Global Economy Chapter 10- Determination of Foreign Exchange Rates

The ________ is the currency most widely used as a reserve asset.

U.S. dollar

In order to join the IMF, a country must contribute a certain sum of money, called a ________.

quota

The primary objective of the International Monetary Fund is to ________.

promote exchange rate stability

Thomas is planning a vacation to Country X. On a tourism Web site, he reads that the government of Country X limits the amount of money a tourist may convert into the country's currency. Country X most likely uses which of the following?

quantity controls

The purchasing power parity theory claims that a change in relative ________ between two countries must cause a change in ________ in order to keep the prices of goods in two countries fairly similar.

inflation; exchange rates

A currency that is pegged to another currency is usually changed on a supply-and-demand basis.

False

Governments use a multiple exchange rate system to ________.

control foreign-exchange convertibility

Which type of exchange rate arrangement is based on supply and demand?

floating

According to purchasing power parity, if the domestic inflation rate is ________ than that in the foreign country, the domestic currency should be ________ than that of the foreign country.

\
lower; stronger

Which of the following is **not** one of the IMF's considerations when choosing it's basket of reserve currencies? The currency must be:

Appreciating over last 12 months

___________. came into official existence on December 27, 1945, with the goal of promoting exchange-rate stability and facilitating the international flow of currencies.

International Monetary Fund (IMF)

The fundamental mission of the IMF is to:

1. foster global monetary cooperation,
2. secure financial stability,
3. facilitate international trade,
4. promote high employment and sustainable economic growth
5. reduce poverty around the world.

The IMF is influenced by the _________

quota system

Quota system

countries contributed funds based on size of the economy to the world

the Quota system determines ______ in the organizations policy

\

voting rights

who has bigger influence on the IMF? small or big economies?

bigger economies

To help increase international reserves, the IMF created the _______________ in 1969 to help reinforce the fixed exchange-rate system that existed at that time

special drawing right (SDR)

SDR is based on three conditions:

Currency must be safe, reliable, and freely used

Today SDR currency includes US Dollar,  Euro,  Japanese Yen,  British Pound, and the Chinese Yuan (Renminbi) was added in 2016

true

SDR serves as the IMF’s *__________* —the unit in which the IMF keeps its records—and can be used for IMF transactions and operations

unit of account

A nation can choose between three broad categories of how their currency can be exchanged with foreign currencies:

Hard Peg

Soft Peg

Floating arrangements

Hard Peg

1. Dollarization - literally adopt the USD

•       E.g. Zimbabwe, El Salvador, and Ecuador


2. currency board – anchor to a currency, and only exchange currencies at one to one rate

Soft Peg

•       Aims to stay closely tied to the value of another currency (like the dollar, yuan, ten, or Euro)

•    More flexible, but still takes considerable government action to work

Floating Arrangement

•       Very little intentional government intervention

•       E.g. United States Dollar, Euro, Yen

•       Majority of the largest economies today use this

Demand for a foreign currency:

based on the domestic demand for goods, services and assets of the foreign country

Supply of the foreign currency:

based on the foreign demand for the goods, services and assets of the domestic economy

Medium Term factors of demand and supply of foreign currency:

1. Relative interest rates – investors/savers want to take advantage of higher rates
2. Economic activity of both nations – production of goods and services, exports and imports
3. Confidence in foreign economy – belief that currency will maintain value

Short Term factors of demand and supply of foreign currency 

speculation from news

Long Term factors of demand and supply of foreign currency 

relative inflation (real values overcome nominal values)

Using the US Dollar as a domestic currency when it depreciates:

\-       Imports become more expensive.

\-       i.e. the USA imports less

\-       Exports become less expensive

\-       i.e. the USA will export more

\-       Foreign Investment in the USA becomes less expensive

\-       Investment abroad becomes more expensive for USA

Using the US Dollar as a domestic currency, when it appreciates:

1. Imports become less expensive

•       i.e. the USA imports more


2. Exports become more expensive

•       i.e. the USA will export less


3. Foreign Investment in the USA becomes more expensive
4. Investment abroad becomes less expensive for USA

Appreciation:

A currency has increased in it’s relative value to another

Depreciation: 

A currency has decreased in it’s relative value to another

United States

the **New York Federal Reserve Bank**, in close coordination with and representing the **Federal Reserve System** of 12 regional banks and the **U.S. Treasury,** is responsible for intervening in foreign-exchange markets to achieve dollar exchange-rate policy objectives and counter disorderly conditions in foreign-exchange markets.

The ________ is responsible for setting exchange-rate policy

U.S. Treasury

The _____ is the central bank and is responsible for executing foreign-exchange intervention.

Fed

Central Bank Reserve Assets Central bank reserve assets are kept in three major forms:

foreign-exchange reserves

MF-related assets (including SDRs)

gold.

the Soft Peg allows for…

\-       Allows for more fluid trade of currencies within a certain range

\-       Central Bank buys and sells foreign currencies to use market forces to adjust the relative value of currencies

the Hard Peg creates:

1. Create strict restrictions about when and where currencies can be exchanged – tight government control
2. These include measures such as licenses, multiple exchange rates, import deposits and quantity controls.

We can measure ___________________________ by comparing a basket of goods, like the Big Mac Index

purchase power parity

f a currency exchange is quoted in the opposite terms than you want, you need to ______________________.

flip the equation terms

flipping equation terms example:

\-       suppose 1.2 US$ buys 1 UK ₤

\-       We express this  mathematically as $1.2 = ₤1

\-       To convert this into terms of how much UK₤ buys 1 US$ simply divide the left side to get to US$ equal to 1.

\-       In this case, divide by 1.2

\-       The result: $1 = 0.833 ₤

We will round to 3-4 decimals here. For a bank, they will carry from four to six decimals

domestic price Equation:

Price in foreign x exchange rate as a direct quote

magnitude equation

most recent exch. rate –5 year old exchange rate) / old exchange rate

Further, assume that the price of a shipment of Italian cheeses has stayed unchanged at €300. How has the US price of the shipment changed between last year and this year?

Equation: Domestic Price = Price in foreign x exchange rate as a direct quote

International Monetary Fund (IMF)

A multi-governmental association organized in 1945 to promote exchange-rate stability and to facilitate the international flow of currencies.

Twenty-nine countries initially signed the IMF agreement; there were 189 member countries as of January 1, 2020

true

Bretton Woods Agreement

An agreement among IMF countries to promote exchange-rate stability and to facilitate the international flow of currencies

The Bretton Woods Agreement established a ________ , or benchmark value, for each currency initially quoted in terms of gold and the U.S. dollar

par value

Special drawing right (SDR)

A unit of account issued to countries by the International Monetary Fund to expand their official reserves bases.

\
The IMF requires countries to identify how they base their exchange-rate policy—hard peg, soft peg, or flexible.

true

*__________________* can occur when a country does not have its own currency but has adopted the U.S. dollar (or possibly the euro) as its currency

*dollarization*

*________*_______ is responsible for issuing domestic currency, typically anchored to a foreign currency.

currency board

\
There are many different kinds of soft pegs, but the most common is a conventional ____________________.

fixed-peg arrangement

The European Central Bank sets monetary policy for the adopters of the ______.

euro

Currencies that freely float respond to _____________ conditions.

supply and demand

Central banks hold foreign currencies in what is known as **__________________**. 

international reserves

A _______ currency is a currency that is usually fully convertible and strong or relatively stable in value in comparison with other currencies.

hard

In a _________________, a government sets different exchange rates for different types of transactions.

multiple exchange-rate system

The ____________________ exchange rate is the rate at which the currency of one country would have to be converted into that of another country to buy the same amount of goods and services in each country

PPP (Purchase Power Parity)

The _________ rate is the real interest rate plus inflation.

nominal interest

_______________________ uses economic variables to predict future exchange rates.

Fundamental forecasting

\
_____________________ uses past trends in exchange-rate movements to spot future trends.

Technical forecasting