot exchange rate increases (domestic currency depreciates)

[short term] if foreign interest rate increases...

international financial repositioning toward foreign currency assets → spot exchange rate increases (domestic currency depreciates)

if domestic interest rate increases...

international financial repositioning → domestic currency assets, exchange rate ↓ (domestic currency appreciates)

George Soros

investment fund earns over 30%/year took speculative positions, earned a ton world's greatest investor says he perceived changes that would've happened anyway has mixed feelings about global financial system

what creates expectations for future spot exchange rate?

investors may expect recent trends to continue (bandwagon- this speculation can be destabilizing) may believe exchange rates will return to values consistent with basic economic conditions (this can be stabilizing) unexpected conditions → reaction

if there is an unexpected increase in country's trade deficit or current account deficit and foreign financing isn't assured to be forthcoming, what happens to currency in foreign exchange market?

it decreases, increasing demand for foreign currency to pay for excess of imports will cause domestic currency to depreciate.

debit item

item country has to pay for-- import goods, domestic firms purchases of consulting services located in other countries, purchases by domestic investors of equity shares of foreign company from foreigner

credit item

item for which the country has to be paid-- exports, foreign tourists' purchases, foreign investing in government bonds

free trade area

keep separate national trade barriers against outsiders, remove trade barriers against each other -- most common (like NAFTA)

difference between lender/borrower and creditor/debtor

lender/borrow is based in time period- creditor/debtor is net stock

profitable price using monopoly model

level of sales where MR=MC (q) price at this D (shaded area between intersection of MC/MR, up to this D is profits before subtracting fixed costs

how does the US finance current account deficit?

liabilities to foreign private/nonofficial investors/lenders; liabilities to foreign monetary authorities; national saving/domestic real investment

what determines national price level/inflation rat?

long run - money supply (therefore also exchange rates)

PPP holds well in the [short/long] run, not in the [short/long] run

long, short

triangle next to profits square

loss - curtails exports that would be worth more to buyers than those exports cost the cartel members themselves to produce

is inflation good or bad for an economy?

low, stable, predictable inflation is best

what are tendencies that create greater gains from a trade bloc?

lower partner costs relative to outside world costs will increase gains (any trade diversion will be less costly) more elastic import demands will increase gains (trade creation in response to domestic price decreases will be greater)

purchasing power parity

money as a determinant of national product price levels & inflation rates basis: people choose to buy goods & services based on price they'll pay

quantity theory equation

money supply = demand for money; directly proportional to money value of GDP m=kPY

synthetic substitutes

more technology leads to more ways to replace minerals/other raw materials

e = p/pf =

ms/msf * kf/k * yf/y

p/pf =

ms/msf * kf/k * yf/y

supply shocks

natural disasters, etc (disrupt production); high oil prices, etc (increase production prices) ↓ overall supply → cost-push inflation

why is deflation bad?

people delay making purchases if they expect deflation, which means there is less economic activity

what types of sanctions failures are there

political failures-- leaders have too much stake in the policy economic failures -- embargo inflicts little damage on the target country (elastic import demand) or too much demage on inflicting country (inelastic export supply)

A current account surplus shows that a country has _________ net foreign investment.

positive

how well can we predict exchange rates in the long run?

slightly better than in the short run

foreign nation will have appreciating currency if some combination of:

slower money growth; faster growth in real output; rise in ratio kf/k

does FDI promote or detract from trade?

some of each, overall promotes trade-- can locate stages of production according to Comparative Advantage and promote intrafirm trade, or do the same thing at every affiliate and merely promote trade by marketing firm abroad

what are benefits of PPP rates for measuring size of economy?

stable, relevant for non-traded goods- BUT harder to measure

what happened with covered interest rates in global crisis & euro crisis?

substantial deviations in global crisis, returns to parity in euro crisis - no government controls causing it- banks chose not to exploit covered interest differentials

Why do cartels usually not work for long?

switching to substitutes; increasing responsiveness of non-cartel suppliers; declining share of cartel's production in world market; cheating by cartel members

arbitrage within spot exchange market

theoretically possible, usually that possibility draws the prices together and the opportunity is rare

are trade blocs good?

they are a move toward free trade but if the removed tariff is from a high-production source, it encourages purchasing more expensive goods (vs equal tariff on all imports would lead consumers to buy most cheaply produced goods)

ex ante

time of initiating foreign investment (e(ex) is uncertain)

what are the two scenarios for trade blocs?

trade creation outweighs trade diversion or trade diversion outweighs trade creation

currency futures (futures contract)

traded on exchanges, lock in price to buy/sell currency in the future (like forward foreign exchange, but tradable); always requires margin (forward only sometimes does; profits & losses accrue daily; available to almost anyone with margin (forwards only for 'highly creditworthy')

triangular arbitrage

trading three different currencies in a triangle because the exchange rates don't add up. usually, the demand for arbitrage will push the rates toward something logical and prevent this.

currency swap

two parties agree to exchange flows of different currencies during specified period of time (benefit of combination: lower transaction costs, subtle decrease in risk)

core consumer inflation

underlying persistent trends, more volatile prices of products like food, energy, most affected by seasonal factors/temporary supply

economic union

unify all economic policies (monetary + fiscal), as well as policies toward trade and factor migration. belgium + luxembourg since 1921, EU on the path toward economic unity

asset market approach to exchange rates

emphasizes rate of portfolio repositioning by international financial investors

ex post

end/maturity of foreign investment, (e(ex) is now certain)

Suppose that back in 1990, the average level of prices in the North Pole was 100 and that in the South Pole was also 100. In the foreign exchange market at the time, one North Pole dollar (NPD) traded freely at par (1-to-1) with the South Pole dollar (SPD). By now, the price level in the North Pole has increased to 180 and that in South Pole has risen to 220. According to the absolute PPP theory, what should the two currencies' exchange rate be nowadays? 1 SPD = 1.222 NPD (220/180 = 1.222) 1 SPD = .818 NPD (180/220 = 0.818) 1 NPD = .818 SPD (180/220 = 0.818) 1 NPD = 1.222 SPD (220/180 = 1.222)

1 NPD = 1.222 SPD (220/180 = 1.222)

What are the four trade policy choices for developing countries?

1) eliminate as many barriers to trade as possible, focus on exporting primaries efficiently 2) attempt to boost world price of exports artificially (cartel) 3) promote new industries through tariffs, tax breaks, subsidized credits - ISI, practically banned by WTO 4) similar measures (to 3) + subsidies to promote/diversify exports (pick winners). also mostly contrary to WTO rules.

All other things being equal, if the British government increases the money supply by 5% while the British economy is experiencing 5% real growth, the exchange rate on the pound will be A. unaffected. B. higher. C. lower. D. a mystery.

A

All other things being equal, which of the following would not cause the price of a foreign currency (e) to fall? A. A rise in the home country's expected inflation rate. B. A rise in the foreign country's expected inflation rate. C. A drop in the foreign country's real income. D. A rise in the foreign country's money supply.

A

Covered interest parity is a condition where A. the forward value of a currency will tend to exceed its spot value by the same percentage as its interest rate is lower than foreign interest rates. B. the spot value will tend to exceed its forward value by the same percentage as the domestic interest rate is lower than foreign interest rates. C. the domestic and foreign interest rates are equalized. D. the spot and forward rates are equalized.

A

If a U.S. firm borrows one billion dollars in Mexican pesos from Citibank's Mexico branch and uses the money to build a factory in Mexico, the transaction will enter the U.S. balance of payments as a credit on A. short-term private capital inflow and a debit on direct investment payments. B. long-term private capital inflow and a debit on long-term private capital outflow. C. long-term private capital inflow and a debit on direct investment. D. short-term private capital inflow and a debit on short-term private capital outflow.

A

If a country's net foreign investment amounts to -$15 billion, this implies an equivalent A. current account deficit. B. current account surplus. C. trade balance surplus. D. overall balance deficit.

A

In order to evade a higher tax burden, a multinational enterprise may engage in transfer pricing, in which the subsidiary in the high-tax country will A. be overcharged when buying from a less-taxed foreign branch. B. be overpaid when selling to a less-taxed foreign branch. C. be charged above-market rates on loans it makes to the less-taxed branch. D. borrow from the less-taxed branch at below-market rates.

A

The demand curve for a foreign currency slopes downward because A. at lower exchange rates, foreign goods look cheaper to home country residents. B. at higher exchange rates, the home currency can buy more foreign goods. C. the quantity supplied of the foreign currency rises as the exchange rate falls. D. marginal utility theory says that individuals substitute into any commodity whose price has fallen.

A

The welfare (supply and demand) analysis of immigration A. assumes that factor price equalization is not achieved through trade alone. B. implicitly assumes factor prices will eventually be equalized through trade alone. C. considers the factor price equalization theorem to be irrelevant. D. acknowledges that commodity price equalization will not be achieved through immigration alone.

A

vehicle currency

A currency used to facilitate an indirect trade between two other currencies. The U.S. dollar is often used as a vehicle currency.

official settlements balance

Also called the "official balance," this is the sum of the current account balance plus the private financial account balance. An imbalance in the official balance must be paid for through official reserves transactions

reserve assets

Assets held by a nation's monetary authorities as a kind of "war chest" to enable them to intervene in the foreign exchange market if and when they decide to do so. Reserve assets include key foreign currencies, gold, official reserves at the IMF, and holdings of Special Drawing Rights (SDRs). Recently, China has accumulated a very large stock of dollar-denominated reserve assets.

An economic transaction is recorded in the balance of payments as a credit if it leads to A. a payment to foreigners. B. the receipt of a payment from foreigners. C. a decrease in foreign exchange reserves. D. neither an inflow nor an outflow of value.

B

An international cartel that maximizes its profits is optimal for A. the member countries and the world. B. the member countries but not the world. C. the consuming countries of the world. D. no country at all.

B

If a dollar equals 400 Mexican pesos in the foreign exchange market, what is the value of one peso? A. $250 B. $0.0025 C. $0.04 D. $1.25 E. None of the above.

B

If today's spot rate on the British pound is $2 and the 30-day forward rate on the pound is $2.10 (ignoring any interest earnings or costs), then a speculator who A. purchased 100 British pounds forward today can make $10 profit in 30 days. B. purchased 100 British pounds spot today can make $10 profit 30 days from now. C. sold 100 British pounds forward today can make £10 profit 30 days from now. D. sold 100 British pounds spot today can make £10 profit 30 days from now. E. none of the above.

B

If, after the creation of the EU, the British have an incentive to purchase less efficiently produced Irish cheese rather than importing inexpensive cheese from New Zealand, this probably shows A. trade creation. B. trade diversion. C. government interference in the marketplace. D. common sense.

B

In the absence of externalities, the countries sending large numbers of workers abroad A. lose only if their emigrants' gains are excluded from net welfare calculations. B. lose with or without consideration of the emigrants' stake. C. lose because per capita income falls. D. gain, even when their emigrants' gains are left out of the net welfare calculation

B

transition economies

Countries of the former Soviet Union (FSU) and its satellites that are moving from central planning to market orientation. Beginning in 1989, these countries started to "liberalize" by moving toward market-determined prices, private ownership of resources and businesses, and openness to international competition and trade. These countries may suffer from a "transition recession" early in the liberalization period as old business practices and relationships are re-organized.

Arguments in favor of having developing countries focus on exporting manufactured goods include A. strong support in industrialized countries for free trade in manufactured goods. B. very low tariffs on manufactured textiles, apparel, and footwear in industrialized countries. C. political preference for VERs among importing countries. D. a downward trend in the prices of primary products.

D

Assume the interest rate in the U.S. exceeds Japan's by 4 percentage points on an annual basis. If you were a speculator, you would take a long position in yen if A. the value of the yen is expected to increase by two percentage points on an annual basis. B. the value of the yen is expected to fall by four percentage points. C. the value of the yen is expected to fall by less than four percentage points. D. the value of the dollar is expected to fall by more than four percentage points.

D

If a country's nominal interest rate increases by the same percentage that the inflation rate has increased, A. international investors will withdraw their funds from the country. B. international investors will pour more funds into the country. C. international investors will demand an increase in the real interest rate they are paid. D. none of the above.

D

If there is a sudden five percent decrease in the domestic money supply, we should expect A. the domestic currency to appreciate by five percent in the long run. B. the domestic currency to appreciate by six percent in the short run. C. the foreign currency to depreciate as demand for foreign assets decreases. D. all of the above.

D

When FDI brings positive technological externalities with it, a case can be made for A. the home country subsidizing outward-bound FDI. B. both the home country and the host country taxing FDI. C. both the home country and the host country subsidizing FDI. D. the host country subsidizing inward-bound FDI.

D

Which of the following is not a valid argument in favor of ISI? A. There can be large economic and social side benefits from industrialization. B. For a large country, replacing imports can bring better terms‑of‑trade effects. C. Replacing imports of manufacturers uses cheap, convenient market information. D. GDP per capita has grown faster in countries with ISI.

D

Which of the following is recorded as a debit item in the U.S. balance of payments accounts? A. An Italian firm pays $5 million in dividends to the holders of its stock in the U.S. B. The French Club Med hires four American scuba diving instructors for its new resort on the Italian island of Sardinia. C. Toyota builds a factory in the U.S. to manufacture automobiles. D. Remittances from Cambodian immigrants in the U.S. flow to their relatives in Thailand's refugee centers.

D

Which of the following is an example of foreign direct investment (FDI)? Ford Motor Company puts $100 million from its pension fund into a mutual fund containing shares of foreign companies. Dr. Gareau, a French biologist living in Paris, buys an apartment in Miami for $250,000. Fidelity Investments buys $1 billion worth of Brazilian government bonds. Microsoft buys 1 million shares of a Bangalore-based software company which has 11 million shares outstanding.

Dr. Gareau, a French biologist living in Paris, buys an apartment in Miami for $250,000.

equation for total expenditures on goods and services (absorption)

E=C+Id+G

expected uncovered interest differential

EUD = (1+iuk) * e(ex)/e - (1+ius) approx = expected appreciation + (iuk-ius)

capital inflow

Either an increase in foreign assets in the nation, such as when a foreigner purchases a U.S. stock; or a reduction in the nation's assets abroad, such as when an American sells a foreign stock.

capital outflow

Either an increase in the nation's assets abroad, such as when an American purchases a foreign asset; or a reduction in foreign assets in the nation, such as when a foreigner sells his American assets.

An economic failure of an embargo is said to have occurred if the: Embargo inflicts little damage on the target country and greater damage on the imposing country. Target country suffers a greater welfare loss than does the imposing country. Price of the good exported by the imposing country to the target country rises substantially in the target country when the embargo is imposed. Prices of the embargoed goods do not decline in the imposing country.

Embargo inflicts little damage on the target country and greater damage on the imposing country.

A negative net foreign investment on this year's balance of payments accounts means the country is a net debtor.

F

An increase in U.S. imports from France will give rise to a supply of euros in exchange for dollars.

F

An increase in the domestic interest rate will cause the home currency to depreciate.

F

Because the balance of payments accounts must balance, sub‑accounts like the financial account must balance, too.

F

Central bank intervention is more prevalent under a floating exchange rate system than under a pegged exchange rate system.

F

Speculating means taking only a short position, not a long position.

F

The formation of a customs union will definitely raise welfare.

F

The forward exchange rate is the same as the future spot rate

F

The less elastic the import demand curve, the greater the gains from a customs union.

F

FDI is essentially a flow of financial capital between countries.

False: FDI usually includes a large component of "human capital" such as management skills and entrepreneurship.

A cartel that is optimal for its members is also optimal for the world.

False: just as in the "optimal tariff," world welfare is reduced by cartels.

All OPEC countries are both wealthy and developed.

False: remember that "developed" refers to variables other than simply wealth or income

Developing countries all have the same problems and potentials.

False: they can be quite different.

The loans made by Wal-Mart to its overseas suppliers are supposed to be recorded in the ____________ balance.

Financial account

When Carrefour, a French multinational retailer, buys a supermarket chain in Argentina and sends the $1 billion payment to the Argentine owner, the transaction should be recorded as a credit in Argentina's ___________________________________________. A year later, when Carrefour headquarters in France is sent a $40 million dividend payment by its supermarket chain in Argentina, the transaction should recorded as a debit in Argentina's _________. Financial account (Argentine incurrence of foreign liabilities); financial account (dividends) Current account (primary payment); current account (primary income payments). Financial account (Argentine incurrence of foreign liabilities); current account (primary income payments). Current account (primary payment); financial account (dividends)

Financial account (Argentine incurrence of foreign liabilities); current account (primary income payments).

FDI

Foreign direct investment. A flow of lending to, or purchase of ownership in, a new or existing foreign enterprise. To qualify as FDI, the investment must represent at least 10% of the value of the firm, and the investor is presumed to have the ability to exert some control over the firm.

The difference between today's futures exchange rate value of a currency and its lower current spot value is called the ________________ . Spot premium. Futures discount. Futures premium. None of the above.

Futures premium

Studies comparing growth rates of countries practicing import-substituting industrialization (ISI) with growth rates of countries using policies that emphasize the expansion of exports have found: Little difference in growth rates between the two groups of countries. Higher growth rates in those countries using policies that emphasize export expansion. Higher growth rates in those countries practicing ISI. No evidence that either type of policy has been successful.

Higher growth rates in those countries using policies that emphasize export expansion.

All of the following statements are true, EXCEPT for: If a currency is trading at a forward premium by as much as its interest rate is lower than the interest rate in the other country, then covered interest parity holds. If the interest rate of a foreign country is less than that in the domestic country, then the foreign country will have a positive forward premium on its currency. If the covered interest differential is zero, then the covered interest rate parity condition has not yet been reached. Empirical studies show that during normal times covered interest rate parity applies almost perfectly in Eurocurrency markets for major currencies.

If the covered interest differential is zero, then the covered interest rate parity condition has not yet been reached.

ISI

Import-substituting industrialization. A strategy for development that calls for governments of developing countries to identify large domestic markets as indicated by substantial imports over the years to ensure technologies of production can be mastered by local manufacturers or supplied by foreign investors, or to use subsidies to make it profitable for potential investors or state enterprises to set up high‑cost local production facilities.

Suppose the interest rate on one-year U.S. T-bills is 1% and interest rate on one-year British T-bills is 3.5%. If the USD is trading at a one-year forward premium against the British pound (GBP) of 3%, the covered interest differential is: The same as the uncovered interest differential. Equally favoring investments in both the nations. In favor of investments in the United Kingdom. In favor of investments in the United States.

In favor of investments in the United States.

A country's demand for foreign currency is derived from: International transactions entering the debit side of its balance of payments accounts. International transactions entering the credit column of its balance of payments accounts. The government's attempt to revalue domestic currency. An increase in foreign capital inflows in the domestic country.

International transactions entering the debit side of its balance of payments accounts.

money supply =

K*P*Y (nominal/money value of GDP = price level & GDP) applies for domestic or foreign currencies)

Economic development is a dynamic process of consecutive improvement, whereby the least successful countries are those whose best companies do business on the basis of: Highest output prices, taking advantage of whatever monopolies and cartels can be established and maintained. Lowest input prices, taking advantage of inexpensive labor and natural resources. Innovative, differentiated products sold via unique marketing strategies. Efficient production, economies of scale, and product quality and reliability.

Lowest input prices, taking advantage of inexpensive labor and natural resources.

Concern about the ability of independent foreign firms to maintain product quality: Often results in the formation of a license agreement between a foreign firm and an MNE. Makes licensing firms in the foreign markets preferable to FDI. Is an inherent disadvantage faced by the multinationals. Makes FDI preferable to licensing firms in the foreign markets.

Makes FDI preferable to licensing firms in the foreign markets.

firm specific advantages

Managerial, technical, and marketing skills and patents that accrue to a particular firm and that help it overcome the inherent native advantages of local rival firms.

MNE

Multinational enterprise. A firm that owns and controls enterprises in more than one foreign country. The parent company is based in the home-country source for the FDI and has one or more foreign branches or subsidiaries. Unlike a foreign direct investor, an MNE also tends to provide brand names, marketing strategies, or management practices.

NICs

Newly-industrializing countries. Most prominent of these are South Korea, Taiwan, Hong Kong, and Singapore ("the Four Tigers"), whose per capita incomes rose to the level of the industrialized countries, thanks to high income growth rates through the late 1990s. "Newly-globalizing developing countries" are those that had closed economies in 1980, but whose growth rates skyrocketed in the late 1990s as trade was liberalized. This group includes China, Brazil, and India.

In order to minimize its overall tax liabilities, a multinational company may engage in transfer pricing, in which its subsidiaries operating in jurisdictions with low corporate-income taxes will be tempted to: Pay high prices for inputs bought from subsidiaries in high-tax jurisdictions. Pay low prices for inputs bought from subsidiaries in other low-tax jurisdictions. Overcharge when selling outputs to subsidiaries in high-tax jurisdictions. Cover the cost of the company's global research-and-development spending.

Overcharge when selling outputs to subsidiaries in high-tax jurisdictions.

You are a Canadian investor in the foreign exchange market, and if you expect the EUR to appreciate against the USD, you would: Purchase Canadian dollars (CAD) spot. Purchase USD spot. Purchase EUR spot. Use CAD to buy EUR spot, then use the EUR to buy USD spot.

Purchase EUR spot

increase in RER over time =

REAL appreciations

It was announced the two days ago that Australia's GDP growth picked up in the latest quarter by as much as analysts anticipated. The Governor of Australia's central bank commented that "our economy is doing relatively well compared with other countries, but it's not growing faster than we had expected." The most reasonable reaction in the foreign exchange market to the GDP news and the official comment would have been for the Australian dollar (AUD) to have: Appreciated Depreciated Remained Unchanged None of the Above

Remained unchanged

Who are the 'four tigers'?

SK, Taiwan, Singapore, HK

official international reserves transactions

The changes in domestic official reserve assets and in domestic official liquid liabilities to foreign officials. It is derived by separating private transactions from official "accommodative" transactions in the balance of payments accounts.

Trade/Merchandise/Goods Balance

The difference between exports and imports of goods

The current account balance is all of the following, EXCEPT for: The difference between savings and domestic investment Net foreign investment The difference between government saving and government investment. The difference between net product and consumption

The difference between government saving and government investment.

brain drain

The emigration, mainly from developing countries, of highly skilled and educated people to higher-wage industrialized countries.

The world prices of the primary products may be boosted or drop less than otherwise when: The governments of the countries that export primary products subsidize the production of these primary products. The production of the primary commodities is increased by a greater proportion than the increase in their demand. The exporters of the primary products form successful international cartels. The major importers of the primary products impose high tariff barriers on their imports.

The exporters of the primary products form successful international cartels.

Which of the following refers to trade creation? The net increase in exports when the currency of a country depreciates with respect to a foreign currency. The net increase in imports when foreign firms lower the prices of their exports. The net volume of new trade that results from the formation of a trade bloc. The net change in the volume of trade when a country raises its barriers on its imports.

The net volume of new trade that results from the formation of a trade bloc.

Financing from the parent company to its foreign affiliates is generally a small percentage of total funding because: The returns on such investment are taxed at very high rates. The parent firm wants to reduce the risks to which its foreign activities are exposed. Most foreign governments have imposed quotas of foreign investment in their domestic economy. Most major home-country governments limit investment in foreign firms by their domestic firms.

The parent firm wants to reduce the risks to which its foreign activities are exposed.

net foreign investment

The part of national saving invested abroad instead of being channeled into domestic capital formation: (S = Id + If). It is also the difference between purchases of financial assets (lending) abroad and asset sales to foreigners (borrowing), that is, a country's accumulation of net claims on other countries.

transfer pricing

The price set on a component moving between units of an MNE. Creative transfer pricing can reduce the parent company's corporate profits taxes by overstating the cost paid for components by the MNE's unit in a high-tax country.

Engel's Law

The principle that states because the income elasticity of demand for food is less than one, as per capita incomes rise in the long run, demand will shift away from food and the relative price of food will fall.

Which of the following increases the speed at which a cartel's power erodes? The cartel agreement is more stringent in imposing penalties on the members who cheat. The share of the cartel in the world market increases. The price elasticity of competing supplies decreases. The product's price elasticity of demand increases.

The product's price elasticity of demand increases.

Embargoes are likely to be economically effective when: The supply curve of the embargoing country is highly inelastic. The demand for imports by the target country is relatively elastic. A small county imposes an embargo on a large country. The sanctions are sudden and comprehensive when first imposed.

The sanctions are sudden and comprehensive when first imposed.

Net International Investment Position:

The stock - as opposed to the flow - of international assets minus liabilities, which as we shall see is affected by the volume of cross-border capital flows but also by currency (exchange rate) changes and by valuation (ups and downs) changes in stock, bond, currency and real estate markets.

Financial Account Balance

The sum total of inflows and outflows of capital, or the increase in cross-border assets and liabilities, from direct and portfolio investments, loans and repayments, and changes in official international reserves.

Current Account Balance

The sum total of the exports and imports of goods and services, plus the primary and secondary income balances. A current account surplus shows that a country has positive net foreign investment.

balance of payments

The systematic set of accounts that records all economic transactions between residents of a country and the rest of the world during a given period of time.

merchandise trade balance

The value of goods exported (credits) minus the value of goods imported (debits). The value of exported goods and services minus imported goods and services is often referred to as "the trade balance."

Which of the following refers to trade diversion? The volume of trade that is redirected from low-cost exporters to higher cost domestic firms when the domestic government imposes import restrictions. The volume of trade that is redirected from low-cost exporters to higher-cost trade bloc member countries. The amount of the imported goods that is substituted with domestically produced goods. The change in the trade pattern such that the good which was formerly imported is now exported as the government subsidizes its production.

The volume of trade that is redirected from low-cost exporters to higher-cost trade bloc member countries.

what are the two forces depressing trend of prices of primaries?

engel's law; synthetic substitutes

Engel's Law means trouble for food producers in a prospering world.

True

Even though FDI raises some political concerns for host countries, these countries may still be better off subsidizing FDI rather than taxing it.

True

"Shock Therapy" appears to work better in transition economies than a "kinder and gentler" approach.

True: as with taking off a Band‑Aid, the record shows a short but sharp removal of controls is less painful for transition economies. Although output levels will decline dramatically at first, GDP recovers relatively quickly. Poland, for example, used shock therapy in 1990 but had resumed real growth by 1992; the country is now a full member of the WTO and the EU. In contrast, Russia liberalized more slowly starting in 1992 and did not see a return to real GDP growth until after 1996.

The public finance effect of immigrant workers on the receiving country will depend upon the skill level of those workers.

True: the taxes paid by those workers are correlated with the level of their skills and wages.

There is an economic gain to workers who stay at home while others emigrate.

True: their wages tend to rise as the domestic labor supply decreases.

Which of the following groups is most likely to benefit from a strengthening of the USD against other major currencies? U.S. exporters. The U.S. government. U.S. consumers. Foreign consumers.

US Consumers

why did Doha fail?

US business lobbies didn't accept it, Obama didn't confront them

what can create a supply of foreign currency & demand for US currency?

US exports of goods and services, US capital inflows

what can create a demand for foreign currency & supply of US currency?

US imports of goods and services, US capital outflows

A decrease in German residents' willingness to invest in USD-denominated assets will shift the demand curve for: Euros (EUR) to the right. EUR to the left. USD to the right. USD to the left.

USD to the left.

Two very useful surveys on competitiveness conditions and the business climate in all kinds of countries around the world are compiled and published by the: World Economic Forum and World Bank. IMF and World Bank. World Economic Forum and U.S. News & World Report. World Bank and U.S. News & World Report.

World Economic Forum and World Bank.

domestic production equation

Y=C+Id+G+X-M C= consumption Id = domestic investment G= government spending X= exports M= imports (Y=E+(X-M))

if Switzerland wanted to maintain prices while they rose 10% elsewhere, they would have to..

accept a 10% increase in exchange rate value of currency

hedging

acquiring asset in foreign currency to offset net liability position already held in foreign currency OR acquiring liability to offset asset reducing long positions and short positions essentially - ensuring that exchange rate WONT effect net worth

product selection bias

advanced economies lower tariff only on products of interest to them from less developed countries, since they expected reciprocal concessions in trade in return for freely given aid

countries with relatively low inflation rates have currencies whose values tend to (appreciate/depreciate) in foreign exchange market

appreciate

what determines elasticity of demand in embargoed country?

availability of substitutes

why use eurocurrencies?

avoid any restriction on international flow of money, regular domestic banking restrictions; offer higher interest rates on deposits, lower on loans -- riskier for depositers

eurocurrency deposit

bank deposit not subject to usual government regulations imposed by country of currency in which deposit is denominated eurodollar = usd deposit not subject to us banking regulations

retail part of the market

banks/traders dealing with customers-- individuals, businesses, organizations

Absolute Purchasing Power Parity

basket/bundle of products will have same cost in different countries if stated in same currency (essentially averaging law of one price) e=P/Pf

what makes sanctions more likely to be effective?

big countries target small ones sudden & comprehensive when first imposed citizens can apply political pressure

GDP deflator

broader coverage, varies annually/more current, includes non-consumer spending (not good measure of COL)

what would an official do if the exchange rate for their currency was at the top of the fixed-rate band?

buy their own currency using the other currency

covered interest parity

condition that CD = 0, arbitrage is self eliminating currency's forward premium is as much as interest rate is lower than in other country (f = ius-iuk) overall covered return = return of comparable domestic currency investment (f +iuk = ius) links current spot, current forward exchange, and both interest rates country with interest rate lower than corresponding rate in US will have forward premium on currency, percentage point difference in interest rates equal to percentage point difference in forward premium

direct investment

control/influence; lasting relationship

trade embargoes

countries discriminate against certain other countries (usually because of policy disputes), deny outflow of goods/services/assets & discriminate against imports

what explains the differences between current spot and current forward exchange rates?

covered interest parity

credit or debit: US resident decreases holding of foreign financial asset

credit

credit or debit: foreign resident increases holding of US financial asset

credit

alternatives to forward foreign exchange contract

currency futures; currency option; currency swap

credit or debit: foreign resident decreases holding of US financial asset

debit

credit or debit: us resident increases holding of foreign financial asset

debit

if the peso depreciates, the dollar value of your investment in mexico (increases/decreases)

decreases (the dollar value of investment depends on market prices of stocks in pesos and changes in dollar price of peso)

how should policies react to inflation?

depends on the cause of inflation- can be contractionary exchange-rate fix price setting :( influence expectations

fast money growth + stagnant real economy, currency likely [depreciating/appreciating]

depreciating

high inflation rate = [appreciating/depreciating]

depreciating, approximately equal to percentage point difference in relevant inflation rates

Relative Purchasing Power Parity

difference between changes over time in produce price levels in two countries will be offset by change in exchange rate over time (et/e0) = (Pt/P0)/(Pft/Pf0) exchange rate year (T) over exchange rate year 0 EQUALS increase in domestic price from year 0 to year T over increase in foreign price from year 0 to year T approximation: rate of appreciation of foreign currency: π-πf (product-price inflation rates for domestic & foreign countries)

in the long term, why do some currencies appreciate and some depreciate?

difference in national rates of inflation; concept of purchasing power parity

portfolio investment

direct access to financial markets, liquidity and flexibility; smaller role in operations (securities have negotiability)

devaluation

discrete official decrease in fixed/managed par value of currency (opposite of revaluation)

how have primary prices been trending since 1900?

downward, .8%/year

trade bloc

each member country can import from other member countries freely or cheaply, impose barriers outside the bloc

Why would the demand curve for foreign currency shift?

economic forces-- shifts toward a country's products, willingness to lend money to that country's people, investments in financial assets based in that currency all shift the curve to the right

monetary approach to exchange rates

emphasizes importance of money demand & supply

why invest uncovered?

expected overall return may be higher (EUD is positive) contribution of this investment to full portfolio (benefits of diversification)

which trade policy option has increasingly been the choice of developing nations?

export of manufactures to industrial countries

depreciation

fall in market price of currency - in floating/flexible exchange rate system (opposite of appreciation)

what are the biases available in measures of primary price trends that may not make the downward trend accurate?

fall in transport costs; faster unmeasured quality change in manufactures

why is foreign exchange activity increasing?

financial institutions, hedge funds, etc. increasing activity as they diversify internationally

if embargoed country's demand curve is ___________ (elastic/inelastic; flatter/steeper), embargo is likely to be ineffective

flatter; elastic

when should market rates be used to measure size of economy?

for financial flows

What is the WTO's stance toward trade blocs?

formally anti-trade discrimination, but none have been ruled in violation-- as long as barriers against outsiders aren't RAISED in the process of creation, they are technically toward the goal of liberalization

does covered interest parity hold?

forward premium should = difference in interest rates applies well to eurocurrency deposits deviations are small, last for about a minute roughly holds when there are no capital controls, no turmoil, no restrictions on international movement of capital

if there is substantial speculation using foreign exchange market,

forward rate should = average market expectation of future spot exchange rate

what happens after the cartels first success in raising price?

four anti-cartel trends set in motion: sagging demand; new competing supply; declining market share; cheating

types of trade blocs

free trade area, customs union, common market, economic union

common market

full freedom of factor flows (migration of labor & capital) among themselves, on top of being a customs union. EU became a common market in 92

what are the two forcing raising trend of prices of primaries?

nature's limits- populations, incomes expand, natural inputs become increasingly scarce, nature's scarcity eventually raises price of primary products (use natural resources more intensively than manufactured goods) relatively slow productively growth in the primary sector - productivity advances more slowly in ag, mining, other primary sectors - cost-cutting breakthroughs in knowledge more important in manufacturing. slow productivity advance -> slower relative advance of supply curves -> rising relative price

NAFTA, twenty year judgement?

net gain- substantial increase in trade, increase in competition, no massive shift of US jobs

why was the european crisis predictable?

net negative international investment positions became very large relative to the sizes of national economies- especially in certain countries (eg Greece).-- heightened sensitivity to risk due to 07 global crisis.

how well can we predict exchange rates in the short run?

no better than random walk

Your sending a $200 check to a relative in Mexico as your wedding gift constitutes a(n): primary income export, debit to current account primary income import, credit to current account financial account debit none of the above

none of the above (transfer, debit to current account but not primary income-- secondary income)

uncovered international investment

not hedged- converted by future spot exchange rate (risk-exposed)

fixed exchange rate system

officials declare allowed band of rates, intervene at top or bottom of the rate

covered international investment

one hedged, eg by forward contract

other investments

other- includes international transactions intermediated by large financial intermediaries by loan/deposits

How long would it take for developing countries to catch up with industrialized countries in terms of average per capita income?

over a century

Should the host country restrict FDI inflows?

overall presumption that host country GAINS workers gain from increased demand, as do suppliers of other inputs host government gains tax revenue domestic firms competing with affiliates lost residual concern mirroring dumping: will thin competitors externalities, workers may get training and then leave

how does short run flow into long run?

overshooting - international investors form expectations of future exchange rates partly on believe that exchange rates will move toward fundamentals, react rationally to news that exchange rate moves past expectation this makes the exchange rate move back. product prices are relatively sticks in the short run increase in money supply drives down domestic interest rate with lower domestic interest rate, favor shifts to foreign currency assets, increased demand for foreign currency → appreciation of foreign currency

what is wrong with comparing prices using exchange rates?

overstate disparity between rich & poor nations price difference ratio is above unite for most industrialized countries non-traded products (e.g. houses & haircuts) differ radically -- land in lower income countries is cheaper, highly sensitive to income as country develops, productivity in making traded goods expands faster

short positions

owing more than one holds in foreign currency

foreign exchange swap

package trade of spot exchange & agreement to reverse forward exchange rates (good when parties only have temporary need for currency they're buying)

spot exchange rate

price for immediate exchange

forward exchange rate

price set now for exchange in the future (30/90/180 days) -- can be outright or swap

forward premium

proportionate difference between current forward value and current spot value F = (f-e)/e rate at which GBP gains value between spot and future

why does interbank trading happen?

provides banks with information on the market, prices being given allows quick adjustment when buying/selling large amounts of currency without finding another customer

floating exchange rate

rate changes freely without intervention by government, central bankers- market driven, clears through price mechanism

customs union

remove internal barriers, adopt common set of external barriers

what are the two parts of the foreign exchange market?

retail, interbank

_____ determine(s) which products have been produced within a free-trade area and which products have been produced outside the area and are therefore subject to trade barriers. Trade diversion. Trade creation. Rules of origin. The most-favored-nation (MFN) principle.

rules of origin

how does the expected future spot exchange rate play a role in the short term?

self-confirming expectations -- if investors expect future spot exchange rate to be higher than previously expected, there is a shift in favor of foreign currency denominated bonds, demand for foreign currency ↑, spot exchange rate ↑, domestic currency depreciates.

what would an official do if the exchange rate for their currency was at the bottom of the fixed-rate band?

sell their own currency in order to buy the other currency

The royalty payments made by cinemas abroad which show movies made in the USA are supposed to be recorded in the U.S. _______________ account. services import; services export; primary income; financial account

services export

maastricht treaty

set process for establishing european monetary union, phasing in Euro and phasing out national currencies; set criteria like inflation rate, long term interest rate, exchange-rate value of currency, government budget deficit, government debt, etc.

e ^ 1% for each 1%

↑ in domestic money supply ↓ in foreign money supply ↓ in domestic real GDP ↑ in foreign GDP unaffected by BALANCED growth

(according to asset market approach) exchange rate value of foreign currency (e) is raised in the short run by what?

↑ in foreign interest rate relative to our interest rate ↑ in expected future spot rate

(according to monetary approach to exchange rates) spot exchange rate raised in LONG RUN by:

↑ in our money supply relative to foreign money supply ↑ in foreign real domestic product relative to our real domestic product