Currency Appreciation
If a currency starts to buy more of another currency we say it has appreciated against that currency
Currency Depreciation
If a currency starts to buy less of another currency we say it has depreciated against that currency.
Bilateral exchange rate
shows the price at which one currency is exchanged for another
nominal effective exchange rate
weighted average value of the currency relative to many foreign currencies
Fixed (pegged) exchange rate
Where a country's exchange rate does not fluctuate at all (or only narrowly) against some base currency over a sustained period, usually a year or longer
Floating exchange rate
A country's exchange rate typically fluctuates over time and
the government makes no attempt to peg the exchange rate against a base currency
Free Floating
exchange rate set completely on the foreign exchange market, no government intervention
Managed floating
the monetary authority (usually the central bank) influences the exchange rate through active forging exchange market intervention with no preannounced path for the exchange rate.
Crawling peg
allows depreciation or appreciation in an exchange rate gradually in a fixed exchange rate regime.
Band
Target value
Dollarization
A country adopts an existing currency-influence over monetary policy.
Monetary Union
An agreement between many European countries to integrate their monetary systems including using a single currency.
spot contract
Agreement to make immediate transaction
derivative
contracts with pricing derived from the spot rate.
forward derivative
A and B agree to trade currencies at set price on the settlement date. Contract cannot be traded to third parties.
swap derivative
A and B agree to trade at set price today and do reverse trade at a set price in the future. Swaps combine two contracts (a spot and a forward) into one, taking advantage of lower transactions costs
future derivative
A and B agree to trade currencies at set price in the future. Either side of contract can be traded to third parties C, D, E,... (on exchanges). Parties left holding contract must deliver.
options derivative
A grants to B option to buy (call) or sell (put) currencies from/to A, at set price in the future. B may or may not execute the option, but if B opts to execute the contract then A must deliver.
arbitrage
Arbitrage refers to a trading strategy that exploits price differences.
riskless arbitrage
Investor covers the risk of the exchange rate changing in the future by using a forward contract (contract won't change).
forward exchange rate
The price of forward contracts-No exchange rate risk in the future.
*covered interest parity
the rate of return on identical investments in two different locations will generate the same rate of return.
law of one price
the price of the good in each market must be the same.
Absolute PPP
implies that a basket of goods purchased in two countries should cost the same in a common currency.
Relative PPP
that the rate of depreciation of the nominal exchange rate equals the inflation differential.
Inflational Differential
The rate of change in relative prices (PUS/PE)
Rate of Change
in the exchange rate is the rate of depreciation in the home currency (U.S. $):
Real Depreciation
If the real exchange rate rises-more home goods needed in exchange for foreign goods
Real Appreciation
If the real exchange rate falls-fewer home goods needed in exchange for foreign goods
Overvalued Currency
If the real exchange rate is above one
Undervalued Curency
if the real exchange rate is below one
Gross National Expenditure
total national spending on final goods and services.
Gross Domestic Product
the total market value of all final goods and services.
Gross National Income
is the sum of factor income payments received by national entities-only resources available from which the closed economy can finance expenditure
Gross National Disposable Income
sum of all
GDP Identity
GDP = GNE + TB
GNI Identity
GNI = GDP + NFIA
GNDI Identity
GNDI = GNI + NUT
Transfer Pricing
adjusting price of good & cost of goods sold form one subsidiary/country to the next. Minimizes taxes & moves currency in undetectable fashion
External Wealth
is equal to foreign assets owned by the home country minus home assets owned by the rest of the world.
consumption smoothing
the idea that; although their incomes fluctuate; people try to stabilize consumption spending from year to year-borrowing & lending, precautionary saving
Diversification
A risk management technique that mixes a wide variety of investments within a portfolio.
Precautionary saving
Keeps high level of external wealth which for use as a buffer against shocks.
Foreign reserves
usually safe assets, e.g. U.S. Treasuries, owned by central bank.
sovereign wealth funds
state-owned companies that invest in safe assets (foreign reserves) and riskier high-return assets (equity and FDI.)