Chap 2

1)      Current acct

-          BOT = X - M

·         Goods (merchandise trade bal)

·         Services (invisible trade)

-          Net factor income = I + div ($ in: pmt; $ out: receipt)

-          Net transfer pmt = aid, grants, gifts (unrequired pmt). Eg: overseas remittance, ODA,…)

→ CA bal = BOT + net factor income + net transfer pmt

2)      Capital acct

-          FDI: invest in fixed assets for operations

-          Portfolio investment: invest in financial assets (stocks/bonds) (no transfer of controls)

-          Other investment (currency related transactions borrowing, deposits)

3)      Change in official reserves: transactions of authority gov to balance ER

If ∆OR > 0 → need to borrow $ to pay or sales gold/foreign currency

→BOP = current acct + capital acct + ∆OR = 0 (depends on ER system)

BCA & BKA move in opposite style because BCA < 0 → M > X                      → need to borrow $ → BKA > 0

                                                                                                          (expense > income)               

∆OR ↑ ↔ deficit CA < surplus KA

                Import >> → demand foreign currency ↑ → foreign currency appr & domestic currency dep

Or

                BOP < 0 → BCA < 0 → M > X → need to limit import & attract FDI

                →competitive advantage is low

Chap 4: factors affecting ER

·         Income lvl

Eg: US income lvl ↑

→DVN goods ↑

→DVND ↑

→VND appr

SVND unchanged

·         Gov’s control

Eg: VN: higher tax on foreigners’ income

→Dinvestment in VN↓

→DVND­↓ (SUSD↓) → VND dep

·         Expectation:

Eg: usd is expected to appr

→buy $, sell VND

→Dusd↑ → $ appr

·         I/r:

i↑, ↓investment in VN to invest in US → Dvnd↓

VN people exchange VND to buy $ → Svnd↑

→VND dep

·         Relative ∏ → PG&S in US↑ → X↓, M↑ → Svnd↓, Dvnd↑ → ↓$

*)Strategy in BSI: - borrow currency that is expected to dep

                                  - invest in currency that is expected to appr

Chap 5:

I.        Gov intervention

1, Direct intervention: exchange of  currencies that the central bank holds as reserves for other currencies in the foreign exchange mkt

(most effective when there is a coordinated effort among central banks)

·         Nonsterilized intervention: intervention in the foreign exchange mkt w/o adjusting for the change in money supply

·         Sterilized intervention: purchase & sale of treasury securities at the same time to maintain the money supply

2, Indirect intervention: influencing the factors that determine the value of a currency

-          Increasing i/r by reducing the US money supply → boost the dollar’s value

-          Using foreign exchange controls: restrictions on currency exchange

II.      Exchange rate system (classified by degree to which the rates are controlled by the gov)

1, fixed: held constant or allowed to fluctuate only within very narrow bands

2, freely floating (clean float): determine solely by mkt forces

3, managed floating (dirty float): allowed to move freely on a daily basis/no official boundaries/gov intervention to prevent the rates from moving too much in a certain direction

4, pegged: home currency’s value

-          Pegged to a foreign currency or to some unit of account

-          Move in line with that currency or unit against other currencies

Chap 6

Bid/Ask spread =

Arbitrage: 3 types

·         Locational: possible when a bank’s buying’s price (bid price) > another bank’s selling price (ask price) for the same currency

Eg:

Bid

Ask

Bank C NZ$

$ .635

$ .640

Bank D NZ$

$ .645

$ .650

Buy NZ$ from bank C @ $.640, and sell it to bank D @ $.645. Profit = $.005/NZ$

·         Triangular: possible when a cross exchange rate quote differs from the rate calculated from spot rates. Eg:

Bid

Ask

British pound (£)

$1.60

$1.61

Malaysian ringgit (MYR)

$.200

$.202

£

MYR8.1

MYR8.2

Calculated rate: £

MYR7.92

MYR8.05

        Offered rate > calculated rate → £: overvalued →if £ to MYR: get profit

        Buy £@$1.61, [email protected]/£, then sell MYR@$.200. Profit = $.01/£ (8.1 x .2 – 1.61)

When the exchange rates of the currencies are not in equilibrium, triangular arbitrage will force them back into equilibrium

·         Covered interest: the process of

-          Capitalizing on the i/r differential btw 2 countries,

-          While covering for exchange rate risk

Covered i/r arbitrage tends to force a relationship btw forward rate premiums & i/r differentials.

Eg: £ spot rate = 90-day forward rate = $1.60

       US 90-day i/r = 2%

       UK 90-day i/r = 4%

Borrow $ at 3%, or use existing funds which are earning interest at 2%

→convert $ to £ at $1.60/£

→if I = 2% in US & I = 4% in UK: lend £ at 4%

→engage in a 90-day  forward contract to sell £ at $1.60/£

Chap 7

I, IRP: (1+id) = (1+if)

·         P =  → p ≈ id – if.

If id>if → forward premium on foreign currency. If id<if → forward discount on foreign currency 

·         Pf =  – 1 or p=

if p > id-if → invest in foreign currency

II, PPP

1)      Absolute: S(f/d) =

2)      Relative PPP

E = e =  ≈ ∏d - ∏f

→∏d - ∏f > 0 → foreign currency ↑ (Se(f/d)↑)

    ∏d - ∏f < 0 → domestic currency ↑

Assume: E/R is controlled by only inflation (no other factors) PPP doesn’t hold bcz

-          Confounding effect (beside ∏, 4 other factors affect E/R)

-          Lack of substitutes for traded goods

PPP is more accurate in LR than SR

Chap 8

ef =      (ef =

(1 + id) = (1 + if)

→uncovered arbitrage

·         Id<if: if higher → ef > 0: foreign currency appr

·         Id­>if → ef > 0 → foreign currency appr cant offset id > if

In SR: IFE may not hold

In LR: deviation → IFE may hold