CFA II Econ

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maxkelly
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195683
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CFA II Econ
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2013-02-02 14:20:34
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CFA II Econ
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CFA II Econ
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  1. Cross rate
    Quote determined using related quotes

    • (a/c)ask = (a/b)ask * (b/c)ask
    • (a/c)bid = (a/b)bid * (b/c)bid

    (a/b)ask =
  2. Premium and discount
    Premium of base: forward - spot > 0

    Discount of base: forward - spot < 0 
  3. Value of forward currency contract prior to expiration
    Contract is to purchase DC:

  4. Covered interest rate parity


    • Spot * (Ra/Rb) < F => Borrow A
    • Spot * (Ra/Rb) > F => Borrow B
  5. Relative PPP
    Changes in exchange rates will be just offset by changes in prices (ie inflation)



    Current prices may be different, but will not become more different

    Holds in long run, not short run
  6. International Fisher Effect


    real rates are all the same; inflation explains the difference in nominal interest rates

    Implies future rates = expected spot rates
  7. Uncovered Interest Rate Parity
  8. Carry Trade
    Borrow at low funding currency and lend at high funding currency

    Return = interest earned on investment - funding cost - currency depreciation

    currency depreciation = (Future spot [ask if lend/borr quote] - current spot [bid if lend/borr quote])/current spot [bid if lend/borr quote]
  9. Balance of Payments
    BoP = current account + capital (financial) account

    current account deficit = buy more than sell => capital account surplus
  10. Current account influences (3)
    All three imply deficit will cause depreciation eventually

    flow mechanism: if have current account deficit then must be selling DC to buy FC => increase supply of DC and demand of FC, so causes DC depreciationHigh debt will eventually lead to depreciation

    Portfolio composition mechanism: Country in deficit to usually invests here (ex deficit to china, so china invests in U.S.). If F country changes, dump DC onto the market

    Debt sustainability mechanism: eventually debt must be paid, only way is by depreciation when it gets too high
  11. Capital (financial) account influences (2)
    In short term, real currency values fluctuate around long-term PPP implied equilibrium

    Real value is positively related to interest rate differential and negatively related to risk premium differential
  12. Mundell-Flemming Model
    Short term effect of monetary and fiscal policy on interest rates and therefore currency

    • E = expansionary
    • R = restrictive
    • Monetary/Fiscal

    • Mobil capital: E/E or R/R = uncertain
    • E/R = Depreciation
    • R/E = Appreciation

    • Immobil Capital: E/R or R/E = uncertain
    • E/E = depreciation
    • R/R = appreciation
  13. Monetary Approach
    Focuses on inflation

    Pure approach: PPP holds and expansionary fiscal policy => high inflation rates => depreciation

    Dornbusch overshooting model: inflation may not reflect policy changes in sync. may first overshoot, then correct
  14. Portfolio Balance Approach
    long-term implications of fiscal policy

    sustained deficits will lead to depreciation
  15. Objectives of central bank
    restrict excessive appreciation

    reduce excessive capital inflow

    allow pursuit of independent monetary policy
  16. Warning signs of Currency Crisis
    1. Terms of trade deteriorate

    2. Dramatic decline in foreign exchange reserves

    3. Real exchange rate substantially higher than mean reverting level

    4. Inflation increases

    5. Equity market experiences boom/bust

    6. Money supply relative to bank reserves increases

    7. Nominal private credit grows
  17. Technical Analysis (3)
    Trend following trading rules: follow trends, buy if going up, sell if going down. Does not work (since 1995)

    FX order books: If could look at books of dealer, look at who's buying/selling. Contemporaneously correlated, but no predictive value

    Currency options market: volatility on calls vs volatility of puts on currency value. High volatility of calls vs puts means will appreciate. Contemporaneous value, no predictive value.
  18. Preconditions for Growth
    • 1. Political stability, rule of law, property rights
    • 2. Savings and investment
    • 3. Financial markets
    • 4. Investment in human capital
    • 5. Tax and regulatory system
    • 6. Free trade and unrestricted capital flows
  19. Stock Market Appreciation
    in the long run: equity growth rate = GDP growth rate
  20. Potential GDP and rates
    High potential GDP growth rate => high real rates

    Actual GDP growth rate > potential GDP growth rate => high inflationary pressure, restrictive monetary/fiscal policy

    High potential GDP growth rate reduces expected credit risk
  21. Cobb-Douglas

    Marginal product of capital

    Returns 




    Diminishing marginal productivity of labor and capital
  22. Productivity curve
    Labor productivity = real GDP per worker

    Curve is labor productivity (y) and capital per worker (x).

    • Sources of economic growth
    • Capital deepening: move along curve

    Technological (total factor productivity) change: new curve
  23. Growth accounting equations
    total potential GDP growth rate = long-term growth rate of tech + alpha*long-term growth rate of capital + (1-alpha)*long-term growth rate of labor

    total potential GDP growth rate per worker (capita) = long-term growth rate of labor force + long-term growth rate in labor productivity
  24. Growth theories
    Classical: no permanent increase in standard of living from new technologies. Economic growth leads to population growth, which reduces amount of output per worker, and the economy reverts to previous condition.

    Neoclassical: Economic growth results from lucky discoveries of new technology. Causes short term economic growth, and new level results in a permanently higher standard of living

    Endogenous: Economy is always advancing, and innovation inspires innovation.
  25. Regulatory Interdependencies: capture, arbitrage, competition
    • Regulatory capture: regulatory body is influenced or controlled by industry being regulated.
    • Regulatory arbitrage: businesses move to a country or jurisdiction with the most favorable regulatory environment.
    • Regulatory competition: regulators compete to provide the most business friendly environment.
  26. Regulatory costs
    • a) Regulatory Burden: incurred by regulated firms
    •     i. Direct: cost of regulatory agency
    •     ii. Indirect: cost of regulated firm to comply
    • b) Net Regulatory Burden: regulatory burden - private benefits
  27. Convergence theories: absolute, conditional, club
    Absolute: All countries will converge to the same standard of living

    Conditional: Countries with similar savings rates, pop growth rates, etc will converge standards of living

    Club: Clusters of countries will converge. Clusters based on institutional

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