40 terms

Foreign Exchange Market

nominal exchange rate
price of one country's currency in terms of another's
*exchange rate
increase in the value of a country's currency compared to the currencies of other countries
decrease in value of a country's currency in comparison to other countries
real exchange rate
is not reflected by the nominal exchange rate
Real exchange rate equation
=(nominal exchange rate*domestic price)/foreign price

foreign exchange markets
international currencies are traded here
it is an OTC
2 types of currency transactions conducted in foreign-exchange markets
1. spot market transactions

2. forward transactions
spot market transactions
currencies or bank depostis are exchanged immediately (subject to a 2 day settlement period)
spot rate
current exchange rate
price at which you may buy a share right now
forward transactons
currencies or bank deposits are to be exchanged at a set date in the future

investors sign the contract today for a given quantity of currency and exchange rate
forward rate
exchange rate that will be used in a forward transaction
demand for us dollars
represents the deman to buy US goods and financial assets
an increase in a country's productivity retlative to that of other countries leads to...
higher demand for the domestic currency, causing the real and nominal exchange rate to increase
common foreign trade barriers

limits on volume for foreign goods that can be brought into a country
foreign trade barrier

taxes on goods purchased from other countries
trade barriers are important because...
they increase demand for domestic currency and make a higher exchange rate in teh long run for the country imposing the barriers
law of one price
if two countries produce an identical good, profit opportunities should ensure that its price is the same in both countries no matter which country produces the good

doesn't hold for differentiated products
purchasing power parity (PPP)
based on the assumption that real exchange rates are constant
differences in inflation rates in the 2 countries cause changes in the nominal exchange rate between two currencies

*assumption that the real exchange rate is constant is unreasonable
nominal interst rate parity condition
when domestic and foreign assets have identical risk, liquidity, and info characteristics, their nominal returns (measured in the same currency) must be identical
real interest rate parity condition
expected real rates of interest measured in terms of the same group of goods are equal
trade surplus
Exports exceed imports
trade deficit
An excess of imports over exports
trade balance
the value of a nation's exports minus the value of its imports; also called net exports
net capital outflow
The purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners
factors that effect exports and imports
1.consumers taste for domestic/foreign goods
2. prices of goods at home and abroad
3. exchange rates at which people can use domestic currency to buy foreign currency
4. incomes
5. government policies toward international trade
North American Free Trade Agreement
General Agreement on Tariffs and Trade
flow of capital
the International Monetary fund facilitates the expansion and balance of growth of international trade, assists in elimination foreign exchange, and smoothes the international balance of payments
labor intensive good
A product requiring a relatively large amount of labor to be produced (Digital camera, DVD player etc)
land intensive good
A product requiring a relatively large amount of land to be produced (Coffee, wheat etc)
capital intensive good
A product that requires a relatively large amount of capital to be produced (automobiles, chemicals etc)
comparative advantage
The ability of an individual, firm, or country to produce a good or service at a lower opportunity cost than other producers.
absolute advantage
Exists when a country can produce a good or service at a lower cost than other countries.
principle of comparative advantage
the proposition that an individual, region, or nation will benefit if it specializes in producing goods for which its own opportunity costs are lower than the opportunity costs of a trading partner, and then exchanging some of the products in which it specializes for other desired products produced by others
trade terms
The rate at which goods are exchanged; the amount of good A given up for good B in trade is:
flexible exchange rates
Rate determined in foreign exchange markets by the forces of demand and supply without government intervention
fixed exchange rates
The official rates of exchange for currencies set by governments; not a dominant mechanism in the international monetary system since 1973.
cost push inflation
increases in the price level (inflation)resulting from an increase in resource costs (for example, raw material prices) and hence in per unit production costs; inflation caused by reductions in aggregate supply
demand push inflation
inflation believed to be triggered when consumers demand more products and the rising demands results in rising prices and wages
Main determinants of exchange
1) trade
2) Relative interest rates
3) relative inflation
4) relative growth in national income