The Foreign Exchange Market

Flashcards reviewing key concepts from the lecture notes on the foreign exchange market.

Foreign Currency

Foreign bank notes, coins, and bank deposits.

Foreign Exchange Market

The market in which the currency of one country is exchanged for the currency of another.

Exchange Rate

The price of one currency in terms of another.

What are the factors that influence the quantity of U.S. dollars that traders plan to buy?

Exchange Rate, World demand for U.S. exports, Interest rates in the United States and other countries, The expected future Exchange Rate

Law of Demand for Foreign Exchange

The higher the exchange rate, the smaller is the quantity of U.S. dollars demanded in the foreign exchange market.

Exports Effect

The larger the value of U.S. exports, the greater is the quantity of U.S. dollars demanded on the foreign exchange market.

Expected Profit Effect

The larger the expected profit from holding U.S. dollars, the greater is the quantity of U.S. dollars demanded today.

What factors influence quantity of U.S. dollars supplied in the foreign exchange market?

The exchange rate, U.S. demand for imports, Interest rates in the United States and other countries, The expected future exchange rate

Law of Supply of Foreign Exchange

The higher the exchange rate, the greater is the quantity of U.S. dollars supplied in the foreign exchange market.

What happens if the exchange rate is too high?

A surplus of U.S. dollars drives it down.

What happens if the exchange rate is too low?

A shortage of U.S. dollars drives it up.

Flexible Exchange Rate

A policy that permits the exchange rate to be determined by demand and supply with no direct intervention in the foreign exchange market by the central bank.

Fixed Exchange Rate

A policy that pegs the exchange rate at a value decided by the government or central bank and is achieved by direct intervention in the foreign exchange market.

Crawling Peg

An exchange rate that follows a path determined by a decision of the government or the central bank and is achieved by active intervention in the market.

Balance of Payments Accounts

A country’s balance of payments accounts records its international trading, borrowing, and lending.

Current Account

Records receipts from exports, payments for imports, net interest paid abroad, and net transfers.

The current accounts balance

exports - imports + net interest income + net transfers

Capital and Financial Account

Records foreign investment in the United States minus U.S. investment abroad.

Official Settlements Account

Records the change in U.S. official reserves.

Net Borrower

A country that is borrowing more from the rest of the world than it is lending to it.

Net Lender

A country that is lending more to the rest of the world than it is borrowing from it.

Debtor Nation

A country that during its entire history has borrowed more from the rest of the world than it has lent to it.

Creditor Nation

A country that has invested more in the rest of the world than other countries have invested in it.