International Capital Flows and Exchange Rates

Flashcards covering the fundamentals of the foreign exchange market, investment types, and exchange rate policies.

Foreign Exchange Market (Forex)

The market in which people use one currency to buy another currency. It is the largest market in the world economy, with about $7.5 \text{ trillion}$ traded daily in $2022$.

Foreign Direct Investment (FDI)

Purchasing at least $10.00\%$ of a firm or starting up a new enterprise in another country.

Portfolio Investment

An investment in another country that is purely financial and does not involve any management responsibility, such as purchasing government bonds or less than $10.00\%$ of a business's stock.

Speculative Portfolio Investments

A strategy where an investor bets that an exchange rate will move in a certain direction to generate profit.

Appreciating (Strengthening)

An increase in the value of a currency relative to other currencies. For example, if the exchange rate moves from $\$1 = \text{€}1$ to $\$1 = \text{€}1.10$, the dollar has appreciated.

Depreciating (Weakening)

A decrease in the value of a currency relative to other currencies. For example, if the exchange rate moves from $\$1 = \text{€}1$ to $\$1 = \text{€}0.90$, the dollar has depreciated.

Cross-Country Rates of Return

The motivation for investment based on earning returns (e.g., interest rates). Relatively high rates in a country attract funds, while low rates cause funds to flee to other economies.

Relative Inflation

Differences in inflation rates between countries; high inflation erodes the buying power of a currency and discourages people from holding it.

Floating Exchange Rate

A policy where a country lets the foreign exchange market determine its currency's value, as used by the U.S. dollar and approximately $40.00\%$ of world countries.

Soft Exchange Rate Peg

An exchange rate policy where the government usually allows the market to set the rate, but the central bank intervenes if it moves rapidly in one direction (e.g., Costa Rica, Vietnam, Nicaragua).

Hard Exchange Rate Peg

An exchange rate policy where the central bank sets a fixed and unchanging value for the exchange rate (e.g., Belize, Jordan, Saudi Arabia).

Merged Currency

When a nation chooses to use another nation's currency, thereby giving up control of domestic monetary policy and eliminating foreign exchange risk.

Dollarize

When a country uses the U.S. dollar as its currency, such as Ecuador, Zimbabwe, Marshal Islands, or Panama.

Eurozone

A monetary union of $19$ countries that have adopted the euro, where the European Central Bank controls interest rates.