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bwood190
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Foreign Exchange Mkt
- where currencies are exchanged.
- Not a place, made up of 1000's
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Exchange Rate
- Price at which one currency exchanges for another
- Appreciates and depreciates
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Demand in foreign exchange mkt (4 things)
- qty demanded depends on
- 1. exchange rate
- 2. World demand for cdn exports
- 3. interest rates in cad and other countries
- 4. expected future exchange rate
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Law of Demand for Foreign Exchange
other things the same, higher exchange rate, smaller qty cdn dollars demanded in mkt
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Exports effect
- larger value of cdn exports larger qty of cad demanded
- value of exports depends on value of cdn g/s in value of foreign dollar and these prices depend on exchange rate
- lower exchange rate, lower price for foreigners, more g/s bought
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Expected Profit Effect (Demand)
- larger expected profit from holding cad, greater qty demanded in foreign mkt
- expected profit depends on exchange rate
- lower exchange rate today, greater expected profit in future, greater qty demanded
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Supply in Foreign Exchange mkt
- qty cad supplied = amount traders plan to sell
- depends on
- 1. exchange rate
- 2. cdn demand for imports
- 3. interest rates in canada and other countries
- 4. expected future exchange rates
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Law of Supply of Foreign Exchange
- other things same, higher exchange rate greater qty cad supplied in foreign mkt
- exchange rate influences for two reasons
- 1. Imports effect
- 2. Expected profit effect
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Imports Effect
- larger value of cdn imports, larger qty of cad supplied
- value of cdn imports depends on prices of foreign produced g/s expressed in cad.. These prices depend on exchange rate
- higher exchange rate, prices of foreign goods lower to canadians, more imports
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Expected Profit Effect (supply)
- similar to demand but in opposite direction
- higher exchange rate today, other things same, larger expected profit today so more cad supplied
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Change in Demand for CAD
- world demand for cdn exports
- cdn interest rate relative to foreign rate
- expected future exchange rate
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World Demand for Cdn Exports
increase in demand for cdn exports increases demand for CAD
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Cdn interest rate relative to foreign interest rate
higher rate that can be earned in canada = more demand for CAD
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Cdn Interest Rate Differential
- cdn rate minus foreign rate
- larger differential larger demand for cad
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Expected Future Exchange Rate
rise in expected rate increase profit people expect to make, demand for cad increases today
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Change in Supply of CAD
- cdn demand for imports
- cdn interest rate relative to foreign interest rate
- expected future exchange rate
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cdn demand for imports
increase in cdn demand for imports increases supply of cad in foreign mkt
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cdn interest rate relative to foreign interest rate (supply)
- opposite to demand
- larger differential, smaller supply of cad in foreign mkt
- b/c people hold on to cdn assets, don't sell cad as much
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Expected future exchange rate (supply)
- fall in future expected, decreases profit made by holding CAD, decreases qty people want to hold
- people sell CAD, supply increases
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Changes in Exchange Rate
- if demand increases w/ no change in supply exchange rate rises
- look at graph to figure out
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What changes expected exchange rate?
- change in demand for cdn exports
- cdn demand for imports
- cdn interest rate relative to world
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Arbitrage
- buying in one mkt, selling for higher price in another unrelated mkt
- can't be done b/c prices are the same around the world
- brings interest rate parity and purchasing power parity
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Interest Rate parity
- equal rates of return
- funds move to get the highest expected return
- changes in demand will change exchange rate and bring equal returns
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Purchasing Power Parity
- equal value of money
- if most prices increase in canada but not japan, value of CAD will drop. Expected exchange rate will drop
- decrease demand, increase supply
- exchange rate will change until prices are equal
- vice versa
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Real Exchange Rate
- relative price of cdn produced g/s to foreign produced g/s
- qty of real GDP of other countries that a unit of cdn real GDP can buy
- RER = (E X P)/P*
- E = exchange rate
- P = cdn price level
- P* = jpn price level
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S/T RER
- if nominal exchange changes, real also changes
- b/c price levels and prices don't change every time exchange rate changes
- changes in real exchange bring s/t changes in qty of imports demanded and qty exports supplied
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L/T RER
- nominal exchange rate and price level are determined together and real exchange does NOT change when nominal exchange changes
- demand and supply in mkt for g/s determine prices
- if dollar appreciates prices will change
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Flexible Exchange Rate
- determined by demand and supply in foreign exchange mkt w/ no direct intervention from central bank
- is influenced by central banks actions
- ex. world will respond to change in cdn interest rate
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Fixed Exchange Rate
- rate determined by decision of gov or central bank to block unregulated supply and demand forces
- no limit to cash central bank can sell, but there is a limit on amount they can buy
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Crawling Peg
- exchange rate that follows a path determined by gov or central bank
- works like fixed, but target value changes
- developing countries use this to control inflation
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Balance of pmts accts
- records intnl trading borrowing and lending in 3 accts
- current
- capital and financial
- official settlements
- sum of all 3 accts ALWAYS = 0
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Current Account
- records receipts from exports of g/s sold abroad, pmts for g/s from abroad, net interest income paid abroad, and net xfers abroad (foreign aid)
- balance = exports - imports - net interest inc - net xfers
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Capital and Financial Acct
- records foreign investment in canada minus cdn investment abroad
- has statistical discrepancy
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Official Settlements Acct
- records change in cdn official reserves (gov holdings of foreign currency)
- if reserves increase, balance is negative b/c holding foreign currency is similar to investing
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Net Borrower
borrows more from rest of world than lends
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Net Lender
lends more to rest of world than borrows
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Debtor Nation
- nation that during entire history has borrowed more from rest of world than has lent
- outstanding debt to rest of world greater than claims to rest of world
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Creditor Nation
nation that during entire history has invested more in rest of world than other countries have invested in it
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Current Acct Balance
- CAB = NX + Net interest inc + net xfers
- nx = net exports
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Gov Sector Balance
- = net taxes - gov expenditure on g/s
- if positive, gov sector surplus lent to other sectors
- if negative, gov deficit must be financed by borrowing from other sectors
- sum of fed, prov, and local gov
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Private Sector Balance
- = saving - investment
- if positive, surplus lent to other sectors
- if negative, deficit financed by borrowing from other sectors
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