ECON FINAL

Assume that the current exchange rate is €1 = $1.50. If you exchange 1,000 euros for dollars, you will receive

$1,500

eurocurrency

- a currency deposit outside its country of issues Eurodollar: US dollars deposited in European banks

international capital markets

-global markets where people companies and govs. with more funds than they need transfer those funds to people, companies, or govs. that have a shortage of funds

appeal of eurocurrency markets

-no regulation -banks can offer higher interest rate on deposits lower interest rate on borrowing know how to explain the smaller interest rate spread in eurocurrency markets

IMF criticisms

1) Conditions for loans 2)exchange rate reforms 3) devaluations 4)Free-market criticisms 5) Lack of transparency and development 6) support of military dictatorships

IMF purposes

1) Promote international monetary cooperation and exchange stability 2) Facilitate the expansion and balanced growth of international trade 3)lender of the last resort

IMF opportunities

1)Flexibility and speed 2)cheerleading 3)adaptability 4)transparency

currency hedging definitions

1)forward exchange rate -The rate at which two parties agree to exchange currency and execute a deal at some specific date in the future usually 30/60/90/130 days in the future 2)forward market -the currency market for transactions at forward rates 3)forward contract -A contract that requires the exchange of an agreed on amount of a currency on an agreed-on date and specific exchange rate

List and explain the 2 benefits of the international capital market.

1. Cheaper borrowing costs: Access to the international capital market makes more borrowing options available and increases the supply of available capital. This, in turn, lowers the interest rates on borrowing. 2. International portfolio diversification: Access to the international capital market allows investors to diversify their portfolio across national borders. This reduces the risk of a portfolio as it can lower systematic risk

The IMF has ________ members today

190

today

21% of imf members: Free floating currency 23% have managed float

eurobond

A bond issued outside the country in whose currency it is denominated

global bond

A bond that is sold simultaneously in several global financial centers

List and explain 3 criticisms of the World Bank. Furthermore, list 2 of the opportunities/improvements the World Bank has made in response to criticisms.

Criticisms: 1. Administrative incompetence: The World Bank has been accused of lax lending standards and weak administrative processes that may lead to inadequate loans. 2. supporting inefficient/corrupt countries: The World Bank gives loans sometimes regardless of the government in power. The accusation is that the World Bank should be aware that some loans may never reach their intended destination due to corrupt governments. 3. Dominance of G7 countries: Wealthy G7 countries contribute to the World Bank, but there have been concerns that G7 countries have too much influence on the approval of projects. Opportunities: 1. Increased transparency: Giving the public better insight into administrative processes. 2. Leveraging the private sector: Helping to build private sectors in countries that were previously under a centrally planned economy.

The ------- is the exchange rate between two currencies, neither of which is the official currency in the country in which the quote is provided.

Cross rate

List 4 functions of the foreign exchange market

Currency Conversion Currency Arbitrage Currency Speculation Currency Hedging

A ------- bond is a bond sold by a company, government, or entity in another country and issued in the currency of the country in which it is being sold

Foreign

Explain how foreign exchange risk can affect international loans. Provide a brief example with your explanation.

Foreign exchange risk can affect international loans if there is an change in exchange rates by the time of repayment. Example: French firm wants to borrow 1 million euros for one year. Option 1: Borrow from a French bank at 15% interest. Pay back 1.15 million euros in 1 year. Option 2: Borrow from international bank at 9% interest. If the exchange rate stays stable at 1 euro = 1 US dollar, the firm will pay back 1.09 million US dollars after 1 year and benefits from a reduced cost of capital (6% cheaper). However, if after one year, the exchange rate is 1 euro = 0.80 US dollar, the French firm has to pay back 1.36 million in terms of euros (1.09 million US dollars / 0.80). This results in an effective cost of capital of 36%

Currency ------- refers to the technique of protecting against the potential losses that result from adverse changes in exchange rates

Hedging

IMF

IMF-a cooperative institution tasked with maintaining orderly international monetary system began December 1945 with 29 member countries today:190 member countries

soft loan

Loans made by an international org. the IDA is a long term option for countries. These loans have no interest and have a grace period of several decades for repayment

capital markets

Markets in which people, companies, and governments with more funds then they need transfer those funds to people, companies, or governments that have a shortage of funds

is characterized by a lack of government regulation.

The Eurocurrency market

Spot exchange rate

The exchange rate transacted at a particular moment by a buyer and seller of a currency

The ------- is a development institution that provides loans to countries in need

World Bank

foreign bond

a bond sold by a company/gov in another country and issued in the currency of the country in which it is being sold

A Eurocurrency is any currency

banked outside of its country of origin.

currency conversion

base currency: the currency that is to be purchased with another currency; always equal to 1 quoted currency: the currency with which another currency is to be purchased Ex: USD/EUR 0.80 means USD is base rate, $1 for 0.8 euros EUR/USD 1.25 means USD is base rate, 1 euro for $1.25

A _____ brings together those who want to invest money and those who want to borrow money.

capital market

Which of the following 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?

carry trade

world bank criticisms

criticisms: administrative incompetence rewarding corrupt/inefficient countries negative influence on theory and practice dominance of G7 countries

capital market list

debt equity direct finance indirect finance

capital market definitions

debt: money borrowed and must be repaid ex: debt instrument equity: Money that is invested in return for a percentage of ownership but is not guaranteed in terms of repayment ex direct finance: a company borrows directly by issuing securities to investors in the capital markets ex indirect finance: involves a financial intermediary between the borrower and the saver ex: If the company deposited the money in a savings acct at their bank then the bank lends the money to a company or the bank is an intermediary

world bank

development institution

After World War II, the world's major industrial nations arranged their currencies against each other at a mutually agreed on exchange rate. This is an example of a _____ system.

fixed exchange rate

bretton woods system

fixed exchange rates national flexibility: possibility of devaluation during economic downturns collapse 1973: Triffin paradox, increased domestic spending

Pegged exchange rate means that the value of a currency is

fixed relative to a reference currency.

In a ------ exchange rate system a currency's value increases or decreases based on demand and supply

floating

The element of risk into investing in foreign assets is greater with _____ exchange rates.

floating

Exchange rates/ float system LIST

floating exchange rate ex: pegged exchange rate ex: managed float system ex: fixed exchange rate ex:

Exchange rates/ float system DEFINITIONS

floating exchange rate: when a currency's value increases or decreases based on demand and supply ex: pegged exchange rate: Currency value that is fixed relative to a reference currency ex: managed float system: When a country's currency is nominally allowed to float freely against other currencies but the gov intervenes by buying and selling currency, if it believes that the currency has deviated too far from its fair value ex: fixed exchange rate: when the exchange rate for converting one currency into another is fixed ex:

currency hedging list

forward exchange rate forward market forward contract

gold standard

gold standard: the pre ww1 global monetary system that used gold as the basis of international economic exchange advantages: reduced exchange rate risk, strict monetary policy collapse: impact of WWI, completely abandoned in 1939

drawbacks of eurocurrency markets

higher chance of bank failure possible exchange to foreign exchange risk

international capital markets benefits and systematic risk

international capital market benefits: 1)higher returns and cheaper borrowing costs 2) more investment opportunities 3)international portfolio diversification reduces risk systematic risk: Movements in a stock portfolios value that are attributable to macroeconomic forces affecting al firms in an economy

world bank opportunities

opportunities increased transparency expanding social issues in the fight on poverty improvements in countries competitiveness improving efficiencies in diverse industries and leveraging the private sector

Purchasing power parity theory states that in efficient markets, the price of a "basket of goods" should be

roughly equivalent in each country.

exchange rate

the price of one currency in terms of a second currency