Chapter 4 - The foreign exchange market and the balance of payments

absolute advantage

where one country can produce goods or services cheaper than another

balance of payments

a systematic record of all transactions between one country and other countries e.g. between South Africa and all other countries in the world

current account of the balance of payments

the balance of payments section that reflects international daily transactions in terms of production, income and expenditure

comparative advantage

a situation where one country has a relative advantage in the production of goods or services as its opportunity costs of production are lower than for other countries

direct investment

includes transactions relating to investment e.g. investments in businesses

debt forgiveness

when an organisation or a country is released from its obligation to repay a loan

exchange rate

the rate at which one currency is exchanged for another; it is also considered the value of one country's currency in terms of another country's currency

free trade

when consumers and producers are free to buy goods and services anywhere in the world without any restrictions

International Monetary Fund (IMF)

an international organisation that lends money to countries with ongoing balance of payment problems

international trade

the exchange of goods and services across international borders

net balance

money that enters the country is offset against money that leaves the country

portfolio investment

buying selling equities and debt securities e.g. shares and bonds. It refers to buying of financial assets such as shares in companies on the stock exchange of another country.

special drawing rights (SDR)

a financing instrument distributed among member countries of the IMF

terms of trade (definition)

compares a countrys export prices with its import prices by means of indexes

terms of trade (formula)

(index of export prices)/(index of import prices) x 100

change in terms of trade

the terms of trade will improve when export prices increase or import prices decrease

trade balance

the value of merchandise exports plus net gold exports minus merchandise imports

transfer payment

money received without any productive service rendered, e.g. gifts

currency depreciation

a decrease in the market value of one currency relative to another currency

currency appreciation

an increase in the market value of one currency relative to another currency

rand depreciates

example: currently, $1 = R18.00 and then changes to $1 = R19.00

rand appreciates

example: currently, $1 = R18.00 and then changes to $1 = R17.00

causes of the rand appreciating

the demand for dollars decreases

the supply of dollars increases

causes of the rand depreciating

the demand for dollars increases

the supply of dollars decreases

free floating exchange rate system

an exchange rate system where exchange rates are determined entirely by market forces, there is no government intervention in the foreign exchange market

effects of a free floating exchange rate system

the country's currency will appreciate or depreciate against other currencies as market forces change

fixed exchange rate system

a currency system in which governments try to keep the values of their currencies constant against one another

effects of a fixed exchange rate system

the country's currency will be devalued or revalued when the government announces a change in the exchange rate of its currency against other currencies

devaluation

deliberate government intervention to reduce the value of a nation's currency in a fixed exchange rate system

revaluation

deliberate government intervention to increase the value of a nation's currency in a fixed exchange rate system

managed floating exchange rate system

an exchange rate system that determines the value of some currencies partly by demand and supply in the foreign exchange market, and partly by active government intervention in the foreign exchange market