Econ test 2

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  1. Nominal exchange rate
    The rate at which the currency of one contry trade for that of another, ie the price of of one currency in terms of another currency.

    if the vlue of the dollar rises from 1 dollar per 100 yen to 1 dollar per 200 yen then the dollar has appreciated and the yen has depreciated
  2. Real exchange rate
    The rate at which the GOODS of one country trade for the goods of another coutnry

    = Dollar price of a good / (euro price of good * nominal exchange rate)

    Should equal 1
  3. Foreign exchange market
    OVer the counter market where curencies are traded... If you want to trade foreign stocks/bonds one must convert first.

    *largest global financial markets
  4. Spot exchange
    Trasactions of currencies immediately at the current exchange rate
  5. Forward rate
    An exchange of currencies at a specified future date at an agreed upon rate

    • A private trasaction
    • Have credit risk.
  6. Futures
    Garenteed by clearing house standardized in terms of quality and settlement date

    *more common
  7. Exchange rate risk
    the rist that a firm will suffer losses because of fluctuations in the future..

    The forward rate reflects where the market expects the spot rate to be in the future.

    *to hedge in a fall in the dallar you sell dollars in the forward market... A hedger uses the derviative market to reduce risk while a speculator uses the market to place a bet on the future value of a currency
  8. What factors drive movements in exchange rates?

    Law of one price

    Theory of purchasing power parity
  9. law of one price
    the idea the identical produst should sell for the same price everywhere or in other words a given quatity of currency should be able to buy the same quantity of goods and services anywhere in the world.
  10. Theory of Purchasing power parity

    Name its limitations
    States that exchange rate move to equalize the purchasing power of different currencies or in other words, nominal exchange rate should moe in such a way that the law of one price holds.

    • PPP is limite because
    • 1 not all products can be traded internationally
    • 2 products are differentiated
    • 3 gov impose barriers to trade
  11. Capital flight
    Domestic people want to get ouus of owning financial capital... drop in demand= less popular. Increase in supply=no one wants its anymore

    Depriciation in currency
  12. Giant pool of money
    global savings appreciated the dollar in early 2000.. cause an increase in demand for us dollar. in 2008 fear came in the global crisis.. there was more demand for the US dollar because they thought the us was stronget than there own currency.. even in the depression
  13. interest rate parity
    The proposition that difference in interest rats on similar bonds in differ countries relect expected future changes in exchange rates.

    Interest rate on domestic bond= interest rate on foreign bonds- expected appreciation of domestic currency
  14. If inflation in rapidly increasing what happens to the curency
  15. The financial system is designed to
    Create long run capital accumulation
  16. What are the 2 key categories of problems that impede the flow of financial capital?
    • Transaction cost: the cost of makeing a trade
    • -Financial intermediaries are able to reduve this through economies of scale-more products equal cheaper prices

    Information costs the cost that a savor incurs to determine the creditworthiness of potential borrowers and to monitor how borrowers use the funds aquired.
  17. Assymmetric information

    Adverse selection
    one party to an economic transaction has better information than does the other party.

    Adverselection.. Lemmons vs peaches (used cars)
  18. How to over some adverse selection
    a. The SEC

    b. S&P and Moody's sell infor related to creditworthinesss. Athough may be believed to be under provided = Free rider problem

    c.Collateral- assets borrower pledges to lender if he defauls on loan

    d. Financial intermediation ; banks are good and producting information about firms.. Not subject to free-rider problem.. MOST LIKELY TO OVER COME ADVERSE SELECTION
  19. Moral hazard
    The risk that people will take actions after they have entered into a trasaction that will make the other party worse off: in financial market the problem investors experience in varifying the borrower are using their funds as intended. This is also assymettric because the borrower knows more than the lender.. PONZI SCHEME
  20. Pricipal agent problem
    The agent or manager may not act in the pricipal or the owners bes interests.. and use money for personal benefits
  21. How the system overcomes the Principal-agent problem
    1. the SEC monitors

    2. Incentive contacts: fixed price contracts

    3.Restrictive covenents are used to limit the uses of funds that a borrower recieves
  22. Three Key features of our financial system
    1. Loans from financial intermediaries are the most important external source of funds for small to medium sized firms... Smaller firms cannot buy directly because costs are to high and cannot sell because of adverse selection

    2.the stock market is a less important source of external funds to corporations than the bond market.- most trading involves existing shares and not knew ones.- corp have been recenly buying back more stock than they have been issueing

    3.Debt contracts usually require collateral or restrictive covenants- goods purchased used as collateral.-corp bonds have collateral-savers recieve higher int rates while borrowers have lowerint rates.
  23. Assymetric information in developing countries
    • -poor system of property rights may prevent collateral
    • -porr legal system make it difficult to enforce restrictive covenants
    • -weak acct standards may reduce access to info
    • -gov intervention throu credit programs and state owned banks are not efficient in allocation of financial capital
  24. Balance sheet Liabilities
    • Checkable deposits
    • Nontransaction deposists-saving acct and CDs
    • Borrowings (from other banks or fed)
    • Bank capital
  25. Balance sheet Assets
    • Reserves (held at fed)
    • Gov Securities (secondary reserves)
    • Loans
    • -real estate
    • -Consumer
    • -Business
  26. Bank Capital
    • Defined as the differnece between assets and liabilites
    • Bank capital as a shcare of assets is an impt parameter
    • Cap/assets ratio was at 12 % in 2010
  27. JObs of bank manager
    • 1. Capital adequacy managment
    • 2.liquidity managment and asset managment
    • 3. credit risk
    • 4. interest rate risk
  28. ROA
    After tax profit / Assets
  29. ROE
    after tax profit / Capital


    ROA * bank leverage

    reflects the return the sharholders invesment
  30. leverage ratio
    capital / assets
  31. bank leverage

    *managers want to hold a high ratio of assets to capital to maximize prfoits

    * a high bank leverage is risky while is can amplify the affects of asset appreciation of ROE...

    Mangers may want to take on more risk than shareholders would prefer if rewarded base on ROE - moral hazard
  32. A reserve shortfall can be remedied by?
    • A) borrowing from another bank
    • B)Borrowing from the fed
    • C) Selling sequirities
    • D) reducing loans
  33. What are the few ways a manager can adrees Credit Risk?
    • 1. Diversification
    • 2. Credit risk anaylsis- the process that bank loan offer to screen loan applicants
    • 3.Collateral or compensating balances
    • 4. Speicalization in lending- when a bank focuses on specific industries that it knows very well
  34. Gap Analysis
    Analyzes the gap between the dollar value of a bank's variable rate asset and the dollar value of its variable rate liabilites... USUALLY NEGATIVE

    (Variable rate asset-variable rate Liability)* interest rate= Profit
  35. duration analysis
    Analyzes how sensitive a banks capital is to changes in maret interest. Avg tim to maturity

    The difference between the avg duration of a banks assets and the avg duration of the banks liabilities...
  36. Positive duration gap
    An increase in the market interest rates the duraction of assets more than the value of the liabilites
  37. Off-balance sheet activities
    • A) Standby letters of credi- a promise by a bank to lend funds to a seller of commercial paper at th time that the commercial paper matrues
    • B) Loan Commitments- an agreement by a bank to provide a borrower with a stated amount of funds during some specified period of time
    • C) Loan sales a financial contract in which a bank agrees to sell the expected future returns from an underlying bank loan to third party
    • D) Trading activities- banks earn fees from trading in derivative markets
  38. the Glass steagall act
    In 1933 seperated the commercial and investment banking
  39. Gramm-Leach Blilty act
    Repealed the glass seagal act

    Developement of financial holding companies
  40. Financial instituations
    raise funds to invest in loans and securities
  41. Mutual funds
    Financial intermederaries that raise funds by selling share to individuals and invest those funds ina portfolio of stcoks, bonds and mortgages and money market securities.

    • -Reduce transaction costs.. provide risk share benefits... help gather infor
    • -began in 1920s
  42. close-ended mutual fund
    A fixed number of nonredeemable shares issued, with the price of a share fluctuating with the market value of the asset. Share may sell at a discount or premium relative to the market value of the asset in the fund
  43. Open-ended mutual fund
    INvestors can redeem shares after the market close for a price tied to the value of the asset in the fund.
  44. Exchange trade funds
    like close ended funds, trade continually but prices track the value of the assetsin the fund more closeyly

    *mutual funds that do not charge commission are called NO-Load Funds
  45. Money Market mutual funds
    Invest exclusively in short-term assets such as treasury bills, negotiable CDs and commercial paper.

    • -allow savers to write checks against accts
    • -popular with small savers as laternatives to commercial bank checking and savings accts because they typically pay a higher rate of interest
    • -increase comp for commercial banks
  46. Hedge funds
    Organized as partnerships of wealthy investors that make relatively high risk speculative investments

    -99 investors
  47. Finance companies

    3 categories
    Nonbanke financial intermediaries that raise money through the sale of commercial paper and other secuties and use the fund to make small loans to housholds or firsm..

    -lower degree of regulation

    • 1. business
    • 2.consumer
    • 3.sales
  48. Contactual savings instituations
    finfnacial intermediatires such as a pension fund or insurance sompany that revieces payments from individuals as reutl of a contrac then uses the funds to make investments
  49. Pensions funds
    finfnacial intermediaries that inves t contributions of worker and firms in stocks bonds and mortgages to procide pension benefits during retirements...

    private state and local gov. are the larges participands in the capital market
  50. insurance companies
    Finincail intermediatres that specialize in writing contracts to protect policy holders form the risk of financial loss associated with particual events

    uses the law of large numbers to make predictisions

    Risk pooling- quotes size of reserves needes

    -acutatries compile probabilties...
  51. Shadow banking system
    financial institutions such as investment banks, hedge funds, and MMMF

    most conserserned with systematic risk
  52. insolvents
    assets are worth more than liabilities
  53. Bank run
    when depositors who ahve lost confidence in a bank simultaneously withdraw enough funds to close the bank
  54. Contagione
    when the closting of one bank spreads to run on other banks
  55. How the government intervenes to prevent bank panics?
    • a. FDIC
    • b. Feds lender of last resort capacity
  56. How the financial environ ment changed since the 2008 Crisis
    • 1. Government as a safety net
    • 2. Restrict competition
    • 3.Capital requirements (CAMEL)
  57. CAMELS
    • Capital adequacey
    • asset quality
    • management
    • earning
    • liquidity
    • Sensitiviey on the market
  58. regulation Q
    lifted in the early 1980s place ceilings on the interest rates that banks could pay... to restict competition
  59. How the FDIC regulates when undercapitalized
    • 1. Submit capital resoration plan
    • 2. restrict asset growth
    • 3. seek regulatory approval for new ine of busines
    • 4. closes bank
  60. The wall street regorm and consumer protections act of 2010 DODD-FRAMK
    -created the consumer financial proection bureau to procect consumers when investing

    -Esablishes the Financial Stability oversight Council - identify systematic risk

    - Ended TBTF

    -Implented the Volcker rule- banned most proprietyary trading at commercial banks

    - SEC
  61. S and L Crisis
Card Set
Econ test 2
The market of foreign exchange
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