Foreign Exchange Markets

These flashcards cover essential concepts, definitions, and examples from the lecture notes regarding foreign exchange markets.

What is the primary function of the Foreign Exchange Market?

To facilitate the conversion of one country’s currency into another and manage foreign exchange exposure.

What are the two main types of exchange rate systems?

Fixed exchange rates and flexible exchange rates.

What is the U.S. dollar's percentage involvement in global currency trading?

87% of all trades involve the U.S. dollar.

What major exchange rate system was established after World War II?

The Bretton Woods exchange rate system.

What does Purchasing Power Parity (PPP) theory state?

It allows the same quantity of goods to be bought in either currency when converted from one to another.

What happens to a currency when it appreciates?

The currency rises in value relative to another currency.

Which institutions typically participate in the Foreign Exchange Market?

Large global banks like Deutsche Bank, HSBC, and Citibank.

What term describes the function of banks that set both buy and sell prices in the Foreign Exchange Market?

Market maker.

What is the approximate daily value of trading in the Foreign Exchange Market?

Almost $7 Trillion per day.

What is meant by the term 'hard peg' in fixed exchange rates?

Hard pegs are not allowed to change in value at all.

What is a spot transaction in the foreign exchange market?

An immediate exchange of bank deposits, typically completed within two days.

What was the effect of the Brexit vote on the British pound's exchange rate?

It led to a nearly 10% depreciation in the pound.

How do changes in interest rates affect the equilibrium exchange rate?

Higher domestic interest rates tend to appreciate the domestic currency.

What is the main implication of interest rate arbitrage?

Investors borrow in low-interest markets and lend in high-interest markets to take advantage of rate differences.

What is a soft peg in fixed exchange rate systems?

Soft pegs are allowed to change within certain limits, but not beyond those limits.

What key factor influences the demand curve for domestic assets?

The relative expected return of domestic assets.

How can the value of a currency affect the price of domestic goods for foreigners?

When a currency appreciates, domestic goods become more expensive for foreigners, and foreign goods become cheaper for domestic consumers.

What does the term 'managed floating' refer to?

An exchange rate system that implies some level of government intervention, but less than with a fixed system.

What does a trade deficit indicate about a country's currency?

It suggests that the value of the currency may need to be adjusted or devalued to correct imbalances.