FIN415 Class Web
Page, Spring '24
Jacksonville
University
Instructor:
Maggie Foley
Term Project Part I
(due with final)
Term
project part II (excel questions)
(due with final)
Weekly SCHEDULE,
LINKS, FILES and Questions
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Coverage, HW, Supplements -
Required |
Supplemental Reaching Materials |
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Week 1 |
Marketwatch Stock Trading Game (Pass
code: havefun) 1. URL for your game: 2. Password for this private
game: havefun. 3. Click on the 'Join Now'
button to get started. 4. If you are an
existing MarketWatch member, login. If you are a new user, follow
the link for a Free account - it's easy! 5. Follow the instructions and
start trading! 6. Game will be over
on 4/17/2019 How to Use
Finviz Stock Screener (youtube, FYI)
How To Win
The MarketWatch Stock Market Game (youtube, FYI)
How Short Selling
Works (Short Selling for Beginners) (youtube, FYI)
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PRESS RELEASE OCTOBER 4,
2023 World Bank’s Fall 2023 Regional Economic Updates
East
Asia and the Pacific: Growth in developing East Asia and
Pacific is projected to remain strong at 5% in 2023 but will ease in the
second half of 2023 and is forecast to be 4.5% during 2024, the World Bank
said on Sunday in its semi-annual economic
outlook for the region. Europe and
Central Asia: Economic growth for the emerging market and developing
economies (EMDEs) of the Europe and Central Asia region has been revised up
to 2.4% for 2023, says the World Bank’s Economic
Update for the region, released today. Latin America
and the Caribbean: Latin America and the Caribbean (LAC) made
progress in macroeconomic resiliency over previous decades and navigated the
multiple post-pandemic crises with relative success. Yet, according to a new World Bank
report, growth remains inadequate to reduce poverty and create
jobs, while fiscal constraints limit necessary investments. Middle East
and North Africa: Growth of the economies in the Middle East
and North Africa (MENA) is expected to fall sharply this year. The region’s
gross domestic product (GDP) is forecast to plummet to 1.9% in 2023 from 6%
in 2022, due to oil production cuts amidst subdued oil prices, tight global
financial conditions, and high inflation, according to the latest issue of
the World Bank MENA Economic Update (MEU). South
Asia: South Asia is expected to grow by 5.8% this year—higher
than any other developing country region in the world, but slower than its
pre-pandemic pace and not fast enough to meet its development goals, says the
World Bank in its twice-a-year regional
outlook. Sub-Saharan Africa: Sub-Saharan Africa’s economic outlook remains bleak amid an elusive growth recovery. According to the latest World Bank Africa’s Pulse report, rising instability, weak growth in the region’s largest economies, and lingering uncertainty in the global economy are dragging down growth prospects in the region. In class exercise: 1. In 2023, which region is projected to have
the highest economic growth? A) East
Asia and the Pacific B)
Europe and Central Asia C)
South Asia Answer:
A the Pacific Explanation: According to the World Bank, East Asia and the Pacific are projected
to have the highest growth at 5% in 2023. 2. Why is economic growth in the Middle
East and North Africa (MENA) expected to fall sharply in 2023? A)
Increased oil production B)
Subdued oil prices C)
Improved global financial conditions Answer: B Explanation: The decline in economic growth in MENA is attributed to oil
production cuts amidst subdued oil prices, among other factors. 3. Which region's economic growth has
been revised up for 2023? A)
Latin America and the Caribbean B)
Sub-Saharan Africa C)
Europe and Central Asia Answer:
C Explanation: The World Bank's Economic Update for the Europe and Central Asia
region revised the growth for 2023 up to 2.4%. 4. What is the projected growth rate for
South Asia in 2023? A) 3.5% B) 5.8% C) 7.2% Answer:
B Explanation: South Asia is expected to grow by 5.8% in 2023 according to the
World Bank. 5. Why does Latin America and the
Caribbean face challenges despite progress in macroeconomic resiliency? A) Insufficient
job creation B) Lack
of poverty reduction C)
Fiscal constraints limiting investments Answer:
C Explanation: The World Bank report mentions that fiscal constraints limit
necessary investments despite progress in macroeconomic resiliency. 6. What is the primary reason for the
projected decline in economic growth in the Middle East and North Africa in
2023? A) Oil production cuts B)
Inflation C) Global financial stability Answer:
A Explanation: The World Bank MENA Economic Update attributes the decline in
economic growth to oil production cuts, among other factors. 7. How does South Asia's expected growth in
2023 compare to its pre-pandemic pace? A)
Higher B)
Lower C) Same Answer:
B Explanation: The World Bank mentions that South Asia's expected growth in 2023 is
slower than its pre-pandemic pace. 8. Which region is forecasted to have the
slowest growth in 2024? A)
Latin America and the Caribbean B) East
Asia and the Pacific C)
Middle East and North Africa Answer:
A Explanation: According to the World Bank,
growth in Latin America and the Caribbean is forecasted to be 4.5% in 2024. Published on Let's Talk Development
https://blogs.worldbank.org/developmenttalk/global-economic-outlook-five-charts-1
The global economy is set to slow substantially in 2023. The
lagged and current effects of monetary tightening, as well as more
restrictive credit conditions, are expected to weigh on activity in the
second half of the year, with weakness persisting into 2024. Excluding China,
growth in emerging market and developing economies (EMDEs) is set to decline
markedly, with the outlook weakest in countries with elevated fiscal and
financial vulnerabilities. The resurgence of recent banking sector turmoil
represents a serious risk. Widespread financial stress could have especially
severe economic consequences.
1. Global growth is slowing
The global economy is forecast to slow substantially this
year, with a pronounced deceleration in advanced economies. Monetary tightening
is expected to have its peak impact this year for many major economies.
Global growth is forecast to decline to 2.1 percent in 2023, a full
percentage point less than in 2022, before a tepid recovery to 2.4 percent in
2024. In emerging market and developing economies (EMDEs) excluding China,
growth is projected to fall to 2.9 percent in 2023, from 4.1 percent in 2022,
as tight global financial conditions and subdued external demand weigh on
activity. Global growth could weaken more than anticipated in the event of
further financial sector stress, or if persistent inflation prompts tighter-than-expected
monetary policy. Contributions
to global growth
In
class exercise 1.
What is the forecasted global growth rate for 2023? A)
3.1% B)
2.1% C)
4.4% Answer:
B Explanation:
The global economy is forecasted to slow substantially in 2023, with a
projected growth rate of 2.1%. 2.
What is the primary factor expected to contribute to the global economic
slowdown in 2023? A)
Monetary tightening B)
Increased government spending C)
Expansionary credit conditions Answer:
A Explanation:
The lagged and current effects of monetary tightening are anticipated to
substantially slow the global economy in 2023. 3.
How much is global growth forecasted to recover in 2024? A)
1.4% B)
3.4% C)
2.4% Answer: C Explanation:
After the projected decline in 2023, global growth is expected to experience
a recovery to 2.4% in 2024. 4.
In emerging market and developing economies (EMDEs) excluding China, what is
the projected growth rate for 2023? A)
3.9% B)
2.9% C)
4.8% Answer:
B Explanation:
Growth in EMDEs, excluding China, is projected to fall to 2.9% in 2023 due to
tight global financial conditions and subdued external demand. 5.
What could lead to a more severe weakening of global growth according to the
information? A)
Further financial sector stress B)
Government stimulus packages C)
Decreased inflation Answer: A Explanation:
Further financial sector stress could lead to a more severe weakening of
global growth. 6.
Which sector poses a serious risk to the global economy? A)
Technology B)
Healthcare C)
Banking Answer: C Explanation:
The resurgence of recent banking sector turmoil represents a serious risk to
the global economy. 7.
What is the expected impact of monetary
tightening on advanced economies in 2023? A)
Acceleration of growth B)
Pronounced deceleration C)
Stable economic conditions Answer: B Explanation:
Monetary tightening is expected to have a pronounced decelerating impact on
advanced economies in 2023. 8.
What is the primary reason for the
projected decline in growth in emerging market and developing economies
(EMDEs) excluding China? A)
Subdued external demand B)
Increased government investment C)
Expansive credit conditions Answer: A Explanation:
The decline in growth is attributed to tight global financial conditions and
subdued external demand. 9.
How much is global growth expected to
decline in 2023 compared to 2022? A)
0.5% B)
1.0% C)
1.5% Answer: B Explanation:
Global growth is forecasted to decline by a full percentage point, from 3.1%
in 2022 to 2.1% in 2023. |
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Part II In class exercise – practice of
converting currencies 1. If the dollar
is pegged to gold at US $1800 = 1 ounce of gold and the British pound is
pegged to gold at £1200 = 1 ounce of gold. What should be the exchange rate between
US$ and British £? How much can you make without any risk if the exchange
rate is 1£ = 2$? Assume that your initial investment is $1800. What about the
exchange rate
set at 1£ = 1.2$? What about your initial investment is £1200? Solution: 1£ = 2$ (note
that the exchange rate is set at 1£ = 1.5$ since $1800 = £1500=1 ounce of
gold è $1.5=1£). è With $1800, you can buy 1 ounce of gold at US $1800
= 1 ounce of gold. èWith
one ounce of gold, you can sell it in UK at £1200 = 1 ounce of gold, so you
can get back £1200 è convert
£ to $ at $2=1£ as given èget
back £1200 * 2$/£ = $2400 > $1800, initial investment è you could make a profit of $600 ($2400 -
$1800=$600) è Yes. 1£ = 1.2$ (note
that the exchange rate is set at 1£ = 1.5$ since $1800 = £1500=1 ounce of
gold è $1.5=1£). è With $1800, you can buy either 1 ounce of gold at US
$1800 = 1 ounce of gold. è With
one ounce of gold, you can sell it in UK at £1200 = 1 ounce of gold, so you
can get back £1200 è convert
£ to $ at $1.2=1£ as givenèget
back £1200 * 1.2$/£ = $1440 < $1800 è you will lose $360 ($1440 - $1800=$-360) è No. è So should convert to £ first and then buy gold in
UK è With $1800, you can convert to £1500 ($1800 /
(1.2$/£ = £1500 ). è buy
gold in UK at £1200 = 1 ounce of gold, so you can get back £1500/£1200 = 1.25
ounce of gold è Sell gold in US at US $1800 = 1 ounce of
gold è So get back 1.25 ounce of gold * $1800 = $2250 >
$1800 è you will make a profit of $450 ($2250 -
$1800=$450) è Yes. 2. If the Euro (EUR) to US Dollar
(USD) exchange rate is 1.18, and the US Dollar to Japanese Yen (JPY) exchange
rate is 110, what is the implied exchange rate between Euro and Japanese Yen?
Answer: The implied exchange rate between
Euro and Japanese Yen is approximately 129.80 (110 * 1.18). Explanation: ·
1
EUR = 1.18 USD; 1 USD = 110 JPY. So
1.18 USD/EUR * 110 JPY/USD = 1.18 * 110 = 129.80 JPY/EUR (one EUR =
129.80 JPY) ·
Or,
1 EUR = 1.18 USD è 1 USD = (1/1.18) EUR; 1USD
= 110 JPY, so è (1/1.18)EUR = 110 JPY è 1 EUR = 110/(1/1.18) =
129.80 JPY 3. If the Euro to the British
Pound (GBP) exchange rate is 0.85, and the Swiss Franc (CHF) to Euro exchange
rate is 1.10, what is the implied exchange rate between British Pound and
Swiss Franc? Answer: The implied exchange rate
between British Pound and Swiss Franc is approximately (1/0.85)/1.1 = 1.07 CHF/GBP è one GBP is worth 1.07 CHF Explanation: ·
1
EUR = 0.85 GBPè 1 GBP = (1/0.85) EUR, 1
CHF = 1.10 EUR, so (1/0.85) EUR/ GBP / 1.1 EUR/CHF = (1/0.85)/1.1 CHF/EUR =
1.07 CHF/GBP ·
Or
1 EUR = 0.85 GBP, 1 CHF=1.1 EUR è 1 EUR = (1/1.1) CHF, so 1
EUR = 0.85 GBP = (1/1.1) CHF è 1 GBP = (1/1.1)/0.85 =
1.07 CHF 4. If the Australian Dollar
(AUD) to US Dollar exchange rate is 0.75, and the Canadian Dollar (CAD) to US
Dollar exchange rate is 1.25, what is the implied exchange rate between
Australian Dollar and Canadian Dollar? Answer: The implied exchange rate
between Australian Dollar and Canadian Dollar is 0.60 (0.75 / 1.25). Explanation: ·
1
AUD = 0.75 USD, 1 CAD = 1.25 USD, So 1 AUD can get 0.75 USD, and since 1 USD
can get (1/1.25=0.8) 0.8 CAD, so 1 AUD = 0.75 *(1/1.25) = 0.6 CAD. So one AUD
is worth 0.6 CAD. ·
Or,
0.75USD/AUD * (1/1.25) CAD/USD = 0.75 * 0.8 CAD/AUD = 0.6 CAD/AUD Homework chapter1-1 (due with first
midterm exam) 1.
If the dollar is pegged to gold at US $1800 = 1 ounce of
gold and the British pound is pegged to gold at €1500 = 1 ounce of gold. What
should be the exchange rate between US$ and Euro €? How much can you make
without any risk if the exchange rate is 1€ = 1.5$? (hint: $1800 è get gold
è sell
gold for euro è convert
euro back to $) How much can you make without any risk if
the exchange rate is 1€ = 0.8$? (hint: $1800 è
get euro è buy gold using euro è
sell gold for $) Assume that your initial
investment is $1800. (answer: $1.2/euro, $450, $900) 2.
If USD to the Chinese Yuan (CNY)
exchange rate is 7.35, and USD to the Indian Rupee (INR) exchange rate is 94.20,
what is the implied exchange rate between Chinese Yuan and Indian Rupee, eg 1
CNY = ? INR? (answer: 1 CNY = 12.816
INR) 3.
If the New Zealand Dollar (NZD) to
Australian Dollar (AUD) exchange rate is 1.05, and the Singapore Dollar (SGD)
to New Zealand Dollar exchange rate is 0.94, what is the implied exchange
rate between Singapore Dollar and Australian Dollar? (answer: 1 AUD = 1.013 SGD, or 1 SGD = 0.987 AUD) 4.
What is your opinion on
arbitrage across borders? Do you think that arbitrage crypto will work? (Optional homework question) Crypto
arbitrage:Cryptocurrency arbitrage is a strategy in which investors buy a
cryptocurrency on one exchange, and then quickly sell it on another exchange
for a higher price. Cryptocurrencies trade on hundreds of different
exchanges, and often the price of a coin or token may differ on one exchange
versus another. How I Became A Crypto Billionaire
In 5 Years (CNBC)
The FTX Collapse,
Explained | What Went Wrong | WSJ (youtube)
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Sam Bankman Fried Explains His Arbitrage Techniques Nicholas Pongratz, April 9, 2021·3 min read https://www.yahoo.com/video/sam-bankman-fried-explains-arbitrage-132901181.html A former ETF trader at Jane Street, Sam Bankman-Fried developed a
net worth of $9 billion from trading crypto in three and a half years. He
explained his success comes from lucrative arbitrage opportunities in crypto. Bankman-Fried launched a crypto-trading firm called Alameda Research
in 2017. The company now manages over $100 million in digital assets. The
firm’s large-scale trades made Bankman-Fried a self-made billionaire by the
age of 29. He is also the CEO and founder of the FTX Exchange, a
cryptocurrency derivatives trading exchange. Upon
entering the crypto markets, he discovered that Bitcoin was growing very
rapidly in trading volumes. This meant there would also be large price
discrepancies, making it ideal for arbitrage, taking advantage of the price
differences. The
Kimchi Premium One
opportunity he exploited was what is known as the kimchi premium. While
Bitcoin was pricing at around $10,000 in the US, it traded for $15,000 on
Korean exchanges. This was because of a huge demand for Bitcoin in Korea,
Bankman-Fried said. Around its peak, there was a vast spread of around 50%, he said. However,
because the Korean won is a regulated currency, it was difficult to scale
this arbitrage. Bankman-Fried said: “Many found a way to do it for small size. Very, very hard to do it
for big size, even though there are billions of dollars a day volume trading
in it because you couldn’t offload the Korean won easily for non-crypto.” Although nowhere near as significant, the premium still exists today.
According to CryptoQuant, the premium is listed at 18%. 10% Daily Returns in Japan Bankman-Fried
then sought a similar opportunity in other markets, which he found in Japan.
He said: “It
wasn’t trading quite the same premium. But it was trading at a 15% premium or
so at the peak, instead of 50%.” After
buying Bitcoin for $10,000 in the US, investors could send it to a Japanese
exchange. There they could sell it for $11,500 worth of Japanese yen. At that
point, they could convert the amount back to dollars. Because
of the trade’s global nature and the wire transfers involved, it would take
up to a day to perform. ”But it was doable, and you could scale it, making
literally 10% per weekday, which is just absolutely insane,” Bankman-Fried
said. Bankman-Fried was successful where others were not because he managed
to facilitate all the different components involved in the trade. For
example, finding the right platform to buy Bitcoin at scale, then getting
approval to use Japanese exchanges and accounts. There was also the
difficulty of even getting millions of dollars out of Japan and into the US
every day. “You do have to put together this incredibly sophisticated global
corporate framework in order to be able to actually do this trade,”
Bankman-Fried said. “That’s the real task, the real hard part.” High
Edge, Low Risk The
decentralized aspect of the crypto ecosystem enables these large arbitrage
premiums to exist. With other financial markets, there is a cross merging
between exchanges and central clearing firms or brokers, Bankman-Fried
explained. “So it’s really capital-intensive, and also you have to worry about
counterparty risk,” he added. But once investors and traders come to understand the crypto space
intimately, they can figure out where the counterparty risk is close to zero,
but the edge is still high. According to Bankman-Fried: “There’s a lot of money to be made, if you can really figure out and
pinpoint when there is and isn’t a ton of edge and when there is and isn’t a
ton of actual counterparty risk.” For
discussion: ·
Any issues with SBF’s trading strategy? Hint: ·
Market Volatility: Cryptocurrency markets are
known for their volatility. Sudden and unpredictable price movements can
affect arbitrage opportunities, leading to unexpected gains or losses. ·
Regulatory Challenges: Dealing with different
regulations in various countries poses a challenge, as mentioned in the case
of the Kimchi Premium in Korea. Regulatory changes or uncertainties can
impact the feasibility and scalability of the strategy. ·
Execution Risk: Coordinating large-scale trades
across different exchanges and regions involves execution risks, such as
delays in wire transfers and potential slippage in prices during the
execution of trades. ·
Liquidity Concerns: In less liquid markets or
during times of high demand, executing large trades without significantly
impacting the market price can be challenging. ·
Other issues??? Changes in investors’
preferences? Market competition? In class
exercise 1. What contributed
significantly to Sam Bankman-Fried's net worth growth in the crypto market? A) Launching a cybersecurity firm B) Exploring lucrative arbitrage opportunities C) Founding a traditional stock brokerage Answer:
B Explanation: Sam Bankman-Fried attributes his success to
identifying and capitalizing on lucrative arbitrage opportunities in the
crypto market. 2. In which year
did Sam Bankman-Fried launch the crypto-trading firm Alameda Research? A) 2015 B) 2017 C) 2019 Answer:
B Explanation: Alameda Research, Sam Bankman-Fried's
crypto-trading firm, was launched in 2017. 3. What is the
primary reason behind the kimchi premium in the crypto market? A) High demand for Bitcoin in Korea B) Regulatory restrictions on Bitcoin trading C) A decline in global Bitcoin trading volumes Answer:
A Explanation: The kimchi premium occurs due to the
significant demand for Bitcoin in Korea, leading to price discrepancies. 4. How did
Bankman-Fried exploit the kimchi premium? A) By manipulating exchange rates B) By taking advantage of
large price discrepancies C) By offloading Korean won
for non-crypto Answer:
C Explanation: Bankman-Fried found it challenging to scale
the arbitrage due to difficulties in offloading Korean won for non-crypto. 5. In the Japanese market, what premium did
Bitcoin trade at its peak? A) 5% B) 15% C) 30% Answer:
B Explanation: Bitcoin traded at a 15% premium in the
Japanese market at its peak, according to Sam Bankman-Fried. 6. What was the
approximate daily return Sam Bankman-Fried mentions for the Japan-related
arbitrage opportunity? A) 5% B) 15% C) 10% Answer:
C Explanation: Bankman-Fried mentioned making
approximately 10% per weekday with the Japan-related arbitrage opportunity. 7. Why does
Bankman-Fried emphasize the importance of a sophisticated global corporate
framework for successful trades? A) To manage counterparty risk
B) To avoid taxes C) To manipulate market prices Answer:
A Explanation: A sophisticated global corporate framework
is necessary to manage counterparty risk and execute complex trades successfully. 8. According to
Bankman-Fried, what makes the crypto space different from traditional
financial markets in terms of arbitrage? A) Higher counterparty risk B) Lower edge C) Decentralized nature and low counterparty risk Answer:
C Explanation: The decentralized nature of the crypto
space reduces counterparty risk, making it more favorable for arbitrage
compared to traditional markets. 9. What does Bankman-Fried highlight as the key
to successful arbitrage in the crypto space? A) High capital investment B) Extensive market knowledge C) Diversified portfolio Answer:
B Explanation: According to Bankman-Fried, understanding
the crypto space intimately is crucial for identifying when there is a high
edge and low counterparty risk in arbitrage opportunities. |
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Part III: Multilateral
Trade vs. Bilateral Trade Trade agreement
(video)
Summary:
The
video mentions several forms of trade barriers, including: ·
Tariffs
or Taxes on Goods: These are mentioned as taxes imposed on
imported goods to make them more expensive in the domestic market. ·
Quotas
or Limits on Quantity: The video discusses limits set on the
quantity or value of goods that can be imported during a specific period, restricting
the volume of foreign products. ·
Standards:
Regulations and requirements, such as safety standards or non-genetically
modified organism (GMO) ingredients, are highlighted as factors influencing
trade. ·
Administrative
Delays: The video refers to inspections,
paperwork, and bureaucratic procedures causing delays in the importation of
goods. ·
Countertrade
Requirements: Mandates for the trade partner to
purchase something from the country are mentioned as a form of reciprocal
obligation in trade agreements. ·
Embargoes:
Complete trade restrictions with specific countries, mentioned in the context
of political actions or disagreements. In class exercise: Question
1: What is a tariff in international
trade? a)
A limit on the quantity of imported goods b)
A tax imposed on exported goods c)
A tax imposed on imported goods Answer: C Explanation:
Tariffs are taxes imposed on imported goods to make them more expensive in
the domestic market. Question
2: What is the purpose of quotas in international trade? a)
To encourage free trade b)
To limit the quantity of imported goods
c)
To set safety standards for imported goods Answer: B Explanation:
Quotas are restrictions on the quantity or value of imported goods during a
specific period. Question
3: How do administrative delays impact international trade? a)
They create delays through inspections and paperwork b)
They expedite the importation process c)
They reduce taxes on imported goods Answer: A Explanation:
Administrative delays involve inspections and paperwork, causing delays in
the importation process. Question
4: What is the purpose of countertrade requirements in trade agreements? a)
To eliminate trade restrictions b)
To create reciprocal obligations for trade partners c)
To set safety standards for exported goods Answer: B Explanation:
Countertrade requirements mandate that the trade partner must purchase
something from the country, creating reciprocal obligations. Question
5: What does an embargo in international trade involve? a)
A tax imposed on imported goods b)
Limits on the quantity of exported goods c)
Complete trade restrictions with specific
Answer: C Explanation:
Embargoes involve complete trade restrictions with specific countries. Question
6: What is the primary purpose of tariffs? a)
To encourage imports b)
To discourage exports c)
To make imported goods more expensive Answer: C Explanation:
Tariffs are taxes imposed on imported goods to make them less competitive in
the domestic market. Question
7: How do quotas impact the availability of foreign goods? a)
They increase the quantity of imported goods b)
They restrict the quantity of imported goods
c)
They have no impact on imported goods Answer: B Explanation:
Quotas limit the quantity or value of imported goods, restricting their
availability. Question
8: What role do standards play in international trade? a)
They set tax rates on exported goods b)
They regulate safety and product specifications c)
They encourage free trade Answer: B Explanation: Standards
involve regulations specifying safety requirements or certain product
specifications. Question
9: How do embargoes differ from tariffs? a)
Embargoes involve complete trade restrictions with specific countries b)
Tariffs are taxes on exported goods c)
Embargoes encourage free trade Answer: A Explanation:
Embargoes involve complete trade restrictions with specific countries, while
tariffs are taxes on imported goods. Multilateralism Explained
| Model Diplomacy (youtube)
In class exercise Question
1: What is the primary focus of multilateralism? a)
Cooperation between two countries b)
Cooperation between three or more countries
c)
Cooperation within a single country Answer: B Explanation:
Multilateralism involves cooperation amongst three or more countries to find
cooperative solutions to common problems. Question
2: Which issue is mentioned as an example of a global problem that requires
multilateral cooperation? a)
Climate change b)
National security c)
Economic inequality Answer: A Explanation:
Climate change is cited as a problem that doesn't respect national boundaries
and requires global cooperation. Question
3: What is the challenge posed by global epidemics? a)
Limited impact on international travel b)
Isolation within a single country c)
Ease of spread between countries Answer: C Explanation:
Global epidemics can spread easily from one country to another, especially
with international travel. Question
4: What are traditional examples of universal membership organizations for
multilateral cooperation? a)
Regional alliances b)
The United Nations, the International Monetary Fund, the World Bank c)
Bilateral agreements Answer: B Explanation:
Traditional examples include global organizations like the United Nations,
the International Monetary Fund, and the World Bank. Question
5: Which multilateral institution is highlighted as an example beyond
treaty-based bodies? a)
United Nations b)
Group of 20 (G20) c)
World Health Organization Answer B Explanation:
The G20, composed of major economies, is mentioned as a broader multilateral
institution. Question
6: What does the G20 symbolize? a)
Exclusivity of Western countries b)
Isolation from emerging nations c)
Expansion of the table to include new global actors Answer C Explanation:
The G20 symbolizes the need to include new actors transforming the world in
global decision-making. Question
7: Which nations are mentioned as part of the BRIC nations? a)
Brazil, Russia, India, China b)
Belgium, Romania, Indonesia, Canada c)
Bahrain, Rwanda, Iran, Colombia Answer: A Explanation:
BRIC stands for Brazil, Russia, India, and China. Question
8: What is mentioned as a challenge to multilateral cooperation in terms of
established powers? a)
Consistent alignment of priorities b)
Difficulty in compromise and sacrifice c)
Homogeneity of values Answer: B Explanation:
Cooperation in multilateral settings requires compromise and sacrifice, which
may be challenging for established powers. Answer Take
away: ·
Multilateral trade
agreements strengthen the global economy by making developing countries
competitive. ·
They standardize
import and export procedures giving economic benefits to all member
nations. ·
Their complexity
helps those that can take advantage of globalization, while those who cannot
often face hardships. For
class discussion: Do you agree with the above points?
Why or why not? Multilateral Trade
Agreements With Their Pros, Cons and Examples
5 Pros and 4 Cons to the World's
Largest Trade Agreements https://www.thebalance.com/multilateral-trade-agreements-pros-cons-and-examples-3305949 BY KIMBERLY AMADEO REVIEWED
BY ERIC ESTEVEZ Updated October
28, 2020 Multilateral trade
agreements are commerce treaties among three or more nations. The
agreements reduce tariffs and make
it easier for businesses to import and export. Since they are
among many countries, they are difficult to negotiate. That same broad scope makes them more
robust than other types of trade agreements once all
parties sign. Bilateral agreements are
easier to negotiate but these are only between two countries. They don't
have as big an impact on economic growth as does a multilateral
agreement. 5 Advantages of multilateral
agreements · Multilateral
agreements make all signatories treat each other equally. No country can
give better trade deals to one country than it does to another. That
levels the playing field. It's especially critical for emerging
market countries. Many of them are smaller in
size, making them less competitive. The Most
Favored Nation Status confers the
best trading terms a nation can get from a trading partner. Developing
countries benefit the most from this trading status. · The
second benefit is that it increases trade for every participant. Their
companies enjoy low tariffs. That makes their exports
cheaper. · The
third benefit is it standardizes commerce regulations for all
the trade partners. Companies save legal costs since they follow the same
rules for each country. · The
fourth benefit is that countries can negotiate trade deals with
more than one country at a time. Trade agreements undergo
a detailed approval process. Most countries would prefer to get one
agreement ratified covering many countries at once. · The
fifth benefit applies to emerging markets. Bilateral trade agreements
tend to favor the country with the best economy. That puts the weaker nation
at a disadvantage. But making emerging markets stronger helps the
developed economy over time. As those emerging markets become
developed, their middle class population increases. That creates
new affluent customers for everyone. 4 Disadvantages of multilateral
trading · The
biggest disadvantage of multilateral agreements is that they are
complex. That makes them difficult and time consuming to
negotiate. Sometimes the length of negotiation means it won't take place
at all. · Second,
the details of the negotiations are particular to trade and business
practices. The public often misunderstands them. As a result, they receive
lots of press, controversy, and protests. · The
third disadvantage is common to any trade agreement. Some companies and
regions of the country suffer when trade borders disappear. · The
fourth disadvantage falls on a country's small businesses. A
multilateral agreement gives a competitive advantage to giant
multi-nationals. They are already familiar with operating in a
global environment. As a result, the small firms can't compete. They lay off
workers to cut costs. Others move their factories to countries with a
lower standard of living. If a region depended on that industry, it
would experience high unemployment rates. That makes multilateral
agreements unpopular. Pros
Cons
Examples Some regional trade
agreements are multilateral. The largest had been the North American
Free Trade Agreement (NAFTA), which was ratified on
January 1, 1994. NAFTA quadrupled trade between the United
States, Canada, and Mexico from its 1993 level to
2018. On July 1, 2020, the U.S.-Mexico-Canada Agreement (USMCA) went
into effect. The USMCA was a new trade agreement between the three countries
that was negotiated under President Donald Trump. The Central American-Dominican
Republic Free Trade Agreement was signed on August 5, 2004. CAFTA-DR
eliminated tariffs on more than 80% of U.S. exports to six countries: Costa
Rica, the Dominican Republic, Guatemala, Honduras, Nicaragua, and El
Salvador. As of November 2019, it had increased trade by 104%, from
$2.44 billion in January 2005 to $4.97 billion. The Trans-Pacific
Partnership would have been bigger than NAFTA.
Negotiations concluded on October 4, 2015. After becoming
president, Donald Trump withdrew from the agreement. He promised to
replace it with bilateral agreements. The TPP was between
the United States and 11 other countries bordering the Pacific
Ocean. It would have removed tariffs and standardized business
practices. All global trade agreements
are multilateral. The most successful one is the General
Agreement on Trade and Tariffs. Twenty-three countries signed GATT in
1947. Its goal was to reduce tariffs and other trade barriers. In September 1986, the Uruguay
Round began in Punta del Este, Uruguay. It centered on extending
trade agreements to several new areas. These included services and
intellectual property. It also improved trade in agriculture and
textiles. The Uruguay Round led to the creation of the World Trade
Organization. On April 15, 1994, the 123 participating governments
signed the agreement creating the WTO in Marrakesh, Morocco. The
WTO assumed management of future global multilateral negotiations. The WTO's first project was the Doha round of
trade agreements in 2001. That was a
multilateral trade agreement among all WTO members. Developing countries
would allow imports of financial services, particularly banking. In so
doing, they would have to modernize their markets. In return, the developed
countries would reduce farm subsidies. That would boost the growth
of developing countries that were good at producing food. Farm lobbies in the United States and
the European Union doomed
Doha negotiations. They refused to agree to lower subsidies or accept
increased foreign competition. The WTO abandoned the Doha round in July 2008. On December 7, 2013, WTO
representatives agreed to the so-called Bali package. All countries
agreed to streamline customs standards and reduce red tape to expedite
trade flows. Food security is an issue. India wants to subsidize food so
it could stockpile it to distribute in case of famine. Other countries worry
that India may dump the cheap food in the global market to gain market
share. In class exercise Question 1: What
is the primary focus of multilateral trade agreements? a) Commerce treaties among three or more nations b) Commerce treaties between two nations c) Bilateral agreements for economic growth Answer: A Explanation: Multilateral trade
agreements involve commerce treaties among three or more nations to reduce
tariffs and ease import-export processes. Question 2: Why are multilateral agreements
considered more robust than bilateral agreements? a) They are easier to negotiate b) They involve many countries and are difficult
to negotiate c) They have a smaller impact on economic growth Answer: B Explanation: The broad
scope of multilateral agreements involving many countries makes them more
robust. Question 3: What advantage do multilateral
agreements provide for emerging market countries? a) Exclusivity in trade deals b) Most Favored Nation Status and equal
treatment c) Preferential treatment for smaller economies Answer: B Explanation: Multilateral
agreements ensure equal treatment among signatories, benefiting emerging
market countries. Question 4: How do multilateral agreements impact
trade for participants? a) They decrease trade for participants b) They have no impact on trade dynamics c) They increase trade by providing low
tariffs Answer: C Explanation: Participants
in multilateral agreements enjoy low tariffs, making their exports cheaper
and increasing trade. Question 5: Why do countries prefer negotiating
trade deals with more than one country at a time? a) Faster approval process b) Detailed approval process for one agreement
covering many countries at once c) Avoidance of trade negotiations Answer: B Explanation: Negotiating
one agreement covering many countries at once is preferred due to the detailed
approval process. Question 6: What is the significance of emerging
markets becoming stronger in the context of multilateral agreements? a) Creates new affluent customers and benefits the
developed economy over time b) No impact on developed economies c) Weakens the developed economy Answer: A Explanation: Strengthening
emerging markets creates new affluent customers, benefiting the developed
economy over time. Question 7: What is the biggest disadvantage of
multilateral agreements mentioned in the video? a) They are easily understood by the public b) They are complex and time-consuming to
negotiate c) They have a minimal impact on businesses Answer: B Explanation: The
complexity of multilateral agreements makes them difficult and time-consuming
to negotiate. Question 8: Why do negotiations of multilateral
agreements often receive press, controversy, and protests? a) Lack of public interest b) Smooth negotiation process c) Public misunderstanding due to particular trade
details Answer: C Explanation: Public
misunderstanding of trade details leads to press, controversy, and protests. Question 9: What is a common consequence when
trade borders disappear? a) No impact on businesses b) Some companies and regions suffer c) Enhanced business opportunities Answer: B Explanation: When trade
borders disappear, some companies and regions may suffer due to increased
competition. Question 10: Which entities benefit the most from
multilateral agreements, creating a competitive advantage? a) Giant multi-nationals b) Small businesses c) Medium-sized enterprises Answer: A Explanation: Multilateral
agreements give a competitive advantage to giant multi-nationals, which are
familiar with global operations. Question 11: What does the video suggest about the
impact of multilateral agreements on small businesses? a) They gain a competitive advantage b) They experience high unemployment rates c) They become globally competitive Answer: B Explanation: Small
businesses may face challenges and lay off workers due to the competitive
advantage given to larger corporations. Question 12: What is the primary benefit of the
Most Favored Nation Status in multilateral agreements? a) Exclusive trade deals for a single country b) Tariff reductions for developed economies c) Best trading terms a nation can get from a
trading partner Answer: C Explanation: Most Favored
Nation Status confers the best trading terms a nation can get from a trading
partner. Bilateral
Trade By JULIA KAGAN Updated December 21,
2020, Reviewed by TOBY WALTERS, Fact checked by ARIEL COURAGE https://www.investopedia.com/terms/b/bilateral-trade.asp What
are bilateral and
unilateral contracts? (youtube)
In class exercise Question 1: What characterizes a bilateral
contract? A) One promise from the offeror B) Two promises exchanged between parties C) Performance as acceptance Answer: B Explanation: In a
bilateral contract, there are at least two promises exchanged between the
parties. Question 2. What is typical of a unilateral
contract? A) Performance as acceptance B) Two promises exchanged C) Money exchange Answer: A Explanation: In a
unilateral contract, performance serves as acceptance of the offer. What Is Bilateral Trade? Bilateral
trade is the exchange of goods between two nations promoting trade and
investment. The two countries will
reduce or eliminate tariffs, import quotas, export restraints, and other
trade barriers to encourage trade and investment. In the United States, the Office of
Bilateral Trade Affairs minimizes trade deficits through negotiating free
trade agreements with new countries, supporting and improving existing trade
agreements, promoting economic development abroad, and other actions. KEY TAKEAWAYS ·
Bilateral trade
agreements are agreements between countries to promote trade and commerce. ·
They eliminate trade
barriers such as tariffs, import quotas, and export restraints in order to
encourage trade and investment. ·
The main advantage
of bilateral trade agreements is an expansion of the market for a country's
goods through concerted negotiation between two countries. ·
Bilateral trade agreements can also result in the closing
down of smaller companies unable to compete with large multinational
corporations. Understanding Bilateral Trade The goals of bilateral trade
agreements are to expand access between two countries’ markets and increase
their economic growth. Standardized business operations in five general areas
prevent one country from stealing another’s innovative products, dumping
goods at a small cost, or using unfair subsidies. Bilateral
trade agreements standardize regulations, labor standards, and environmental
protections. The
United States has signed bilateral trade agreements with 20 countries,
some of which include Israel, Jordan, Australia, Chile, Singapore, Bahrain,
Morocco, Oman, Peru, Panama, and Colombia. Advantages and Disadvantages of
Bilateral Trade Compared to multilateral trade
agreements, bilateral trade agreements
are negotiated more easily, because only two nations are party to the
agreement. Bilateral trade agreements initiate and reap trade benefits faster
than multilateral agreements. Examples of Bilateral Trade The European Union and the United States have the largest bilateral trade and
investment relationship and enjoy the most integrated economic relationship
in the world. Although overtaken by China in 2020 as the largest trading
partner specifically for goods, when services and investment are taken into
account, the US remains the EU’s largest trading partner by far. The transatlantic relationship is a
key artery of the world economy. Either the EU or the US is the largest trade
and investment partner of almost every other country in the global economy.
Taken together, the economies of both territories account for one third of
global trade in goods and services and close to one third of world GDP in
terms of purchasing power. Trade picture ·
Bilateral trade and
investment support millions of jobs in the EU and the US. Around 9.4 million
people are directly employed. Indirectly, as many as 16 million jobs on both
sides of the Atlantic are supported. ·
The EU-US trade and
investment relationship remains strong despite the economic challenges
related to the Covid-19 pandemic. ·
Transatlantic trade
reached an all-time high of 1.2 trillion euro in 2021, surpassing
pre-pandemic levels by more than 10%. ·
The United States
remains the EU’s number one trading partner in services. Bilateral trade in
services reached a record in 2021 and accounted for more than 500 billion
euro. ·
The size of trade in
services and goods between the EU and the US is matched by their mutual
investments, which are the biggest in the world and which are a substantial
driver of the transatlantic relationship. ·
Total US investment
in the EU is four times higher than in the Asia-Pacific region. EU foreign
direct investment in the US is around 10 times the amount of EU investment in
India and China together. ·
Total investment
includes foreign direct investment, where the EU and the US are each other’s
biggest sources. In 2020, the EU registered €2.1 trillion in outward stock,
and €2.3 trillion in inward stock. ·
The transatlantic
relationship is a key feature of the overall global economy and trade flows.
For most countries, either the EU or the US is the largest trade and
investment partner.
In class exercise Question 1:
What is bilateral trade? A) The exchange of goods
between two nations B) The exchange of goods
within a single nation C) The exchange of goods in
a multilateral setting Answer:
A Explanation:
Bilateral trade involves the exchange of goods between two nations. Question 2: What do
bilateral trade agreements aim to achieve? A) Increase trade barriers B) Standardize business
operations C) Encourage competition Answer:
B Explanation:
Bilateral trade agreements aim to standardize business operations and
eliminate trade barriers. Question 3: What is a key
advantage of bilateral trade agreements? A) Slower negotiation
process B) Faster initiation and
benefits C) Increased competition Answer:
B Explanation:
Bilateral trade agreements initiate and reap trade benefits more quickly
compared to multilateral agreements. Question 4: How do bilateral
trade agreements affect smaller companies? A) Promote their growth B) Have no impact C) May lead to closure due
to competition Answer:
C Explanation:
Bilateral trade agreements can result in the closing down of smaller companies
unable to compete with large multinational corporations. Question 5: Which areas do
bilateral trade agreements standardize? A) Regulatory standards,
labor standards, and environmental protections B) Marketing strategies and
pricing C) Technology and innovation Answer:
A Explanation:
Bilateral trade agreements standardize regulations, labor standards, and
environmental protections. Question 6: Which country
has signed bilateral trade agreements with 20 nations, including Israel and
Jordan? A) China B) United States C) European Union Answer:
B Explanation:
The United States has signed bilateral trade agreements with various
countries, including Israel and Jordan. Question 7: How do bilateral
trade and investment support jobs in the EU and the US? A) 9.4 million jobs directly
employed B) No significant impact on
employment C) Decrease in job
opportunities Answer:
A Explanation:
Bilateral trade and investment support around 9.4 million jobs directly
employed in the EU and the US. Question 8: What is a key
feature of the transatlantic relationship in terms of trade and investment
flows? A) Least influential in the
global economy B) Mutual investments being
the smallest in the world C) Either the EU or the US
is the largest trade and investment partner for most countries Answer:
C Explanation:
Either the EU or the US is the largest trade and investment partner for most
countries, making it a key feature of the transatlantic relationship. Homework chapter1-2 (due with first
midterm exam) 1)
What is bilateralism? What is Multilateralism? 2)
Do you advocate for bilateralism or multilateralism as being
more suitable for the U.S. economy? Why
Trade
agreement https://ustr.gov/trade-agreements/free-trade-agreements https://www.trade.gov/us-free-trade-agreement-partner-countries 3)
Watch Hear Trump hint at what to
expect in his second term (CNN). ·
What
are your thoughts on the proposed policies outlined in Trump's second-term agenda,
particularly focusing on trade, energy, regulation, education, and
environmental issues? ·
How
do you think these policies might impact the United States and its global
relations, and what aspects do you find most noteworthy or concerning? |
Rust Belt https://www.investopedia.com/terms/r/rust-belt.asp (FYI) By JAMES CHEN Updated Aug 25, 2020 What happened to the Rust
Belt? (youtube)
In class exercise Question 1: What term was coined in the 1980s to describe the former
industrial heartland of America? A) Steel Belt B) Rust Belt C)
Manufacturing Zone Answer: B Explanation: The term
"Rust Belt" came into use in the 1980s to describe the declining
industrial region. Question
2: What event largely attributed to the upset in the Rust Belt during the
2016 election? A)
Hillary Clinton's extensive campaigning B)
Donald Trump's refusal to visit the region C)
Hillary Clinton's reluctance to campaign in the Rust Belt Answer: C Explanation: The upset in
the Rust Belt during the 2016 election is largely attributed to Hillary Clinton's
refusal to campaign there. Question
3: What region was once referred to as the industrial heartland of America? A)
West Coast B)
Midwest C)
Northeast Answer: B Explanation: The Midwest was
once referred to as the industrial heartland of America. Question
4: What contributed to the decline of American manufacturing in the Midwest? A)
Labor costs and increased competition B)
Increased demand for American goods C)
Decreased foreign trade ties Answer: A Explanation: The decline in
the Midwest was fueled by labor costs and increased competition. Question
5: What fueled the post-war boom for the U.S.? A)
European economic decline B)
Increased domestic manufacturing C)
The Marshall Plan Answer: C Explanation: The Marshall Plan
fueled a post-war economic boom for the U.S. by aiding European
reconstruction. Question
6: Which region faced competition from East Asia during the Cold War? A)
South America B)
Middle East C)
Midwest Answer: C Explanation: The Midwest
faced competition from East Asia, including Japan, during the Cold War. Question
7: What technological advancement contributed to job loss in the Midwest? A)
Increased manual labor B)
Automation C)
Traditional manufacturing methods Answer: B Explanation: Increased use
of automation reduced the number of laborers in manufacturing. Question
8: What term describes the region challenged by Japan in the auto and
electronics industries? A)
Silicon Valley B)
Manufacturing Hub C)
Rust Belt Answer: C Explanation: Japan challenged
the Rust Belt in the auto and electronics industries. What
Is the Rust Belt? The Rust Belt is a colloquial term used to
describe the geographic region stretching from New York through the Midwest
that was once dominated by the coal industry, steel production,
and manufacturing. The Rust Belt became an industrial hub due to its proximity to
the Great Lakes, canals, and rivers, which allowed companies to
access raw materials and ship out finished products. The region received the name Rust Belt in the
late 1970s, after a sharp decline in industrial work left many
factories abandoned and desolate, causing increased rust from exposure to the
elements. It is also referred to as the Manufacturing Belt and the
Factory Belt. KEY TAKEAWAYS
Understanding
the Rust Belt The term Rust Belt is often used in a derogatory sense to
describe parts of the country that have seen an economic decline—typically
very drastic. The rust belt region
represents the deindustrialization of an area, which is often
accompanied by fewer high-paying jobs and high poverty rates. The result
has been a change in the urban landscape as the local population has moved to
other areas of the country in search of work. Although there is no definitive boundary, the states that are
considered in the Rust Belt–at least partly–include the following:
There are other states in the U.S. that have also experienced
declines in manufacturing, such as states in the deep south, but they are not
usually considered part of the Rust Belt. The region was home to some of
America's most prominent industries, such as steel production
and automobile manufacturing. Once recognized as the industrial
heartland, the region has experienced a sharp downturn in industrial activity
from the increased cost of domestic labor, competition from overseas,
technology advancements replacing workers, and the capital
intensive nature of manufacturing. Poverty in the Rust Belt Blue-collar jobs have increasingly moved
overseas, forcing local governments to rethink the type of manufacturing
businesses that can succeed in the area. While some cities managed to adopt new technologies, others
still struggle with rising poverty levels and declining populations. Below are the poverty rates from the U.S. Census
Bureau as of 2018 for each of the Rust Belt states listed above. Poverty Rates in the Rust Belt. There are other U.S. states that have high poverty rates, such
as Kentucky (16.9%), Louisiana (18.6%), and Alabama (16.8%). However, the
rust belt states have–at a minimum–a double-digit percentage of their
population in poverty. History
of the Rust Belt Before being known as the Rust Belt, the area was generally
known as the country's Factory, Steel, or Manufacturing Belt. This area, once
a booming hub of economic activity, represented a great portion of U.S.
industrial growth and development. The natural resources that were found in the area led to its
prosperity—namely coal and iron ore—along with labor and ready access to transport
by available waterways. This led to the rise in coal and steel plants, which
later spawned the weapons, automotive, and auto parts industries. People
seeking employment began moving to the area, which was dominated by both the
coal and steel industries, changing the overall landscape of the region. But that began to change between the 1950s and 1970s. Many
manufacturers were still using expensive and outdated equipment and
machinery and were saddled with the high costs of domestic labor and materials.
To compensate, a good portion of them began looking elsewhere for cheaper
steel and labor—namely from foreign sources—which would ultimately lead to
the collapse of the region. There is no definitive boundary for the Rust
Belt, but it generally includes the area from New York through the Midwest. Decline
of the Rust Belt Most research suggests the Rust Belt started to falter in the
late 1970s, but the decline may have started earlier, notably in the 1950s,
when the region's dominant industries faced minimal competition.
Powerful labor unions in the automotive and steel manufacturing
sectors ensured labor competition stayed to a minimum. As a result, many of
the established companies had very little incentive to innovate or expand
productivity. This came back to haunt the region when the United States
opened trade overseas and shifted manufacturing production to the south. By the 1980s, the Rust Belt faced competitive
pressure—domestically and overseas—and had to ratchet down wages and prices. Operating in
a monopolistic fashion for an extended period of time played an
instrumental role in the downfall of the Rust Belt. This shows that
competitive pressure in productivity and labor markets are important to
incentivize firms to innovate. However, when those incentives are weak,
it can drive resources to more prosperous regions of the country. The region's population also showed a rapid
decline. What was once a hub
for immigrants from the rest of the country and abroad, led to an exodus of
people out of the area. Thousands of
well-paying blue-collar jobs were eliminated, forcing people to move away in
search of employment and better living conditions. Politics
and the Rust Belt The term Rust Belt is generally attributed to Walter Mondale, who
referred to this part of the country when he was the Democratic presidential
candidate in 1984. Attacking President Ronald Reagan, Mondale claimed his
opponent's policies were ruining what he called the Rust Bowl. He was
misquoted by the media as saying the rust belt, and the term stuck. Since
then, the term has consistently been used to describe the area's economic
decline. From a policy perspective, addressing the specific needs of the
Rust Belt states was a political imperative for both parties during the 2016
election. Many believe the national
government can find a solution to help this failing region succeed again. Trump's second-term agenda: revenge, trade
wars, mass deportations Reuters December 27, 202311:22 AM EST Updated 19 days
ago WASHINGTON, Dec 27 (Reuters) - Republican Donald Trump is planning to
punish his political enemies, deport millions of migrants and reshape global
trade with pricey tariffs if he wins a second White House term in the
November 2024 presidential election, according to his campaign and media
reports. Here is a look at some of the policies Trump
has pledged to institute: TRADE Trump has floated the idea of a 10% tariff on all goods imported
into the United States, a move he says would eliminate the trade
deficit but one critics say would lead to higher prices for American
consumers and global economic instability. He has also said he should have the authority to set higher
tariffs on countries that have established tariffs on American imports. Trump, in particular, has targeted China. He proposes phasing out
Chinese imports of goods such as electronics, steel and pharmaceuticals over
four years. He seeks to prohibit Chinese companies from owning U.S.
infrastructure in the energy and tech sectors. FEDERAL BUREAUCRACY Trump would seek to decimate what he terms the “deep state” –
career federal employees he says are clandestinely pursuing their own agendas
– through an executive order that would reclassify thousands of workers to
enable them to be fired. That would likely be challenged in court. He has vowed to fire what he terms
"corrupt" actors in national security positions and "root
out" his political opponents. Trump would require every federal employee to
pass a new civil service test of his own creation. His team is also vetting scores
of potential hires who could be counted on to implement his policies or
perhaps investigate Trump’s political enemies. He would crack down on federal whistleblowers who are typically
shielded by law and would institute an independent body to "monitor"
U.S. intelligence agencies. Trump also would seek to bring independent regulatory agencies
such as the Federal Communications Commission and the Federal Trade
Commission under presidential control. ENERGY Trump has vowed to increase U.S. production of fossil fuels by
easing the permitting process for drilling on federal land and would
encourage new natural gas pipelines. He has said he will pull the United States out of the Paris
Climate Accords, a framework for reducing global greenhouse gas emissions and
would support increased nuclear energy production. He would also roll back
the Biden White House’s electric-vehicle mandates and other policies aimed at
reducing auto emissions. ECONOMY Along with his trade and energy agendas, Trump has promised to
slash federal regulations he argues limit job creation. He and his economic
team have discussed a further round of individual and corporate tax cuts
beyond those enacted in his first term. He said as president he would
pressure the Federal Reserve to lower interest rates. Trump is proposing the government establish
so-called "freedom cities" on federal land that he says would spur
job growth and technological innovation. IMMIGRATION Trump has vowed to reinstate first-term
policies targeting illegal border crossings, roll back Biden's pro-immigrant
measures and forge ahead with sweeping new restrictions. Trump has pledged to limit access to asylum at
the U.S.-Mexico border and embark on the biggest deportation effort in
American history, which would likely trigger legal challenges and opposition
from Democrats in Congress. Trump has said he would seek to end automatic
citizenship for children born to immigrants, a move that would run against
the long-running interpretation of the U.S. Constitution. ABORTION Trump appointed three justices to the U.S.
Supreme Court who were part of the majority that did away with constitutional
protection for abortion. He likely would continue to appoint federal judges
who would uphold abortion limits. At the same time, he has said a federal
abortion ban is unnecessary, and that the issue should be resolved on a
state-by-state basis. He has argued a six-week ban favored by some Republicans
is overly harsh and that any legislation should include exceptions for rape,
incest and the health of the mother. FOREIGN AFFAIRS Trump has been critical of the U.S.'s support for Ukraine in its
war with Russia and has said he could end the war in 24 hours if elected. He has argued that Europe should reimburse the U.S. for
ammunition used in the conflict. Trump
has also said that under his presidency, America would fundamentally rethink
"NATO's purpose and NATO's mission." He has supported Israel in its fight against Hamas despite
initially criticizing its leaders after the October attacks. On the campaign trail,
he has also floated sending armed forces into Mexico to battle drug cartels
and slapping expansive tariffs on friends and foes alike. EDUCATION Trump has pledged to require America’s colleges and universities to “defend American
tradition and Western civilization” and purge them of diversity programs.
He said he would direct the Justice Department to pursue civil rights cases
against schools that engage in racial discrimination. On the K-12 level, Trump would support programs allowing parents
to use public funds for private or religious instruction. CRIME Trump has pledged to appoint U.S. attorneys
who would launch probes into liberal prosecutors and district attorneys he
says are failing to contain crime in America's cities. He has said he would institute the death
penalty for human traffickers and drug dealers. He also has suggested that
looters of retail stores could be "shot" while on site. HOMELESSNESS Trump has vowed to ban so-called “urban camps”
from America’s cities and require homeless people to accept drug treatment or
face arrest. He said he would then "open large parcels
of inexpensive land" where tent cities would be relocated and staffed
with doctors, drug counselors and mental health experts. Reporting by James Oliphant; Additional
reporting by Ted Hesson; Editing by Ross Colvin and Jonathan Oatis In class exercise Question 1. Trade Policies - What is the proposed tariff
percentage on all goods imported into the United States? A) 5% B) 10% C) 15% Answer:
B Explanation: Trump suggests a 10% tariff to eliminate
the trade deficit. Question 2. Federal Bureaucracy - What executive order does Trump
plan to use to target career federal employees? A) Executive Order on National Security B) Executive Order on Tariffs C) Executive Order on Civil Service Answer:
C Explanation: Trump aims to reclassify workers to enable
their dismissal. Question 3. Energy Policies - What does Trump propose to do
with U.S. participation in the Paris Climate Accords? A) Increase commitment B) Maintain current commitment C) Withdraw Answer:
C Explanation: Trump plans to pull the U.S. out of the
Paris Climate Accords. Question 4. Economic Measures - In addition to tax cuts, what
does Trump propose to pressure the Federal Reserve to do? A) Raise interest rates B) Maintain interest rates C) Lower interest rates Answer:
C Explanation: Trump wants the Federal Reserve to lower
interest rates. Question 5. Foreign Affairs - How does Trump view the U.S.'s
support for Ukraine in its war with Russia? A) Supportive B) Critical C) Neutral Answer:
B Explanation: Trump has been critical of U.S. support for
Ukraine. Question 6. Education Policies - What does Trump want colleges
and universities to defend and purge? A) American tradition and Western civilization B) Cultural diversity C) Scientific innovation Answer:
A Explanation: Trump aims to defend these values and purge
diversity programs. Question 7. Trade with China - Which of the following goods
does Trump propose to phase out in Chinese imports over four years? A) Textiles B) Electronics, steel, and pharmaceuticals C) Agricultural products Answer:
B Explanation: Trump aims to phase out these specific
Chinese imports. Question 8. Regulatory Agencies - Which agencies does Trump
aim to bring under presidential control? A) Environmental Protection Agency (EPA) B) Federal Communications Commission (FCC) and Federal Trade
Commission (FTC) C) Department of Education Answer:
B Explanation: Trump wants these independent regulatory
agencies under presidential control.
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Chapter 2 Let’s watch this video together. Imports, Exports, and Exchange Rates: Crash Course
Economics #15 (youtube) In class exercise 1.
Who is the world's largest importer? A. China B. Canada C. United States Answer: C. 2.
Which country is the largest trading
partner of the United States? A. China B. Mexico C. Canada Answer: C. Explanation: Despite the common perception of China, the episode reveals that Canada is the largest trading partner of the United States. 3.
What is the annual difference between a
country's exports and imports called? A. Net exports B. Trade surplus C. Trade deficit Answer: A. Explanation: Net exports represent the annual difference between a country's exports and imports. 4.
What is the role of exchange rates in
international trade? A. Influencing trade balances B. Determining political stability C. Regulating labor costs Answer: A. Explanation: Exchange rates impact the affordability of imports and exports, influencing trade balances. 5.
Which organization is mentioned as working
to eradicate protectionism in international trade? A. United Nations B. World Trade Organization (WTO) C. International Monetary Fund (IMF) Answer: B. Explanation: The WTO is mentioned as an organization working to eradicate protectionism in international trade. 6.
What is the main purpose of the financial
account in the balance of payments? A. Recording the sale and purchase of goods B. Tracking financial assets' transactions C. Documenting foreign aid and donations Answer: B. Explanation: The financial account records transactions related to financial assets, such as stocks and bonds. 7.
Why did some critics argue against NAFTA
(North American Free Trade Agreement)? A. It increased trade deficits B. It created manufacturing jobs C. It favored rich countries Answer: A. Explanation: Critics argued that NAFTA significantly increased US trade deficits. 8.
Why do some countries choose to peg their
currency to another currency? A. To increase exchange rates B. To maintain stability in exchange rates C. To encourage imports Answer: B. Explanation: Some countries peg their currency to another to keep the exchange rate in a certain range and maintain stability. 9.
What does the episode emphasize as the
overall impact of international trade on the global standard of living? A. It has no impact on the global standard of living B. It always improves the global standard of living C. It improves the global standard of living, despite individual challenges Answer: C. Explanation: The episode concludes that, in the aggregate, international trade improves the global standard of living, even though there may be individual challenges. 10. What does the episode suggest
about protectionist policies like high tariffs on imports? A. They always benefit the economy B. They have no impact on the economy C. They usually hurt the economy Answer: C. Explanation: Protectionist policies, like high tariffs, are mentioned as usually hurting the economy more than helping.
Topic 1- What is BOP? The balance of payment of a country contains two
accounts: current and capital. The current account records exports and imports of goods and services
as well as unilateral transfers, whereas the capital account records purchase and sale transactions of foreign
assets and liabilities during a particular year. Summary: Current Account: ·
Definition: The
current account represents the country's transactions in goods, services,
income, and current transfers with the rest of the world. ·
Components: A. Trade Balance: The difference between exports and imports
of goods. B. Services: Transactions related to services (e.g.,
tourism, transportation). C. Income: Receipts and payments of interest, dividends, and
wages. D. Current Transfers: Gifts, aids, and remittances. Capital Account: ·
Definition: The
capital account tracks capital transfers and the acquisition or disposal of
non-financial assets. Now includes financial account. ·
Components: A. Capital Transfers: Non-financial transfers (e.g., debt
forgiveness) and financial transfers. B. Acquisition/Disposal of Non-Financial Assets: Sale or
purchase of non-financial assets, such as patents, goodwill, copy rights,
etc, and financial assets, such as FDI, changes in reserves, portfolio
investment, and financial derivative. Balance of Payments (BoP): ·
Definition: The BoP
is a comprehensive record of a country's economic transactions with the rest
of the world over a specific period. ·
Equation: BoP = Current Account + Capital Account ·
Significance: It
indicates whether a country has a surplus or deficit in its transactions with
the rest of the world. Summary: ·
Current Account: Records
day-to-day transactions, including trade, services, income, and transfers. ·
Capital Account:
Deals with transfers of non-financial and financial assets and capital
transfers. ·
Balance of Payments:
The overall record combining the Current and Capital Accounts, reflecting a
country's economic relationship with the world. Part I
- What is the current account? From
khan academy:
Current vs. Capital Accounts: What's the
Difference? By
THE INVESTOPEDIA TEAM, Updated June
29, 2021, Reviewed by ROBERT C. KELLY Current
vs. Capital Accounts: An Overview The
current and capital accounts represent two halves of a nation's balance of
payments. The current account
represents a country's net income over a period of time, while the capital
account records the net change of assets and liabilities during a particular
year. In
economic terms, the current account deals with the receipt and payment in
cash as well as non-capital items, while the capital account reflects sources
and utilization of capital. The sum of
the current account and capital account reflected in the balance of payments
will always be zero. Any surplus or deficit in the current account is matched
and canceled out by an equal surplus or deficit in the capital account. KEY
TAKEAWAYS ·
The current and
capital accounts are two components of a nation's balance of payments. ·
The current account
is the difference between a country's savings and investments. ·
A country's capital
account records the net change of assets and liabilities during a certain
period of time. Current Account The
current account deals with a country's short-term transactions or the
difference between its savings and investments. These are also referred to as
actual transactions (as they have a real impact on income), output and
employment levels through the movement of goods and services in the economy. The current account consists of visible trade
(export and import of goods), invisible trade (export and import of services),
unilateral transfers, and investment income (income from factors such as land
or foreign shares). The credit and debit of foreign exchange from these
transactions are also recorded in the balance of the current account. The
resulting balance of the current account is approximated as the sum total of
the balance of trade. Current Account vs. Capital Account Transactions
are recorded in the current account in the following ways: Exports are noted as credits in the balance
of payments Imports are recorded as debits in the
balance of payments The
current account gives economists and other analysts an idea of how the
country is faring economically. The
difference between exports and imports, or the trade balance, will determine
whether a country's current balance is positive or negative. When it is
positive, the current account has a surplus, making the country a "net
lender" to the rest of the world. A deficit means the current account
balance is negative. In this case, that country is considered a net borrower. If imports
decline and exports increase to stronger economies during a recession, the
country's current account deficit drops. But if exports stagnate as imports
grow when the economy grows, the current account deficit grows. Capital Account The capital account is a record of the
inflows and outflows of capital that directly affect a nation’s foreign
assets and liabilities. It is concerned
with all international trade transactions between citizens of one country and
those in other countries. The
components of the capital account include foreign investment and loans,
banking, and other forms of capital, as well as monetary movements or changes
in the foreign exchange reserve. The capital account flow reflects factors
such as commercial borrowings, banking, investments, loans, and capital. A surplus in the capital account means
there is an inflow of money into the country, while a deficit indicates money
moving out of the country. In this case,
the country may be increasing its foreign holdings. In
other words, the capital account is concerned with payments of debts and
claims, regardless of the time period. The balance of the capital account
also includes all items reflecting changes in stocks. The
International Monetary Fund divides capital account into two categories: The
financial account and the capital account. The term capital account is also used in accounting. It
is a general ledger account used to record the contributed capital of
corporate owners as well as their retained earnings. These balances are
reported in a balance sheet's shareholder's equity section. Balance of payments: Current account
(video, Khan academy) In class
exercise 1. What is the focus of the current account in the balance
of payments? A)
Imports and exports B)
Changes in ownership
of assets C) Net
transfers Answer: A Explanation: The current account focuses on
trade, including imports and exports. 2.
What is the result if the current account
calculation shows a positive number? A) Current
account surplus B) Trade
deficit C) Net
transfers deficit Answer: A Explanation: A positive current account indicates
a surplus. 3.
What is the primary reason for the U.S.
running a current account deficit in this scenario? A) High net
transfers B) Excessive
exports C) Trade
deficit and income payments to foreign-owned assets Answer: C Explanation: The U.S. runs a deficit due to
a trade deficit and payments on foreign-owned assets. 4.
Which factor indicates an outflow of
currency from the U.S.? A) Exports B) Income on
U.S. assets abroad C) Net
transfers deficit Answer: C Explanation: Net transfers deficit represents an
outflow of currency. 5.
What is the primary focus of the current
account in a nation's balance of payments? A) Changes in
foreign assets and liabilities B) Net change
of assets and liabilities C) Net income
over a period of time Answer: C Explanation: The current account represents
a country's net income over a period of time. 6.
How is the balance of the current account
and capital account related in the balance of payments? A) They are
independent and unrelated B) Their sum
is always zero C) Capital account
surplus cancels out current account deficit Answer: B Explanation: The sum of the current account
and capital account in the balance of payments is always zero. 7.
What are components of the current account? A) Visible
trade, invisible trade, unilateral transfers, and investment income B) Foreign
investments and loans C) Monetary
movements and changes in foreign exchange reserves Answer: A Explanation: Components of the current
account include visible trade, invisible trade, unilateral transfers, and investment
income. 8.
How are exports and imports recorded in the
balance of payments under the current account? A) Both are
recorded as debits B) Exports are
credits, and imports are debits C) Both are
recorded as credits Answer: B Explanation: Exports are noted as credits,
and imports are recorded as debits in the balance of payments. 9.
What does a positive trade balance in the
current account indicate? A) Current
account deficit B) Net
borrower status C) Current
account surplus Answer: C Explanation: A positive trade balance
indicates a current account surplus. 10.
What does a surplus in the capital account
represent? A) Inflow of
money into the country B) Net
borrower status C) Outflow of
money from the country Answer: A Explanation: A surplus in the capital
account indicates an inflow of money into the country. 11.
What does a deficit in the capital account
signify? A) Inflow of
money into the country B) Outflow of
money from the country C) Balanced
capital account Answer: B Explanation: A deficit in the capital
account signifies an outflow of money from the country. 12.
How does the capital account differ from
the current account in terms of the time period considered? A) Capital
account focuses on short-term transactions B) Both
accounts consider the same time period C) Capital
account is concerned with long-term changes Answer: C Explanation: The capital account is
concerned with long-term changes in assets and liabilities. 13. What
components does the capital account include? A) Foreign investments
and loans B) Changes in
stocks C) Monetary
movements and changes in reserves Answer: A Explanation: Components of the capital
account include foreign investments and loans. 14. How is the
balance of the capital account related to surplus and deficit? A) Surplus
indicates a deficit in the capital account B) Surplus
indicates an inflow of money into the country C) Deficit
indicates a current account surplus Answer: B Explanation: Surplus indicates an inflow of
money into the country. 15. How are deficits
and surpluses balanced in the balance of payments? A) Surplus in
the current account balances deficit in the capital account B) Equal
surpluses in both accounts C) Equal
deficits in both accounts Answer: A Explanation: Surplus in the current account
balances deficit in the capital account. 16. What does
a current account deficit imply about a country's economic status? A) Net lender
status B) Economic
recession C) Net
borrower status Answer: C Explanation: A current account deficit
implies that the country is a net borrower. 17. What is
the relationship between the balance of trade and the current account? A) They are
independent B) Balance of
trade is a subset of the current account C) Current
account is a subset of the balance of trade Answer: B Explanation: The resulting balance of the
current account is approximated as the sum total of the balance of trade. 18. How are
income receipts from factors like land or foreign shares accounted for in the
current account? A) As credits B) As debits C) As net
transfers Answer: A Explanation: Income receipts from factors
like land or foreign shares are accounted for as credits in the current
account. 19. What determines
whether a country is a net lender or net borrower based on the current
account? A) Net income
over a short period B) Difference
between exports and imports C) Balance of
trade Answer: B Explanation: The difference between exports
and imports determines whether a country is a net lender or net borrower
based on the current account. 20. How is a
deficit in the current account balanced in the balance of payments? A) With a
surplus in the capital account B) By
increasing net transfers C) By
increasing exports Answer: A Explanation: A deficit in the current
account is matched and canceled out by a surplus in the capital account. 21. What does
a capital account deficit indicate? A) Inflow of
money into the country B) Outflow of
money from the country C) Balanced
capital account Answer: B Explanation: A capital account deficit
indicates an outflow of money from the country. https://www.bea.gov/data/intl-trade-investment/international-transactions
The U.S.
current-account deficit narrowed by
$16.5 billion, or 7.6 percent, to $200.3 billion in the third quarter of 2023,
according to statistics released today by the U.S. Bureau of Economic
Analysis. The revised second-quarter deficit was $216.8 billion. The
third-quarter deficit was 2.9 percent of current-dollar gross domestic
product, down from 3.2 percent in the second quarter. https://www.bea.gov/sites/default/files/2023-12/trans323.pdf
•
·
Exports of goods increased $19.1 billion to $516.4 billion,
and imports of goods increased $4.6 billion to $777.4 billion. The increases
in both exports and imports reflected increases in most major categories. The
increase in exports was led by industrial supplies and materials, primarily
petroleum and products. The increase in imports was led by automotive vehicles,
parts, and engines, primarily passenger cars and other parts and accessories.
Partly offsetting this increase was a decrease in imports of nonmonetary
gold. Trade in
services ·
Exports of services increased $2.7 billion to $252.2 billion, reflecting
an increase in travel, mainly other personal travel, that was partly offset
by a decrease in technical, trade-related, and other business services, a
subcategory of the broader other business services category as presented in
table 3. Imports of services decreased $1.9 billion to $176.0 billion,
reflecting a decrease in transport, mostly sea freight transport. Primary
income ·
Receipts of primary income increased $11.8 billion to $362.1 billion,
and payments of primary income increased $14.0 billion to $332.1 billion. The
increases in both receipts and payments reflected increases in most major
categories. The increase in receipts was led by direct investment income,
mainly earnings. The increase in payments was led by other investment income,
mostly interest on loans and deposits. Secondary
income Receipts of
secondary income decreased $0.7 billion to $45.1 billion, reflecting a
decrease in general government transfers, mostly fines and penalties.
Payments of secondary income decreased $0.3 billion to $90.7 billion,
reflecting a decrease in general government transfers, mainly international
cooperation, that was mostly offset by an increase in private transfers, led
by fines and penalties. Capital-Account
Transactions ·
Capital-transfer receipts increased $10 million to $18
million. Capital-transfer payments decreased $0.6 billion to $2.1 billion,
reflecting a decrease in infrastructure grants. Financial-Account
Transactions ·
Net financial-account transactions were −$138.6 billion
in the third quarter, reflecting net U.S. borrowing from foreign residents. https://www.bea.gov/news/2023/us-international-transactions-3rd-quarter-2023 In class exercise 1. What is the U.S. current-account deficit
in the third quarter of 2023? A) $183.8
billion B) $200.3 billion C) $216.8 billion Answer:
B Explanation: The U.S. current-account deficit in the third quarter of
2023 is $200.3 billion, as stated in the provided information. 2. How did the third-quarter current-account deficit
change compared to the revised second-quarter deficit? A) Decreased by $16.5 billion B) Increased by $16.5 billion C) Remained unchanged Answer:
A Explanation: The third-quarter current-account deficit decreased by
$16.5 billion compared to the revised second-quarter deficit, indicating an
improvement. 3. Which category led the increase in exports of goods in
the third quarter? A) Automotive vehicles B) Nonmonetary gold C) Industrial supplies and materials Answer:
C Explanation: The increase in exports of goods was led by industrial
supplies and materials, primarily petroleum and products. 4. What contributed to the increase in imports of goods in
the third quarter? A) Passenger cars, parts and accessories B) Nonmonetary gold C) Industrial
supplies and materials Answer:
A Explanation: The increase in imports of goods was led by automotive
vehicles, parts, and engines, primarily passenger cars and other parts and
accessories. Part II - What
is the Capital Account
Balance of payments: Capital account (video,
Khan Academy) In class
exercise Question
1: In the context of the capital account, what is the focus of the change in
assets? A)
Changes in foreign
reserves B) Changes in
official government ownership C) Changes in
privately owned assets Answer: C Explanation: The capital account focuses on
changes in privately owned assets. Question 2: If
a foreign individual buys a house in the U.S., how is it classified in the
capital account? A) Inflow B) Outflow C) Statistical
discrepancy Answer: A Explanation: It is considered an inflow as
the foreign national is buying a U.S. asset. Question 3: In
the capital account, what does the U.S. Federal Reserve primarily deal with? A) Privately
owned assets B) Changes in
foreign reserves C) Official
government ownership changes Answer: C Explanation: The U.S. Federal Reserve deals
with official government ownership changes. Question 4:
How is the purchase of a vacation home in Italy by a U.S. national classified
in the capital account? A) Inflow B) Outflow C) Private sector
transaction Answer: B Explanation: It is considered an outflow as
the U.S. national is making a payment to a foreign individual. Question 5:
According to the video, what should be true if a country is running a current
account deficit? A) Capital account
surplus B) Capital
account deficit C) No impact
on the capital account Answer: A Explanation: If there's a current account
deficit, there should be a corresponding capital account surplus. https://fred.stlouisfed.org/tags/series?t=capital+account NOTES
Source: U.S. Bureau of Economic Analysis Release: U.S.
International Transactions Units: Frequency: Calculated by subtracting the
capital transfer payments and other debits from the capital transfer receipts
and other credits Suggested
Citation:
U.S. Bureau of Economic Analysis, Balance
on capital account [IEABCPA], retrieved from FRED, Federal Reserve Bank of
St. Louis; https://fred.stlouisfed.org/series/IEABCPA, January 21, 2024. Top Trading Partners - November 2022 https://www.census.gov/foreign-trade/statistics/highlights/toppartners.html Year-to-Date
Total Trade (Jan 2023 – Nov 2023)
In class exercise 1. Which country is the largest exporter
among the top 15 countries listed? A) Canada B) Mexico C) China Answer: B 2. What is the total trade volume for the top 15
countries as a percentage of the total global trade? A) 11.3% B) 15.2% C) 74.7% Answer: C Explanation: The total trade for the top 15 countries
constitutes 74.7% of the global total trade. 3. Which two countries have a total trade volume that,
when combined, contributes the most to the top 15 countries' total trade? A) China and Mexico B) Canada and China C) Mexico and Japan Answer: B Explanation: The combined total trade of Canada and China
contributes significantly to the top 15 countries' total trade. 4. Which country has the highest import value among the
top 15 countries? A) China B) Canada C) Mexico Answer: C Explanation: Mexico has the highest import value among the
listed countries. 5. Which country has the highest export-to-import ratio
among the top 15 countries? A) Vietnam B) Germany C) Vietnum Answer: A Explanation: Vietnam has the highest export-to-import ratio
among the listed countries, indicating a strong export-oriented economy. 6. Which country has the highest total trade volume among the top 15
countries? A) China B) Mexico C) Canada Answer: A Explanation: Canada has the highest total trade volume among the
listed countries. Topic 2: Trade war with China to
reduce trade deficit (current account deficit) For Class Discussion: Has the US won the trade war against China?
Can trade war help reduce the US current account deficit? America v China: why the trade war won't end soon | The Economist (youtube)
2022
: U.S. trade in goods with China
NOTE:
All figures are in millions of U.S. dollars on a nominal basis. https://www.census.gov/foreign-trade/balance/c5700.html
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|
Month |
Exports |
Imports |
Balance |
|
January 2023 |
13,092.6 |
38,252.9 |
-25,160.3 |
|
February 2023 |
11,618.6 |
30,620.6 |
-19,002.0 |
|
March 2023 |
14,181.1 |
30,789.7 |
-16,608.6 |
|
April 2023 |
12,794.4 |
33,077.3 |
-20,283.0 |
|
May 2023 |
10,679.2 |
35,890.6 |
-25,211.5 |
|
June 2023 |
10,223.1 |
34,334.1 |
-24,111.1 |
|
July 2023 |
10,659.5 |
36,099.5 |
-25,440.0 |
|
August 2023 |
10,765.3 |
36,724.7 |
-25,959.4 |
|
September 2023 |
11,834.6 |
40,282.0 |
-28,447.4 |
|
October 2023 |
16,046.5 |
41,570.7 |
-25,524.2 |
|
November 2023 |
13,903.9 |
35,494.9 |
-21,591.1 |
|
TOTAL 2023 |
135,798.7 |
393,137.1 |
-257,338.4 |
Chapter
2 part 1 (Due with the first mid term exam)
1. From the classroom discourse and accessible online documents, do you believe that engaging in a trade war against China has the potential to assist the United States in diminishing its trade deficit (or current account deficit) and mitigating inflation? Kindly provide specific details.
2.
As per the article "US tariffs on Chinese imports might increase
in 2024, analysts say" [source: https://www.scmp.com/news/china/diplomacy/article/3248691/us-tariffs-chinese-imports-might-increase-2024-analysts-say],
what potential ramifications could arise from an escalation in US tariffs on
Chinese products? Explore the potential consequences for consumers and stock
market investors.
3. Internet
exercises (not required,
information for intereted students only)
a. IMF,
world bank and UN are only a few of the major organizations that
track, report and aid international economic and financial
development. Based on information provided in those websites, you could learn
about a country’s economic outlook.
· IMF: www.imf.org/external/index.htm
· UN: www.un.org/databases/index.htm
· World bank: www.worldbank.org’
· Bank of international settlement: www.bis.org/index.htm
b. St. Louis
Federal Reserve provides a large amount of recent open economy macroeconomic
data online. You can track down BOP and GDP data for the major industrial
countries.
· Recent international economic data: https://research.stlouisfed.org/publications/
· Balance of Payments statistics: https://fred.stlouisfed.org/categories/125
Balance
of payments: Current account (video, Khan academy) (FYI)
Balance of payments:
Capital account (video, Khan Academy) (FYI)
Reference
of useful websites for global economy
International Trade
Statistics (PDF)
Current
Account (BOP) Data – World Bank
http://data.worldbank.org/indicator/BN.CAB.XOKA.CD
IMF,
world bank and UN are only a few of the major organizations that
track, report and aid international economic and
financial development. Using these website, you can summarize the
economic outlook for each country.
IMF: www.imf.org/external/index.htm
UN: www.un.org/databases/index.htm
World
bank: www.worldbank.org
Bank
of international settlement: www.bis.org/index.htm
St.
Louis Federal Reserve provides a large amount of recent open economy
macroeconomic data online. You can track down BOP and GDP data for the major
industrial countries.
Recent international
economic data: research.stlouisfed.org/publicaitons/ie
Topic 2: Trade war with China to
reduce trade deficit (current account deficit)
For Class Discussion:
Has the US won the trade war against
China? Can trade war help reduce the US current account deficit?
America v China: why the trade war won't end soon | The Economist (youtube)
As Biden and Xi meet, Asian manufacturing slowdown returns to a 2020
low, led by a softer China (video https://www.cnbc.com/2023/11/15/asia-manufacturing-slowdown-returns-to-2020-low-led-by-softer-china.html)
PUBLISHED WED, NOV 15 20236:52 AM ESTUPDATED
WED, NOV 15 20237:54 AM EST
KEY POINTS
· Asia’s suppliers are
seeing the largest rise in idle capacity since June 2020 as the region’s economy weakens, according to GEP’s
Global Supply Chain Volatility Index.
· Idle Chinese manufacturing is a result of
sluggish demand, including from the U.S.
· Trade war tariffs are still impacting both U.S.
and Chinese goods and the latest data comes as President Biden meets with
Chinese President Xi Jinping in San Francisco.
As President Biden meets with Chinese President
Xi Jinping in San Francisco, the Asian manufacturing sector is experiencing a
slowdown not seen since the 2020 peak of the Covid pandemic.
According to GEP’s Global Supply Chain Volatility Index,
Asia’s suppliers are seeing the largest rise in idle capacity since June 2020 as the
region’s economy remains soft, and amid sluggish
demand from the U.S. market where consumers are pulling back on
spending.
The GEP Global Supply Chain Volatility Index, produced by S&P Global
and GEP, tracks supply chain orders which show rising spare supplier capacity as a
result of a pullback in global demand. Transportation costs were also a
factor.
Some recent data coming out of China has shown
economic improvement, from third quarter GDP to retail sales, and the
International Monetary Fund recently raised its outlook for the economy based
on new support measures from the government amid real estate sector debt
issues and high youth unemployment. But trade, which is a forward-looking
indicator of a country’s economic health, is fueled
by manufacturing. The GEP index shows a depressed level of demand for raw
materials, components, and commodities since manufacturing orders are down.
The data is in line with other recent checks on
manufacturing orders for the remainder of 2023 and 2024, including the CNBC
Supply Chain Survey, in which logistics companies warned of a continuing
freight recession until at least the middle of 2024.
According to GEP, conditions remain negative
and global purchasing activity fell again in October, at a pace similar to
what was recorded mid-year. An increase in supplier spare capacity can also
be seen rising modestly in North America.
U.S.-China talk on trade and tariffs
John Piatek, vice president of supply chain
consulting at GEP, said trade tensions between the U.S. and China will
further impair demand and create lose-lose scenarios.
“Business leaders are watching to see if the
two leaders signal smoother times ahead,” Piatek said
of the Biden-Xi meeting planned for Wednesday. “A
positive meeting would go a long way to pausing or slowing some of the
growing re-shoring trends. A negative meeting would signal that firms may
need to act faster to get in front of an evolving and changing U.S.-China
relationship by adjusting their supply chain strategies.”
Piatek said among other issues to be covered by
the world leaders, the U.S. and China are expected to focus on kickstarting
demand by removal of trade barriers and sanctions, and lowering the cost of
doing business with each other.
Tariffs on select Chinese goods were imposed in
three stages between 2018 and 2022. China retaliated quickly in 2018 with
both sides sharply increasing tariffs. The initial round saw average U.S.
tariffs increase from 3.8 percent to 12 percent, and China’s
average tariffs increased from 7.2 percent to 18.3 percent.
Presently, 66.4% of U.S. imports from China are under tariff. The
average U.S. tariff on Chinese exports is set at 19.3%. That is more than six times higher than before
the trade war began. Chinese tariffs cover 58.3% of U.S. exports at an
average of 21.1 percent.
“As much
as business leaders talk about re-shoring, the reality is that China is a
huge, reliable, and cost-effective partner,”
Piatek sad. “Business leaders want to see a positive
meeting between Biden and Xi as this partnership is a safer bet than ripping
out manufacturing assets and moving supply chains to riskier parts of the
world.”
Jon Gold, vice president, supply chain and
customs policy at the National Retail Federation, said the ongoing trade
dispute continues to have an impact on retailers of all sizes. The NRF
continues to call on the Biden Administration to restart a dialogue with
China about the tariffs and ultimately remove them.
“The uncertainty surrounding the Section 301
tariffs, and especially the exclusions, poses a challenge for retailers who
are planning months and sometimes years in advance,”
Gold said. “The tariffs contribute to additional
costs that retailers are either forced to absorb or pass along to consumers.
While many retailers have been looking to diversify their supply chains, it
takes significant time to shift sourcing.”
In class exercise
3.
What is the
main reason for the slowdown in the Asian manufacturing sector?
A) Increased demand from the U.S.
B) Economic support measures
from the Chinese government
C) Sluggish
demand from the U.S. market
Answer: C
Explanation: The slowdown is attributed to sluggish demand from the
U.S. market, leading to rising spare supplier capacity.
4.
What does the GEP Global
Supply Chain Volatility Index track?
A) Supply
chain orders and spare supplier capacity
B) Currency
exchange rates
C) Global
economic growth
Answer: A
Explanation: The index tracks supply chain orders, showing rising spare
supplier capacity due to a pullback in global demand.
5.
According to the GEP
index, what is a contributing factor to the rise in idle capacity in Asia?
A)
Increased global demand
B) Pullback
in global demand
C)
Transportation efficiency
Answer: B
Explanation: The rise in idle capacity is a result of a pullback in
global demand.
6.
What recent data from
China has shown improvement?
A) Decline
in GDP
B) Decrease
in retail sales
C) Third
quarter GDP and retail sales
Answer: C
Explanation: Recent data from China indicates improvement in third
quarter GDP and retail sales.
7.
What is the primary focus
of the U.S.-China talk on trade and tariffs, as mentioned in the article?
A) Strengthening
trade barriers
B)
Kickstarting demand and lowering the cost of doing business
C) Imposing
additional tariffs
Answer: B
Explanation: The leaders are expected to focus on kickstarting demand
and lowering the cost of doing business with each other.
8.
How have tariffs on
select Chinese goods evolved since the trade war began?
A) They
have decreased over time
B) They
have remained constant
C) They
have increased significantly
Answer: C
Explanation: Tariffs on select Chinese goods have increased significantly
since the trade war began.
9.
What percentage of U.S.
imports from China is currently under tariff?
A) 19.3%
B) 66.4%
C) 58.3%
Answer: B
Explanation: Presently, 66.4% of U.S. imports from China are under
tariff.
6.
Why do business leaders express
a preference for a positive meeting between Biden and Xi, according to John
Piatek?
A) To
maintain a reliable and cost-effective partnership with China
B) To
increase trade barriers
C) To
encourage re-shoring trends
Answer: A
Explanation: Business leaders prefer a positive meeting to maintain a
reliable and cost-effective partnership with China.
7.
What impact does the
ongoing trade dispute between the U.S. and China have on retailers, according
to Jon Gold?
A)
Increased profit margins
B) Reduced
operational costs
C)
Additional costs passed along to consumers
Answer: C
Explanation: The trade dispute contributes to additional costs that
retailers may pass along to consumers.
8.
What does the NRF call on
the Biden Administration to do regarding the tariffs?
A) Increase
tariff rates
B) Restart
a dialogue with China about the tariffs and ultimately remove them
C) Maintain
the current tariff structure
Answer: B
Explanation: The NRF calls on the Biden Administration to restart a dialogue
with China about the tariffs and ultimately remove them.
US tariffs on Chinese imports might increase
in 2024, analysts say
China EVs: Biden considers
raising tariffs, WSJ reports (youtube)
·
China’s slow economic
recovery suggests it may need to increase exports to other countries,
including the US, which could react with new tariffs
·
However, one expert contends, ‘it’s going to take longer than 2024 to get there, because it’s a process issue, and the process is not short’
Published:
7:07am, 17 Jan, 2024 by
Ji Siqi
Washington seems inclined to increase
tariffs on Chinese imports in 2024, analysts said
on Tuesday, despite opposition by Beijing and US businesses.
“We’re going to see a revival and increased attention on
tariffs in 2024 from the US,” Scott Kennedy, a chair
in Chinese business and economics at the Centre for Strategic and
International Studies (CSIS), told a virtual panel discussion organised by
the Washington think tank.
One reason
Kennedy cited was China’s slow economic recovery
from the Covid-19 pandemic: while domestic demand was low, Chinese government
encouraged manufacturing and production, leading to overcapacity.
Therefore, he said, it will have to
export more to other countries, including the US –
which may respond with increasing tariffs.
Imposed
since the Donald Trump administration, average US tariffs on imports from
China remain elevated at 19.3 per cent. The US also has 247
anti-dumping and countervailing duty measures in place against Chinese goods,
including steel, chemicals, machinery and automobiles, Kennedy added.
To
retaliate, China attached additional tariffs on certain US goods. And
the issue remains a friction point between the two nations.
William
Reinsch, a chair in international business at CSIS, said, though, that a
lengthy legislative process and lack of consensus in the US Congress could
delay final enactment of any potential new tariffs.
“It’s going to take longer than 2024 to get there, because it’s a process issue,” Reinsch said. “And the process is not short.”
Historically,
passing significant legislation tends to be difficult in an election year, but
tough-on-China bills could be the exception, given bipartisan wariness
towards Beijing.
So far,
there has been no broad national consensus on increasing tariffs against
China, and the idea is unpopular with the US business community, which has
sought to remove the Trump-era tariffs.
Still, any
announcement of trade bills or import duties investigations would have a
chilling effect on bilateral trade and investment, Reinsch added.
In 2023,
China’s exports to the US suffered their deepest
decline in almost three decades, falling by 13.1 per cent compared to a year
earlier to US$500.3 billion, according to China customs data.
The
panellists noted that while the US and its allies share rising economic and
security concerns towards Beijing, it remains very challenging to take joint
actions. Many US allies, they noted, do not have not much interest in a
broader decoupling with China.
“One of the risks that the US runs – if it heads in that direction [of decoupling] – is getting out of step with its trading partners around
the world and ending up isolating itself,” Kennedy
said.
While semiconductors and critical
minerals are already contested areas, electric vehicles might emerge as a new
focus dominating US-China economic competition this year, said Ilaria
Mazzocco, a chair in Chinese business and economics at CSIS.
“The debate
is not necessarily going to be just about EV imports into the United States,
which of course are not particularly significant at this time,” she said.
“It’s going to be about future imports. More importantly, it’s going to be about the whole value chain.”
When all
the data is tabulated, China is set to have surpassed Japan as the world’s leading exporter of automobiles in 2023, with major
destinations spanning from Europe to Southeast Asia.
But a stiff 27.5 per cent tariff – in place since Trump’s presidency
– along with US President Joe Biden’s
signature legislation, the Inflation Reduction Act, that provides subsidies
for domestic electric vehicle manufacturers, have largely kept Chinese EVs at
bay in the US market.
Morris
Chang, founder of the Taiwan Semiconductor Manufacturing Company, speaks in
New York on Thursday. Photo: AFP
Still, US
reliance on imports of Chinese-made lithium batteries has continued to rise
in recent years. In the first 11 months of 2023, China’s
share of US total lithium battery imports was more than 70 per cent,
according to South China Morning Post calculations based on US census data.
“In EVs,
there’s a fundamental question about whether China’s going to be part of the solution or they’re just the entire problem,”
Kennedy said.
“I think it’s going to be hard for the US to make its energy
transition, particularly in transportation, without having some amount of
Chinese participation – particularly in batteries.”
In class exercise
1.
What is the main reason cited for the
potential increase in US tariffs on Chinese imports in 2024, according to
analysts?
A) China's economic boom
B) Overcapacity in Chinese
manufacturing
C)
Sluggish demand from the US market
Answer: B
Explanation: Analysts suggest that China's overcapacity
in manufacturing, driven by the encouragement of production, may lead to
increased exports and potential US tariff hikes.
2.
What is the average current US tariff on imports
from China, as mentioned in the article?
A)
12.5%
B)
19.3%
C)
24.7%
Answer: B
Explanation: The average US tariffs on imports from
China remain elevated at 19.3%.
3.
How many anti-dumping and countervailing duty
measures does the US have in place against Chinese goods, according to Scott
Kennedy?
A)
120
B)
200
C)
247
Answer: C
Explanation: The US has 247 anti-dumping and
countervailing duty measures in place against Chinese goods.
4.
What factor might contribute to a delay in
enacting potential new tariffs, according to William Reinsch?
A)
Bipartisan consensus
B)
Lack of consensus in the US Congress and a lengthy legislative process
C)
Speedy legislative procedures
Answer: B
Explanation: Reinsch suggests that the legislative
process and lack of consensus in the US Congress could delay the enactment of
potential new tariffs.
5.
How did China's exports to the US perform in
2023, based on China customs data?
A)
13.1% decline
B)
5.8% growth
C)
20.5% increase
Answer: A
Explanation: China's exports to the US experienced their
deepest decline in almost three decades, falling by 13.1% in 2023.
6.
What is the potential consequence for the US if
it moves towards decoupling with China, according to Scott Kennedy?
A)
Increased economic growth
B)
Enhanced global influence
C)
Isolation from trading partners
Answer: C
Explanation: Kennedy suggests that one risk for the US
is getting out of step with its trading partners and ending up isolating
itself.
7.
What emerging focus in US-China economic
competition is mentioned by Ilaria Mazzocco?
A)
Textile industry
B)
Semiconductor manufacturing
C)
Electric vehicles (EVs)
Answer: C
Explanation: Mazzocco highlights electric vehicles as a
new focus in US-China economic competition, particularly regarding the whole
value chain.
8.
What has largely kept Chinese EVs at bay in the
US market?
A)
Lack of consumer interest
B)
High demand for domestic EVs
C)
Tariffs and subsidies for domestic EV manufacturers
Answer: C
Explanation: A stiff tariff and subsidies for domestic
electric vehicle manufacturers have largely kept Chinese EVs at bay in the US
market.
9.
What does Scott Kennedy believe is a fundamental
question in the electric vehicle (EV) industry?
A)
China's role in the EV solution
B)
Global consumer preferences for EVs
C)
The affordability of EVs
Answer: A
Explanation: Kennedy raises the question of whether
China will be part of the solution or the entire problem in the EV industry.
10. What percentage
of US total lithium battery imports does China account for, based on South
China Morning Post calculations?
A)
50%
B)
70%
C)
90%
Answer: B
Explanation: In the first 11 months of 2023, China's
share of US total lithium battery imports was more than 70%.
Khan Academy’s view of the trade deficit
with China (video)
In
class exercise
1.
Why would a free-floating currency system lead to
a weaker dollar in this situation?
A) Higher demand for yuan
B) Oversupply of dollars
C) Decreased demand for yuan
Answer: B.
Explanation:
In a free-floating system, an oversupply of dollars would weaken its value.
2.
What does China aim to avoid by not allowing its
currency to strengthen?
A) Increased trade deficit
B) Cheaper goods in the US
C) Depreciation of the yuan
Answer: B.
Explanation:
A stronger yuan would make Chinese goods more expensive in the US.
3.
How does the People's Bank of China create
additional demand for dollars?
A) Printing more yuan
B) Printing more dollars
C) Selling goods to the US
Answer: A.
Explanation:
By printing 180 million yuan, they create demand for an extra $30 million.
4.
Why does China print additional yuan instead of
directly buying dollars?
A) To increase its money supply
B) To reduce inflation
C) To avoid impacting exchange rates
Answer: C.
Explanation:
Directly buying dollars would impact exchange rates, so they print yuan
instead.
5.
What does the intervention by the People's Bank
of China aim to maintain?
A) Trade surplus
B) Exchange rate fluctuation
C) Trade imbalance
Answer: C.
Explanation:
It aims to maintain the existing trade imbalance.
6.
In a free-floating system, what would happen to
the dollar's value with an oversupply of dollars?
A) Strengthen
B) Remain unchanged
C) Weaken
Answer: C.
Explanation:
An oversupply of dollars would weaken its value.
7.
What is the primary reason for China's
intervention in this scenario?
A) To strengthen its currency
B) To weaken the US dollar
C) To maintain trade competitiveness
Answer: C.
Explanation:
To maintain competitiveness by avoiding a stronger yuan.
Part II of Chapter 2 --- Evolution
of international monetary system
Finance: The
History of Money (combined) (video, fan to watch)
In class exercise
1.
What was one of the challenges faced by early communities as they engaged
in more numerous exchanges?
A)
Keeping track of taxes
B)
Maintaining a record of payments and receipts
C)
Enforcing IOU notes
Answer: B
Explanation:
As communities grew and exchanges became more numerous, it became
increasingly hard to keep track of payments and receipts.
2.
What was one of the characteristics of barley that made it unsuitable as a
form of money?
A)
It was easily divisible
B)
It was portable
C)
It was heavy to carry
Answer: C
Explanation:
Barley, being heavy to carry, was not portable or even durable, making it
unsuitable as a form of money.
3.
What was a noticeable feature of metal money that made it appealing for
trade?
A)
Lack of intrinsic value
B)
Ease of forgery
C)
Intrinsic value and durability
Answer: C
Explanation:
Metal money had intrinsic value due to the precious metals used, and it was
durable, making it suitable for trade.
4.
What was the innovation introduced by early Chinese rulers to facilitate
long-distance trading?
A)
IOU certificates on paper
B)
Minted coins
C)
Barley as currency
Answer: A
Explanation:
Early Chinese rulers issued IOU certificates on paper for long-distance
trading, allowing traders to carry around lighter certificates instead of
heavy coins.
5.
What did traders and lenders attempt to link the value of paper money to?
A)
Value of gold
B)
Value of shells
C)
Value of feathers
Answer: A
Explanation:
Traders and lenders attempted to link the value of paper money to the value
of gold to create a standard for exchange between different currencies.
6.
What significant event caused the American War of Independence,
according to Benjamin Franklin?
A)
Disadvantageous trade with Britain
B)
Burden of British taxation
C)
Forced use of pounds for taxes
Answer: B
Explanation:
Benjamin Franklin attributed the American War of Independence to the burden
of British taxation and disadvantageous trade.
7.
What practice allowed banks to lend out more money than they had on
deposit?
A)
Fractional reserve banking
B)
Full reserve banking
C)
Gold standard banking
Answer: A
Explanation:
Fractional reserve banking allowed banks to lend out more money than they had
on deposit by only keeping a fraction of deposits as reserves.
8.
What action did the government take to prevent runs on banks in the 19th
century?
A)
Increased interest rates
B)
Ensured customers' deposits
C)
Reduced reserve requirements
Answer: B
Explanation:
The government ensured customers' deposits to prevent runs on banks in the
19th century, thereby restoring confidence in the banking system.
9.
What event marked the disappearance of the gold standard in 1973?
A)
Adoption of the euro
B)
Signing of the Bretton Woods Agreement
C)
Last traces of the gold standard
Answer: C
Explanation:
The last traces of the gold standard disappeared in 1973, marking a
significant shift in monetary policy.
10.
What characteristic of bitcoin challenges the power of government-backed
money?
A)
Portability
B)
Divisibility
C)
Limited supply
Answer: C
Explanation:
Bitcoin, with their limited supply, challenge the power of government-backed
money, as they are not subject to government control over money supply.
Timeline
of the history of Money:
·
Bimetallism: Before
1875 The Flexible Exchange Rate Regime: 1973-present
·
Classical
Gold Standard: 1875-1914
The Gold Standard Explained in One
Minute (video)
§
International value
of currency was determined by its fixed relationship to gold.
§
Gold was used to
settle international accounts, so the risk of trading with other countries
could be reduced.
·
Interwar Period:
1915-1944
§
Countries suspended
gold standard during the WWI, to increase money supply and pay for the war.
§
Countries relied on
a partial gold standard and partly other countries’ currencies
during the WWII
·
Bretton Woods System: 1945-1972
The Bretton Woods Monetary System (1944 -
1971) Explained in One Minute (video)
·
All currencies were
pegged to US$.
·
US$ was the only
currency that was backed by gold.
·
US$ was world
currency at that time.
· The Flexible Exchange Rate Regime: 1973-present
FLOATING AND FIXED EXCHANGE RATE (video)
In class exercise - Gold standard The Gold Standard Explained in One
Minute (video)
1. What
significant change occurred in the way currencies were pegged after 1945?
A) Currencies
were pegged directly to gold
B) Currencies
were pegged to the British Pound
C) Currencies
were pegged to the US Dollar
Answer: C
Explanation: After 1945, currencies were
pegged to the US Dollar, which was pegged to gold at a rate of $35 per ounce.
2. How are
fiat currencies backed?
A) By
confidence in the issuing country
B) By tangible
assets like gold
C) By supply
and demand dynamics
Answer: A
Explanation: Fiat currencies are backed by
confidence, such as the confidence people have in the US for the US Dollar, and
by extension, confidence in the issuing country.
3. Why did
some countries, like France, stop trusting the US Dollar?
A) Lack of
confidence in the US economy
B) Depletion
of US gold reserves
C) Increase in
US dollar value
Answer: B
Explanation: Some countries, like France,
stopped trusting the US Dollar because they perceived a depletion of US gold
reserves as more dollars were converted to physical gold.
4. What led
President Nixon to take the United States off the gold standard in 1971?
A) Decreasing
value of the US Dollar
B) Depletion
of US gold reserves
C) Increase in
gold prices
Answer: B
Explanation: President Nixon took the United
States off the gold standard in 1971 due to the depletion of US gold reserves
caused by countries converting their dollars to physical gold.
In class
exercise – Bretton Woods Agreement The Bretton Woods Monetary System (1944 -
1971) Explained in One Minute (video)
1.
What was a major
concern that led to the Bretton Woods conference in 1944?
A) The fear of
countries devaluing their currency to boost exports
B) The need
for a new global financial system after World War II
C) The desire
to link all currencies directly to gold
Answer: A
Explanation: Economists were worried that
countries would devalue their currency to boost exports, which led to the
Bretton Woods conference in 1944.
2. Which
institution was created to lend money to countries facing economic crises?
A) The
International Bank for Reconstruction and Development
B) The
International Monetary Fund
C) The World
Bank
Answer: B
Explanation: The International Monetary
Fund (IMF) was created to lend money to countries that are in trouble and
cannot attract financing from other sources.
3. What was
one reason for the decline of the Bretton Woods system?
A) Countries
demanding more gold in exchange for their dollars
B) The United
States running deficits to fund various projects
C) The failure
of the International Bank for Reconstruction and Development
Answer: B
Explanation: The Bretton Woods system
declined because the United States kept running deficits to fund various
projects, leading to an increase in the amount of dollars in existence while
the US gold reserves shrank.
4. What
significant announcement did President Nixon make on August 15, 1971?
A) The
creation of the World Bank
B) The
devaluation of the US dollar
C) The end of
the Bretton Woods system
Answer: C
Explanation: President Nixon announced on
August 15, 1971, that dollars would no longer be convertible to gold, thereby
ending the Bretton Woods system.
5. What was
the primary purpose of the Bretton Woods system?
A) To link all
currencies directly to gold
B) To
establish the International Bank for Reconstruction and Development
C) To create a
new global financial system after World War II
Answer: C
Explanation: The primary purpose of the
Bretton Woods system was to establish a new global financial system after
World War II, addressing concerns such as currency devaluation and economic
crises.
In Class Exercise –
Floating vs. Fixed exchange rate system
1. What is the
main difference between floating and fixed exchange rates?
A) Floating
exchange rates fluctuate with market forces, while fixed exchange rates are
controlled by the government.
B) Fixed
exchange rates fluctuate with market forces, while floating exchange rates
are controlled by the government.
C) Both
floating and fixed exchange rates are controlled by the government.
Answer: A
Explanation: Floating exchange rates
fluctuate based on demand and supply in the market, while fixed exchange
rates are set and controlled by the government.
2. Why might a
government prefer to maintain a fixed exchange rate?
A) To allow
market forces to determine the exchange rate.
B) To keep the
value of its currency stable relative to another currency.
C) To
encourage capital inflows into the country.
Answer: B
Explanation: Governments may prefer fixed
exchange rates to keep the value of their currency stable relative to another
currency, which can benefit trade and investment.
3. How might a
government intervene to maintain a fixed exchange rate?
A) By
adjusting interest rates to influence demand for its currency.
B) By reducing
its currency reserves.
C) By allowing
unrestricted transactions in the foreign exchange market.
Answer: A
Explanation: Governments can intervene to
maintain a fixed exchange rate by adjusting interest rates to influence
demand for their currency.
4. What is one
potential consequence of a fixed exchange rate policy?
A) Increased
volatility in the foreign exchange market.
B) Limited
government control over monetary policy.
C) Higher
levels of inflation.
Answer: B
Explanation: One potential consequence of a
fixed exchange rate policy is limited government control over monetary
policy, as the exchange rate is fixed and not determined by market forces.
5. Which
countries below have floating exchange rates?
A) United
States, Canada, UK
B) Hong Kong,
Argentina, Bulgaria
C) China, Japan,
Germany
Answer: A
Explanation: The United States, Canada, and the
UK have floating exchange rates, meaning their exchange rates fluctuate based
on market forces.
6. In a
floating exchange rate system, how are exchange rates determined?
A) By government
intervention and control.
B) By fixed
ratios established between currencies.
C) By market
forces of supply and demand.
Answer: C
Explanation: In a floating exchange rate
system, exchange rates are determined by the interactions of supply and
demand in the foreign exchange market. Governments do not intervene to set or
control exchange rates; instead, they fluctuate based on market dynamics.
7. What is a
potential advantage of a floating exchange rate system for countries with
diverse trading partners, like USA?
A) It reduces
currency risk for exporters.
B) It promotes
stability in exchange rates.
C) It allows
currencies to adjust to varying economic conditions.
Answer: C
Explanation: A potential advantage of a
floating exchange rate system for countries with diverse trading partners is
that it allows currencies to adjust to varying economic conditions. This
flexibility can help maintain competitiveness and balance in trade
relationships with different countries.
For class discussion:
Read
the following. Is there any knowledge that is new to you?
Bretton Woods Agreement and System
By
JAMES CHEN Updated April 28, 2021, Reviewed by SOMER ANDERSON
What
Was the Bretton Woods Agreement and System?
The Bretton Woods Agreement was
negotiated in July 1944 by delegates from 44 countries
at the United Nations Monetary and Financial Conference held in Bretton
Woods, New Hampshire. Thus, the name “Bretton Woods Agreement.”
Under
the Bretton Woods System, gold was the
basis for the U.S. dollar and other currencies were pegged to the U.S.
dollar’s value. The Bretton Woods
System effectively came to an end in the early 1970s when President Richard
M. Nixon announced that the U.S. would no longer exchange gold for U.S.
currency.
The
Bretton Woods Agreement and System Explained
Approximately
730 delegates representing 44 countries met in Bretton Woods in July 1944 with the principal goals of creating an
efficient foreign exchange system, preventing competitive devaluations of
currencies, and promoting international economic growth. The Bretton Woods
Agreement and System were central to these goals. The Bretton Woods Agreement
also created two important organizations—the International Monetary Fund
(IMF) and the World Bank. While the Bretton Woods System was dissolved in
the 1970s, both the IMF and World Bank have remained strong pillars for the
exchange of international currencies.
Though
the Bretton Woods conference itself took place over just three weeks, the
preparations for it had been going on for several years. The primary
designers of the Bretton Woods System were the famous British economist John
Maynard Keynes and American Chief International Economist of the U.S.
Treasury Department Harry Dexter White. Keynes’ hope was to establish a
powerful global central bank to be called the Clearing Union and issue a new
international reserve currency called the bancor. White’s plan envisioned a
more modest lending fund and a greater role for the U.S. dollar, rather than
the creation of a new currency. In the end, the adopted plan took ideas from
both, leaning more toward White’s plan.
It wasn't until 1958 that the Bretton
Woods System became fully functional. Once implemented, its
provisions called for the U.S. dollar to be pegged to the value of gold.
Moreover, all other currencies in the system were then pegged to the U.S.
dollar’s value. The exchange rate
applied at the time set the price of gold at $35 an ounce.
KEY
TAKEAWAYS
·
The Bretton Woods
Agreement and System created a collective international currency exchange
regime that lasted from the mid-1940s to the early 1970s.
·
The Bretton Woods
System required a currency peg to the U.S. dollar which was in turn pegged to
the price of gold.
·
The Bretton Woods
System collapsed in the 1970s but created a lasting influence on
international currency exchange and trade through its development of the IMF
and World Bank.
Benefits
of Bretton Woods Currency Pegging
The
Bretton Woods System included 44 countries. These countries were brought
together to help regulate and promote international trade across borders. As
with the benefits of all currency pegging regimes, currency pegs are expected
to provide currency stabilization for
trade of goods and services as well as financing.
All
of the countries in the Bretton Woods System agreed to a fixed peg against
the U.S. dollar with diversions of only 1% allowed. Countries were required
to monitor and maintain their currency pegs which they achieved primarily by
using their currency to buy or sell U.S. dollars as needed. The Bretton Woods System, therefore,
minimized international currency exchange rate volatility which helped
international trade relations. More stability in foreign currency
exchange was also a factor for the successful support of loans and grants
internationally from the World Bank.
The
IMF and World Bank
The
Bretton Woods Agreement created two Bretton Woods Institutions, the IMF and
the World Bank. Formally introduced in December 1945 both institutions have
withstood the test of time, globally serving as important pillars for
international capital financing and trade activities.
The
purpose of the IMF was to monitor exchange rates and identify nations that
needed global monetary support. The World Bank, initially called the
International Bank for Reconstruction and Development, was established to
manage funds available for providing assistance to countries that had been
physically and financially devastated by World War II.1
In the twenty-first century, the IMF has 189 member countries and still
continues to support global monetary cooperation. Tandemly, the World Bank
helps to promote these efforts through its loans and grants to governments.2
The Bretton Woods System’s Collapse
In 1971, concerned that the U.S. gold
supply was no longer adequate to cover the number of dollars in circulation,
President Richard M. Nixon devalued the U.S. dollar relative to gold. After a
run on gold reserve, he declared a temporary suspension of the dollar’s
convertibility into gold. By 1973 the Bretton Woods System had collapsed. Countries
were then free to choose any exchange arrangement for their currency, except
pegging its value to the price of gold. They could, for example, link its value
to another country's currency, or a basket of currencies, or simply let it
float freely and allow market forces to determine its value relative to other
countries' currencies.
The
Bretton Woods Agreement remains a significant event in world financial
history. The two Bretton Woods Institutions it created in the International
Monetary Fund and the World Bank played an important part in helping to
rebuild Europe in the aftermath of World War II.
Subsequently, both institutions have continued to maintain their founding
goals while also transitioning to serve global government interests in the
modern-day.
In class
exercise
1.
What was the
primary goal of the Bretton Woods Agreement?
A) Establishing a global
central bank
B) Preventing competitive
devaluations of currencies
C) Creating a new international
reserve currency
Answer:
B
Explanation: The primary
goal of the Bretton Woods Agreement, was to prevent competitive devaluations
of currencies.
2.
Who were the principal designers of the
Bretton Woods System?
A) John Maynard Keynes and Harry
Dexter White
B) Richard M. Nixon and John F.
Kennedy
C) Franklin D. Roosevelt and Winston
Churchill
Answer:
A
Explanation: The principal
designers of the Bretton Woods System were John Maynard Keynes and Harry
Dexter White.
3.
What were the two organizations created by
the Bretton Woods Agreement?
A) International Monetary Fund (IMF)
and World Bank
B) World Trade Organization (WTO) and
United Nations (UN)
C) European Union (EU) and NATO
Answer:
A
Explanation: The Bretton
Woods Agreement created the International Monetary Fund (IMF) and the World
Bank.
4.
When did the Bretton Woods System become
fully functional?
A) 1944
B) 1958
C) 1971
Answer:
B
Explanation: The Bretton Woods
System became fully functional in 1958.
5.
What was the basis for the U.S. dollar
under the Bretton Woods System?
A) Silver
B) Oil
C) Gold
Answer:
C
Explanation: Gold was the
basis for the U.S. dollar under the Bretton Woods System.
6.
What event marked the collapse of the
Bretton Woods System?
A) President Nixon's announcement of
gold exchange suspension
B) The establishment of the IMF and
World Bank
C) The adoption of the euro as a
common currency
Answer:
A
Explanation: President
Nixon's announcement of suspending the gold exchange marked the collapse of
the Bretton Woods System.
7.
What was the primary function of the IMF?
A) Providing loans and grants to
governments
B) Promoting international trade
across borders
C) Monitoring exchange rates and
providing global monetary support
Answer:
C
Explanation: The primary
function of the IMF was to monitor exchange rates and provide global monetary
support.
8.
What was the initial purpose of the World
Bank?
A) Supporting international trade activities
B) Managing funds for post-war
reconstruction
C) Facilitating currency stabilization
Answer:
B
Explanation: The initial
purpose of the World Bank was to manage funds for post-war reconstruction.
9.
How many member countries does the IMF have
in the twenty-first century?
A) 44
B) 189
C) 73
Answer:
B
Explanation: In the
twenty-first century, the IMF has 189 member countries.
10.
How did countries in the Bretton Woods
System maintain their currency pegs?
A) By using their currency to buy or
sell U.S. dollars
B) By buying or selling gold
C) By floating their currency freely
Answer:
A
Explanation: Countries in
the Bretton Woods System maintained their currency pegs by using their
currency to buy or sell U.S. dollars.
11.
What did President Nixon do in response to
concerns about the adequacy of the U.S. gold supply?
A) Suspended the convertibility of the
dollar into gold
B) Increased gold reserves
C) Devalued the U.S. dollar
Answer:
A
Explanation: President Nixon
suspended the convertibility of the dollar into gold in response to concerns
about the adequacy of the U.S. gold supply.
12.
How did the Bretton Woods Agreement
contribute to international trade relations?
A) By promoting currency devaluations
B) By limiting international capital
financing
C) By minimizing currency exchange
rate volatility
Answer:
C
Explanation: The Bretton
Woods Agreement contributed to international trade relations by minimizing
currency exchange rate volatility.
13. What was the significance of
the IMF and World Bank created by the Bretton Woods Agreement?
A) They facilitated currency pegging
to gold
B) They supported global monetary
cooperation and post-war reconstruction
C) They promoted competitive
devaluations of currencies
Answer:
B
Explanation: The IMF and
World Bank created by the Bretton Woods Agreement supported global monetary
cooperation and post-war reconstruction.
14. What option did countries have
regarding their exchange arrangement after the collapse of the Bretton Woods
System?
A) Pegging their currency to the price
of gold
B) Letting their currency float freely
C) Linking their currency value to the
U.S. dollar
Answer:
B
Explanation: After the
collapse of the Bretton Woods System, countries were free to let their currency
float freely.
Bitcoin Could Become World Reserve
Currency, Says Senator Rand Paul
CONTRIBUTOR Namcios Bitcoin Magazine, PUBLISHED OCT
25, 2021 1:55PM EDT
Bitcoin could rise to that spot as people keep losing faith and
confidence in governments and their policies, Paul said.
As people lose confidence
in the government institutions, bitcoin could benefit and rise to become the
world's reserve currency, Senator Rand Paul said.
"I've started to question now whether or not cryptocurrency
could actually become the reserve currency of the world as more and more
people lose confidence in the government," he said.
Senator Paul has never publicly endorsed any cryptocurrency
other than Bitcoin.
Bitcoin could become
the world's reserve currency if more people lose trust in the government,
said Senator Rand Paul, who accepted BTC donations in its 2016 campaign. The Republican Senator was interviewed on
Axios, discussing the future of bitcoin and fiat currency in the U.S.
"The government currencies are so unreliable — they're
also fiat currencies. They're not backed by anything," Sen. Paul said.
A Gallup poll published on September 30 highlighted how
Americans' trust in government remains low. The survey found that overall
trust in the federal government to handle international problems sits at a
record-low 39%, whereas confidence in the judicial branch is at 54%, down 13
points since 2020. U.S. citizens' trust in their state (57%) and local (66%)
governments continues to be higher than trust in the federal government.
As people keep losing
faith in their government's ability to handle problems and best represent
their interests, Bitcoin and cryptocurrencies are set to benefit and be even
more embraced, Senator Paul highlighted.
-
"I've started to question now whether or not cryptocurrency
could actually become the reserve currency of the world as more and more
people lose confidence in the government," he said.
The Senator has touted cryptocurrency before. During his
presidential campaign in 2016, in addition to donations in U.S. dollars, Paul
accepted donations in bitcoin.
Even though the Republican Senator was not specific about which
cryptocurrency he was referring to in the interview, he has not publicly
endorsed any cryptocurrency other than BTC, indicating he was likely
referring to bitcoin itself. Which shouldn't come as a surprise, given that
BTC is the only cryptocurrency suitable to function as currency.
Central Bank Digital Currency (CBDC)
By SHOBHIT SETH Updated August 25, 2021, Reviewed by ERIKA
RASURE
https://www.investopedia.com/terms/c/central-bank-digital-currency-cbdc.asp
What Is a Central Bank Digital Currency (CBDC)?
The term central bank digital currency
(CBDC) refers to the virtual form of a fiat currency. A CBDC is an
electronic record or digital token of a country's official currency. As
such, it is issued and regulated by the nation's monetary authority or
central bank. As such, they are
backed by the full faith and credit of the issuing government. CBDCs can simplify the
implementation of monetary and fiscal policy and promote financial inclusion
in an economy by bringing the unbanked into the financial system. Because
they are a centralized form of currency, they may erode the privacy of
citizens. CBDCs are
in various stages of development around the world.
KEY TAKEAWAYS
· A central bank digital currency is the virtual
form of a country's fiat currency.
· A CBDC is issued and regulated by a nation's
monetary authority or central bank.
· CBDCs promote financial inclusion and simplify
the implementation of monetary and fiscal policy.
· As a centralized form of currency, they may
erode the privacy of citizens.
Although they aren't formally being used, many countries are
exploring the introduction and use of CBDCs in their economy.
How Central Bank Digital Currencies (CBDCs) Work
Fiat money is the term that refers to currency issued by a
country's government. It comes in the form of banknotes and coins. It is
considered a form of legal tender that can be used for the sale and purchase
of goods and services along with kinds of transactions. A central bank digital currency is the virtual form of fiat money.
As such, it has the full faith and
backing of the issuing government, just like fiat money does.
CBDCs are meant to represent fiat currency. The goal is to
provide users with convenience and security of digital as well as the
regulated, reserve-backed circulation of the traditional banking system. They are designed to function as a unit of account, store of
value, and medium of exchange for daily transactions. CBDCs will be backed by the full faith of the
issuing government—just like fiat currency. Central banks or monetary
authorities will be solely liable for their operations.
There were 83 countries around the
world pursuing CBDC development as of October 2021.Their reasons for pursuing this venture
varied. For example:
Sweden's Riksbank began developing an electronic version of the
krona (called e-krona) after the country experienced a decline in the use of
cash.
The United States wants to introduce CBDCs in its monetary
system to improve the domestic payments system.
Developing countries may have other reasons. For instance, a
significant number of people in India are unbanked. Setting up the physical
infrastructure to bring the unbanked into the financial ecosystem is costly.
But establishing a CBDC can promote financial inclusion in the country's
economy.
CBDCs are not meant to be interchangeable with the
national currency (fiat or otherwise) of a country or region.
Types of CBDCs
There are two types of CBDCs: Wholesale and retail central bank
digital currencies. We've listed some of the main features of each below.
Wholesale CBDCs
Wholesale CBDCs use the existing tier of banking and financial
institutions to conduct and settle transactions. These types of CBDCs are
just like traditional central bank reserves.
One type of wholesale CBDC transaction is the interbank payment.
It involves the transfer of assets or money between two banks and is subject
to certain conditions. This transfer comes with considerable counterparty
risk, which can be magnified in a real-time gross settlement (RTGS) payment
system.
A digital currency's ledger-based system enables the setting of
conditions, so a transfer won't occur if these conditions are not satisfied.
Wholesale CBDCs can also expedite and automate the process for cross-border
transfers.
Current real-time settlement systems mostly work in single
jurisdictions or with a single currency. The distributed ledger technology
(DLT) available in wholesale CBDCs can extend the concept to cross-border
transfers and expedite the process to transfer money across borders.5
Retail CBDCs
Wholesale CBDCs improve upon a system of transfers between
banks. Retail CBDCs, on the other hand, involve the transfer of
central government-backed digital currency directly to consumers. They eliminate the intermediary risk or the risk that banking
institutions might become illiquid and sink depositor funds.
There are two possible variants of retail CBDCs are possible,
depending on the type of access they provide:
Value- or cash-based access: This system involves CBDCs that are
passed onto the recipient through a pseudonymous digital wallet. The wallet will be
identifiable on a public blockchain and, much like cash transactions, will be
difficult to identify parties in such transactions. According to
Riksbank, the development of a value- or cash-based access system is easier
and quicker compared to token-based access.
Token- or account-based access: This
is similar to the access provided by a bank account. Thus,
an intermediary will be responsible for verifying the identity of the
recipient and monitoring illicit activity and payments between accounts. It
provides for more privacy. Personal transaction data is shielded from
commercial parties and public authorities through a private authentication
process.
The two types of CBDCs are not mutually exclusive. It is
possible to develop a combination of both and have them function in the same
economy.
Advantages and Disadvantages of CBDCs
Advantages
CBDCs simplify the process of implementing monetary policy and
government functions. They automate the process between banks through
wholesale CBDCs and establish a direct connection between consumers and
central banks through retail CBDCs. These digital currencies
can also minimize the effort and processes for other government functions,
such as distribution of benefits or calculation and collection of taxes.
Disbursement of money through intermediaries introduces
third-party risk to the process. What if the bank runs out of cash deposits?
What if there is a bank run due to a rumor or an external event? Events like
these have the potential to upset the delicate balance of a monetary system. A CBDC eliminates third-party risk. Any
residual risk that remains in the system rests with the central bank.
One of the roadblocks to financial inclusion for large parts of
the unbanked population, especially in developing and poor countries, is the
cost associated with developing the banking infrastructure needed to provide
them with access to the financial system. CBDCs can establish a
direct connection between consumers and central banks, thus eliminating the
need for expensive infrastructure.
CBDCs can prevent illicit activity because they exist in a
digital format and do not require serial numbers for tracking. Cryptography and a public ledger make it easy for a
central bank to track money throughout its jurisdiction, thereby preventing
illicit activity and illegal transactions using CBDCs.
Disadvantages
CBDCs don't necessarily solve the problem of centralization. A
central authority (the central bank) is still responsible for and invested
with the authority to conduct transactions. Therefore, it still
controls data and the levers of transactions between citizens and banks.
Users would have to give up some degree of privacy since the
administrator is responsible to collect and disseminate digital
identifications. The provider would become privy to every transaction conducted.
This can lead to privacy issues, similar to the ones that plague tech
behemoths and internet service providers (ISPs). For example, criminals could
hack and misuse information, or central banks could disallow transactions
between citizens.
The legal and regulatory issues pertaining to CBDCs are a black
hole. What will be the role of these currencies and who will regulate them? Considering their benefits in
cross-border transfers, should they be regulated across borders? Experiments
in CBDCs are ongoing, and this could translate to a long-term frame.
The portability of these systems means that a strong CBDC issued
by a foreign country could end up substituting a weaker country's currency. A digital U.S. dollar could substitute the local currency
of a smaller country or a failing state. Let's look at Ecuador, which replaced its official currency
(the sucre) with the U.S. dollar in 2000 after high inflation forced citizens
to convert their money to U.S. dollars.
CBDCs vs. Cryptocurrencies
The idea for central bank digital currencies owes its origins to
the introduction of cryptocurrencies which are digital currencies secured by
cryptography. This makes them hard to duplicate or counterfeit. They
are decentralized networks that are based on blockchain technology. The
invention of a secure and immutable ledger allows transactions to be
tracked. It also enables
seamless and direct transfers, without intermediaries and between recipients
simplifies the implementation of monetary policy in an economy.
The cryptocurrency
ecosystem also provides a glimpse of an alternate currency system in which
cumbersome regulation does not dictate the terms of each transaction. Established in 2009, Bitcoin is one of the
world's most popular cryptocurrencies. No physical coins actually trade
hands. Instead, transactions are traded and recorded on a public, encrypted
ledger, which can be accessed by anyone. The process of mining allows all
transactions to be verified. No governments or banks back Bitcoin.
Though the current
cryptocurrency ecosystem does not pose a threat to the existing financial
infrastructure, it has the potential to disrupt and simplify the existing
system. Some experts believe the moves by central banks to design and develop
their own digital currencies will act as a measure to pre-empt such an
eventuality. Facebook's, now
Meta's (FB), proposed cryptocurrency, formerly known as Libra, was an example
of such a system, one that existed beyond borders and was not regulated by a
single regime.
Examples of CBDCs
Central-bank-backed digital currencies haven't been formally
established yet. Many central banks have pilot programs and research projects
in place that are aimed at determining the viability and usability of a CBDC
in their economy. China is the
furthest along this route, having already laid down the groundwork and
initiated a pilot project for the introduction of a digital yuan.
Russia's plan to create the
CryptoRuble was announced by Vladimir Putin in 2017. Speculators
suggest that one of the main reasons for Putin's interest in blockchain is
that transactions are encrypted, making it easier to discreetly send money
without worrying about sanctions placed on the country by the international
community.
A number of other central banks have been researching the
implementation of a CBDC, including:
Sweden's Riksbank, which began exploring the issuance of a
digital currency in its economy in 2017 and has published a series of papers
exploring the topic.
The Bank of England (BoE), which is among the pioneers to
initiate the CBDC proposal.
The Bank of Canada (BOC).
The central banks of Uruguay, Thailand, Venezuela, and
Singapore.1
Part III: Shall we go back to Gold
Standard for its currency?
Video:
The US should not return
to the gold standard for its currency: Jerome Powell (youtube)
In class exercise
1. What is Herman Powell's stance on
returning to the gold standard for the US currency?
a) He strongly supports it
b) He is neutral about it
c) He opposes it strongly
Answer: c
Explanation: Herman Powell clearly states his opposition to
returning to the gold standard.
2. Why does Powell believe linking
the currency to gold would be problematic?
a) It would stabilize prices
b) It would not align with the Fed's
directive
c) It would increase volatility
Answer: b
Explanation: Powell mentions that linking the currency to gold
wouldn't align with the Fed's directive of managing maximum employment and
stable prices.
3. What common view does Powell
share with CEOs of major banks regarding the gold standard?
a) They oppose a return to the gold
standard
b) They believe it would stabilize
the economy
c) They support Judy Shelton's
nomination
Answer: a
Explanation: Powell mentions a shared reluctance among major bank
CEOs to return to the gold standard.
4. What was the projection made by
the Bipartisan Policy Center regarding the US Treasury?
a) The Treasury will have surplus
funds
b) The Treasury will run out of
money by early September
c) The Treasury's revenues will
increase significantly
Answer: b
Explanation: The Bipartisan Policy Center projected that the US
Treasury could run out of money by early September if the debt ceiling is not
raised.
5. What is the main reason for the
projected shortfall in US Treasury funds?
a) Decreased government spending
b) Increased corporate tax revenues
c) Lower-than-expected corporate tax
revenues due to tax cuts
Answer: c
Explanation: Powell attributes the projected shortfall to
lower-than-expected corporate tax revenues resulting from tax cuts.
6. What does Powell emphasize about
the importance of raising the debt ceiling?
a) It's optional for Congress to
consider
b) It's essential to avoid defaulting
on bills
c) It's irrelevant to the
functioning of the economy
Answer: b
Explanation: Powell stresses the importance of raising the debt
ceiling to ensure that the US can continue to pay its bills.
7. What does Powell believe would be
the consequence of failing to raise the debt ceiling?
a) Loss of confidence in the US's
fiscal management
b) Increased fiscal stability
c) Higher interest rates
Answer: a
Explanation: Powell suggests that failing to raise the debt
ceiling could result in a loss of confidence in the US's ability to manage
its fiscal responsibilities.
8. What is Powell's view on the
potential outcomes of the US defaulting on its debts?
a) It would have no significant
impact
b) It would lead to increased stability
c) It would result in substantial
uncertainty
Answer: c
Explanation: Powell expresses concern about the uncertainty and
negative consequences that could arise from a US default on its debts.
9. How does Powell describe the
impact of returning to the gold standard on monetary policy?
a) It would align with the Fed's
directive
b) It would require a change in the
Fed's objectives
c) It would have no effect on
monetary policy
Answer: b
Explanation: Powell suggests that returning to the gold standard
would necessitate a change in the Fed's objectives away from its current
focus on maximum employment and stable prices.
10. What does Powell suggest would
be the primary focus of monetary policy under a gold standard?
a) Managing inflation rates
a) Maximizing employment
c) Stabilizing the dollar price of
gold
Answer: c
Explanation: Powell indicates that under a gold standard, the
primary focus of monetary policy would be to stabilize the dollar price of
gold.
11. According to Powell, why is the
gold standard no longer used by any country?
a) Because it guarantees economic
stability
b) Because it increases volatility
c) Because it aligns with modern
monetary objectives
Answer: b
Explanation: Powell attributes the abandonment of the gold
standard by all countries to its increased volatility and its disconnect from
modern monetary objectives.
Mar 27, 2020,04:54pm
EDT|30,167 views
What
If We Had A Gold Standard System, Right Now?
Nathan
LewisContributor https://www.forbes.com/sites/nathanlewis/2020/03/27/what-if-we-had-a-gold-standard-right-now/?sh=1bfba3313e58
For most of the 182 years between 1789 and 1971, the United
States embraced the principle of a dollar linked to gold — at first, at
$20.67/oz., and then, after 1933, $35/oz. Nearly every economist today will
tell you that was a terrible policy. We can tell it was a disaster because,
during that time, the United States became the wealthiest
and most prosperous country in the history of the world.
This is economist logic.
But, even if some economists might agree with the general
principle, they might be particularly hesitant to apply such monetary
discipline right now, in the midst of economic and financial turmoil. This
kind of event is the whole reason why we put up with all the chronic
difficulties of floating currencies, and economic manipulation by central
banks. Isn't it?
So, let's ask: What if we were on a gold standard system, right
now? Or, to be a little more specific, what if we had been on a gold standard
system for the last ten years, and continued on one right now, in the midst
of the COVID-19 panic and economic turmoil?
In the end, a gold standard system is just a fixed-value
system. The International Monetary Fund tells us that more than half the
countries in the world, today, have some kind of fixed-value system —
they link the value of their currency to some external standard, typically
the dollar, euro, or some other international currency. They have fixed
exchange rates, compared to this external benchmark. The best of these
systems are currency boards, such as is used by Hong Kong vs. the U.S.
dollar, or Bulgaria vs. the euro.
If you think of a gold standard as just a "currency
board linked to gold," you would have the general idea. These currency boards
are functioning right now to keep monetary stability in the midst of a lot of
other turmoil. If you had all the problems of today, plus additional monetary
instability as Russia or Turkey or Korea has been experiencing (or the euro
...), it just piles more problems on top of each other.
Actually, it would probably be easier to link to gold
than the dollar or euro, because gold's value tends to be stable, while the
floating fiat dollar and euro obviously have floating values, by design. If
you are going to link your currency to something, it is easier to link it to
something that moves little, rather than something that moves a lot. Big
dollar moves, such as in 1982, 1985, 1997-98 and 2008, tend to be accompanied
by currency turmoil around the world.
But, even within the discipline of a gold standard system, you
could still have a fair amount of leeway regarding central bank activity, and
also various financial supports that arise via the Treasury and Congress.
Basically, you could do just about anything that is compatible
with keeping the value of the dollar stable vs. gold.
In the pre-1914 era, there was a suite of policies to this
effect, generally known as the "lender of last resort," and
described in Walter Bagehot's book Lombard Street (1873).
Another set of solutions resolved the Panic of 1907, without ever leaving the
gold standard. The Federal Reserve was explicitly designed to operate on a
gold standard system; and mostly did so for the first 58 years of its
existence, until 1971. Others have argued that a functional "free
banking" system, as Canada had in the pre-1914 era, would allow private
banks to take on a lot of these functions, without the need for a central
bank to do so.
What could the Federal Reserve do today, while still adhering to
the gold standard?
First: It could expand the monetary base, by any amount
necessary, that meets an increase in demand to hold cash (base money). Quite commonly, when
things get dicey, people want to hold more cash. Individuals might withdraw
banknotes from banks. Banks themselves tend to hold more "bank
reserves" (deposits) at the Federal Reserve — the banker's equivalent of
a safe full of banknotes. This has happened, for example, during every major
war. During the Great Depression, the Federal Reserve expanded its balance
sheet by a huge amount, as banks increased their bank reserve holdings in the
face of uncertainty. Nevertheless, the dollar's value remained at its $35/oz.
parity.
Federal Reserve Liabilities 1917-1941.
NATHAN LEWIS
Second: The Federal Reserve could extend loans to certain
entities - banks, or corporations - as long as this lending is consistent
with the maintenance of the currency's value at its gold parity. In the pre-1914 era, this was done via
the "discount window." One way this could come about is by swapping
government debt for direct lending. For example, the Federal Reserve could
extend $1.0 trillion of loans to banks and corporations, and also reduce its
Treasury bond holdings by $1.0 trillion. This would not expand the monetary
base. But, it might do a lot to help corporations with funding issues.
What the Federal Reserve would not be able to do is: expand the
"money supply" (monetary base) to an excessive amount — an amount
that tended to cause the currency's value to fall due to oversupply, compared
to its gold parity.
Now we come to a wide variety of actions that are not really
related to the Federal Reserve, but rather, to the Treasury and Congress.
In 1933, a big change was Deposit Insurance. The Federal Government
insured bank accounts. It helped stop a banking panic at the time. This is a
controversial policy even today, and some think it exacerbated the Savings
and Loan Crisis of the 1980s, not to mention more issues in 2008. But,
nevertheless, it didn't have anything to do with the Federal Reserve.
In 2009, the stock market bottomed when there was a rule change
that allowed banks to "mark to model" rather than "mark to
market." Banks could just say: "We are solvent, we promise."
It worked.
Today, Congress has been making funds available to guarantee
business lending, and for a wide variety of purposes that should help
maintain financial calm. Whether this is a good idea or not will be debated
for a long time I am sure. But, it has nothing to do with the Federal
Reserve. All of these actions are entirely compatible with the gold standard.
What about interest rates? Don't we want the Federal Reserve to
cut rates when things get iffy? In the 1930s, interest rates were set by
market forces. Given the economic turmoil of the time, government bond rates,
and especially bill rates, were very low. The yield on government bills
spent nearly
the whole decade of the 1930s near 0%. Markets lower "risk-free" rates
automatically, during times of economic distress, when you just allow them to
function without molestation. Every bond trader already knows this.
U.S. interest rates, 1919-1941
NATHAN LEWIS
When we go down the list of all the things that the Federal Reserve,
the Treasury, Congress and other regulatory bodies could do, while also
adhering to the gold standard, we find that there is really not much left. It
turns out that many of the things that supposedly justify floating
currencies, are also possible with a gold standard system.
In class exercise
1. What was the
primary monetary standard embraced by the United States for most of its
history until 1971?
a)
Gold standard
b)
Silver standard
c)
Fiat currency system
Answer: a
Explanation: The text mentions that the United States embraced a
dollar linked to gold for most of its history until 1971.
2.
What does the author compare a gold standard system to?
a)
Flexible monetary policies
b)
Fixed-value system
c)
Economic instability
Answer: b
Explanation: The author compares a gold standard system to a
fixed-value system, similar to currency boards.
3.
Why does the author suggest it might be easier to link a currency to gold
than to the dollar or euro?
a)
Gold's value tends to fluctuate less
b)
Gold's value is more volatile
c)
Gold is less stable than fiat currencies
Answer: a
Explanation: The author implies that gold's value tends to be more
stable compared to the dollar or euro.
4.
What action could the Federal Reserve take to provide funding assistance to
banks and corporations under a gold standard?
a)
Increase interest rates
b)
Purchase government debt
c)
Extend loans consistent with maintaining currency value
Answer: c
Explanation: The author suggests that the Federal Reserve could extend
loans to banks and corporations while maintaining currency value.
5.
What historical policy helped stop a banking panic in 1933 but was
controversial due to its potential exacerbation of later crises?
a)
Deposit Insurance
b)
Stock market regulation
c)
Interest rate manipulation
Answer: a
Explanation: The author mentions that Deposit Insurance helped stop a
banking panic in 1933 but was controversial due to its potential negative
effects.
6.
What conclusion does the author draw regarding the feasibility of various actions
under a gold standard system?
a)
Many actions are incompatible with the gold standard
b)
Only a few actions are compatible with the gold standard
c)
Most actions are compatible with the gold standard
Answer: c
Explanation: The author concludes that many actions, including those
related to monetary policy and financial support, are compatible with the
gold standard system.
7.
According to the author, what is the primary benefit of a gold standard
system during economic turmoil?
a)
Increased economic manipulation
b)
Enhanced monetary stability
c)
Chronic difficulties with floating currencies
Answer: b
Explanation: The author suggests that a gold standard system provides
enhanced monetary stability during economic turmoil.
8.
How does the author characterize the role of the Federal Reserve within a
gold standard system?
a)
Limited involvement in monetary policy
b)
Active participation in economic regulation
c)
Operation within a gold standard system
Answer: c
Explanation: The author describes the Federal Reserve as operating
within a gold standard system.
9.
What action could the Federal Reserve take to expand the monetary base under
a gold standard system?
a)
Purchase government debt
b)
Increase interest rates
c)
Extend loans consistent with currency value
Answer: c
Explanation: The author suggests that the Federal Reserve could extend
loans while maintaining currency value.
10.
According to the author, what could the Federal Reserve not do under a gold
standard system?
a)
Expand the money supply excessively
b)
Manipulate interest rates freely
c)
Purchase unlimited government debt
Answer: a
Explanation: The author states that the Federal Reserve could not
expand the money supply excessively under a gold standard system.
Homework of chapter 2 part ii (due with the first midterm
exam)
·
Do you support returning to gold standard? Why or why not?
Hint:
|
Aspect |
Gold Standard |
Floating Exchange Rate |
|
Stability |
Pro: Offers stable exchange rates |
Pro: Allows for automatic adjustments to imbalances |
|
|
Con: Can lead to deflationary pressures |
Con: Can result in volatility and uncertainty |
|
Economic Control |
Pro: Limits government intervention |
Pro: Provides flexibility for monetary policy |
|
|
Con: Restricts policy options in times of crisis |
Con: May lead to currency manipulation |
|
Trade |
Pro: Facilitates international trade |
Pro: Adjusts to trade imbalances naturally |
|
|
Con: Can lead to trade imbalances |
Con: May impact export competitiveness |
|
Public |
Pro: Offers a tangible asset backing currency |
Pro: Offers monetary policy independence |
|
|
Con: Limited supply of gold |
Con: Vulnerable to speculative attacks |
|
Inflation Influence |
Pro: Tends to limit inflationary pressures |
Pro: Can help mitigate inflation through policy measures |
|
|
Con: May constrain growth during deflationary times |
Con: May struggle to control inflation in some cases |
|
Job Unemployment Rate |
Pro: Can help stabilize employment levels |
Pro: Allows for independent monetary and fiscal policies |
|
|
Con: Can lead to rigidities in labor markets |
Con: May struggle to address structural unemployment |
·
What is the Bretton Woods agreement? Why is the Bretton Woods Agreement a
significant event in world financial history?
·
What are
some alternative currencies that have emerged as potential contenders to
challenge the dollar's supremacy? Chinese Yuan? Euro? Yen? Bitcoin?... And
why?
(Hint:
according to Why The U.S. Dollar May Be In
Danger (youtube), the three necessary conditions for a currency to
be perceived as a global reserve currency are: An independent central bank;
Strong military backing; A large and liquid debt market).
Why The U.S. Dollar May Be
In Danger (youtube)
In class exercise
1. What is the main concern expressed about the
future of the US dollar?
a) Its rapid depreciation
b) Its potential collapse in the long term
c) Its dominance in global trade
Answer:
b
Explanation: The video mentions concerns about the
dollar's impending doom and suggests it could be doomed in the long term,
indicating a potential collapse.
2. What is cited as one of the biggest threats to
the dollar's status as the world's reserve currency?
a) Growing account deficit
b) Decreasing foreign investment
c) Increasing national savings rate
Answer:
a
Explanation: The video highlights America's growing
account deficit as a significant threat to the dollar's status due to its
implications for inflation and the dollar's value.
3. What has been a consistent trend in America's
current account balance since the early 1980s?
a) Surplus every year
b) Deficit every year
c) Fluctuating between surplus and deficit
Answer:
b
Explanation:
America's current account balance has been in deficit every single
year since the early 1980s.
4. Which factor contributed to the decline in the
dollar's share in global foreign exchange reserves?
a) Introduction of the euro
b) Decrease in international trade
c) Increase in US exports
Answer:
a
Explanation: The
rise of alternative currencies like the euro has contributed to the decline
in the dollar's share in global reserves.
5. How has the recent geopolitical crisis
affected the dollar's position?
a) Weakened its position as a safe haven
b) Strengthened its position due to increased investor confidence
c) Had no impact on its position in global markets
Answer:
b
Explanation: The recent crisis caused investors to flock
to the dollar, strengthening its position as a safe haven.
6. What is mentioned as a potential benefit of a
weaker dollar for the US economy?
a) Decreased inflation
b) Increased foreign investment
c) Boost to exports by making them more competitive
Answer:
c
Explanation: A
weaker dollar can make US exports more competitive in the global market.
7. What impact does a severely weakened dollar
have on commodity prices?
a) Decreases commodity prices
b) Has no impact on commodity prices
c) Increases commodity prices
Answer:
c
Explanation: A severely weakened dollar would increase
commodity prices as most commodities are priced in dollars.
8. Why do experts believe a collapse of the US
dollar is unlikely?
a) Lack of alternatives to the US dollar as a reserve currency
b) Due to low interest rates in the US
c) Because of the strength of US financial markets
Answer:
a
Explanation: Experts believe a collapse is unlikely
because there are no realistic alternatives to the US dollar as a reserve
currency.
9. Why do concerns over the account deficit and
net savings rate seem overblown?
a) Because of the decrease in US debt to GDP ratio
b) Because the cost of financing US debt has been low
c) Because of the increase in US national savings rate
Answer:
b
Explanation: Despite the deficits, the cost of financing
US debt has been low, minimizing concerns.
10. What is a critical requirement for a currency
to become the world's reserve currency?
a) Absence of significant military support
b) Availability of capital controls
c) Presence of large and liquid debt markets
Answer:
c
Explanation: Large and liquid debt markets are essential
for a currency to become the world's reserve currency.
11. What role does the US financial market play
during global financial turmoil?
a) It exacerbates the turmoil in other economies
b) It serves as a safe haven for investors
c) It remains unaffected by global financial turmoil
Answer:
b
Explanation: During global financial turmoil, investors
seek safety in the US financial market, making it a safe haven.
12. Why is the US dollar unlikely to be replaced
as the world's reserve currency?
a) Because of its decreasing share in global reserves
b) Because of the lack of alternatives with freely convertible
currencies
c) Because of the increasing dominance of cryptocurrencies
Answer:
b
Explanation: The lack of alternatives with freely
convertible currencies makes it unlikely for the US dollar to be replaced.
13. What is the overall sentiment regarding the
future of the US dollar's dominance?
a) It will remain dominant, but speculation about its health will
continue
b) It is likely to collapse soon due to mounting debts
c) It will be replaced by cryptocurrencies in the near future
Answer:
a
Explanation: The
US dollar's dominance will likely continue, but there will be ongoing
speculation about its health and future.
Chapter 3 International Financial Market/
References:
Go to www.forex.com and set up a practice account
and you can trade with $50,000 virtue money.
Visit http://www.dailyfx.com/to get daily foreign exchange
market news.
Part I: international
financial centers
*Ranking
The ranking is an aggregate of indices
from five key areas: "business environment", "financial sector
development", "infrastructure factors", "human
capital", "reputation and general factors". As of September
2022, the top centres worldwide are:
|
Ranking |
Financial Center |
Country |
Change in Rank |
|
1 |
New York |
|
+0 |
|
2 |
London |
|
+0 |
|
3 |
Singapore |
|
+0 |
|
4 |
Hong Kong SAR |
|
+0 |
|
5 |
San Francisco |
|
+0 |
|
6 |
Los Angeles |
|
+1 |
|
7 |
Shanghai |
|
-1 |
|
8 |
Chicago |
|
+4 |
|
9 |
Boston |
|
+5 |
|
10 |
Seoul |
|
+1 |
|
11 |
Washington DC |
|
+4 |
|
12 |
Shenzhen |
|
-3 |
|
13 |
Beijing |
|
-5 |
|
14 |
Paris |
|
-4 |
|
15 |
Sydney |
|
-2 |
|
16 |
Amsterdam |
|
+3 |
|
17 |
Frankfurt |
|
+1 |
|
18 |
Munich |
|
+6 |
|
19 |
Luxembourg |
|
+2 |
|
20 |
Zurich |
|
+2 |
U.S. https://www.visualcapitalist.com/top-global-financial-centers-in-2023/
in class exercise
1. Which
financial center retained its top rank from 2022 to 2023?
a) London
b) New York
c) Singapore
Answer: b
2. Which financial
center experienced the largest positive change in rank?
a) Chicago
b) Munich
c) Boston
Answer: b
3. Which country had
three financial centers listed in the top 10?
a) United States
b) China
c) Germany
Answer: a
4. Which financial
center dropped the most in rank from 2022 to 2023?
a) Beijing
b) Paris
c) Shanghai
Answer: a
5. Which financial center
in Germany saw a positive change in rank from 2022 to 2023?
a) Frankfurt
b) Munich
c) Berlin
Answer: b
What Makes a City a
Financial Hub?
https://www.investopedia.com/articles/investing/091114/worlds-top-financial-cities.asp
A financial center, or a financial hub,
refers to a city with a strategic location, leading financial institutions, reputed
stock exchanges, a dense concentration of public and private banks and
trading and insurance companies. In addition, these hubs are equipped with
first-class infrastructure, communications and commercial systems, and there
is a transparent and sound legal and regulatory regime backed by a stable
political system. Such cities are favorable destinations for
professionals because of the high living standards they offer along with
immense growth opportunities.
Here
is a look at the top financial hubs across the globe, in no particular order.
KEY
TAKEAWAYS
·
Cities that are
concentrations of commerce, trading, real estate, and banking tend to become
global financial hubs.
·
These important
cities employ a large number of financial professionals and are home to stock
exchanges and corporate headquarters for investment banks.
·
Found around the
world, examples include New York City, Frankfurt, and Tokyo.
London
Since
the middle ages, London has been one of the most prominent trade and business
centers. The city is one of the most visited places on earth and is among the
most preferred places to do business. London is a well-known center for
foreign exchange and bond trading in addition to banking activities and
insurance services. The city is a
trading hub for bonds, futures, foreign exchange and insurance. The United
Kingdom’s central bank, the Bank of England, is the second oldest central
bank in the world and is located in London. The bank controls the
monetary system and regulates the issue of currency notes in the United
Kingdom. London is also the seat of
the London Stock Exchange, which is the second largest stock exchange in
Europe. Another financial paragon is The London bullion market, managed
by London Bullion Market Association (LBMA), which is the world's largest
market for gold and silver bullion trading. Due to Brexit uncertainty,
London may ultimately lose its stature as a global financial hub.
Singapore
From
a business perspective, Singapore's attractiveness lies in its transparent
and sound legal framework complementing its economic and political stability.
The small island located in the Southeast Asia region has emerged as one of
the Four Asian Tigers and established itself as a major financial center.
Singapore has transformed its economy despite the disadvantages of limited
land and resources. Singapore is both
diversified and specialized across industries such as chemicals, biomedical
sciences, petroleum refining, mechanical engineering and electronics.
Singapore has deep capital markets and is a leading insurance and wealth
management marketplace. It has a disciplined and efficient workforce with
a population made up of people of Chinese, Malay and Indian origin.
Zurich
Zurich,
the largest city in Switzerland, is recognized as a financial center
globally. The city has a disproportionately large presence of financial
institutions and banks and has developed into a hub for insurance and asset
management companies. The low tax regime makes Zurich a good investment
destination, and the city attracts a large number of international companies.
Switzerland’s primary stock exchange, the SIX Swiss Exchange, is in Zurich
and is one of the largest in the world, with a market capitalization of $1.4
trillion as of July 2021. The city has a robust business environment and
offers many finance sector jobs. Zurich is one of the cleanest, most
beautiful and crime free places to live and work.
New
York City
New
York, commonly regarded as the finance capital of the world, has been ranked first
in the World’s Financial Centers by the Global Financial Centres Index.9 New
York is famous for Wall Street, the most happening stock market and the New
York Stock Exchange (NYSE), the largest stock exchange by market
capitalization. The city is a mix of various cultures from across the globe
providing a diverse population and workforce. It plays host to some of the
largest and finest companies (Fortune 500 and Fortune 1000), biggest banks
(Goldman Sachs, Morgan Stanley, and Merrill Lynch, JP Morgan) and industries.
It is difficult to find a big name in the world of business that does not
have a presence in the city.
Hong
Kong
Hong
Kong is a key financial hub with a high number of banking institutions. The
former British colony also has a sound legal system for both residents and
companies and is the home of many fund management companies. Hong Kong has
benefited from its strategic location. For
more than a century, the city has been a conduit of trade between China and
the world. Hence, Hong Kong is China's second largest trading partner
after the United States. Its proximity to other countries in the region has
also worked in its favor. Hong Kong has an efficient and transparent judicial
and legal system with excellent infrastructure and telecommunication
services. It has a favorable tax
system in place with very few and low tax rates, which adds to its
attractiveness. The Hong Kong Stock Exchange is the fourth largest in the
world.
Chicago
Chicago owes its fame to the derivative
market (CME group), which started at the Chicago Board of Trade (CBOT) in
1848 with commodity futures trading. It is the oldest futures exchange in
the world and the second largest by volume, behind the National Stock
Exchange of India. The Chicago-based
Options Clearing Corporation (OCC) clears all U.S. option contracts.
Chicago is the headquarters of over 400 major corporations, and the state of
Illinois has more than 30 Fortune 500 companies, most of which are located in
Chicago. These companies include State Farm Insurance, Boeing, Archer Daniels
Midland and Caterpillar. Chicago also one of the most diverse economies
excelling from innovation in risk management to information technology to
manufacturing to health. Another
financial notable is the Federal Reserve Bank of Chicago.
Tokyo
Tokyo
is the capital of the third-largest economy in the world and a major
financial center.16 The city is the headquarters of many of the world’s
largest investment banks and insurance companies. It is also the hub for the
country’s telecommunications, electronic, broadcasting and publishing
industries. The Japan Exchange Group
(JPX) was established January 1, 2013, by combining the Tokyo Stock Exchange
(TSE) Group and the Osaka Securities Exchange. The exchange had a market
capitalization of $5.9 trillion as of July 2021. The Nikkei 225 and the TOPIX are the main indices tracking the buzz
at the TSE. Tokyo has time and
again been rated among the most expensive cities in the world.
Frankfurt
Frankfurt is home to the European Central
Bank (ECB) and the Deutsche Bundesbank, the central bank of Germany. It has one of the busiest airports in the world and is
the address of many top companies, national and international banks. In 2014,
Frankfurt became Europe's first renminbi payment hub. Frankfurter
Wertpapierbörse, the Frankfurt Stock Exchange, is among the world’s largest
stock exchanges. It had a $2.65 trillion market capitalization as of July
2021. Deutsche Börse Group operates the Frankfurt Stock Exchange.
Shanghai
Shanghai
is the world's third most populous city, behind Tokyo and Delhi. The Chinese
government in early 2009 announced its ambition of turning Shanghai into an
international financial center by 2020. The
Shanghai Stock Exchange (SSE) is mainland China’s most preeminent market for
stocks in terms of turnover, tradable market value and total market value.
The SSE had a market capitalization of $7.63 trillion as of July 2021.
The China Securities Regulatory Commission (CSRC) directly governs the SSE.
The exchange is considered restrictive in terms of trading and listing
criteria.
In class exercise
1. Which city is home to the London Stock Exchange, the second-largest
stock exchange in Europe?
a) Zurich
b) Singapore
c) London
Answer: c
Explanation: London is home to the London Stock Exchange,
which is the second-largest stock exchange in Europe.
2. Which financial hub is known for its transparent legal framework and
political stability, making it attractive for businesses?
a) Zurich
b) Singapore
c) New York City
Answer: b
Explanation: Singapore is known for its transparent legal
framework and political stability, making it attractive for businesses.
3. Which financial center is commonly regarded as the finance capital
of the world and is home to Wall Street?
a) New York City
b) Singapore
c) Hong Kong
Answer: a
Explanation: New York City is commonly regarded as the finance
capital of the world and is home to Wall Street.
4. Which former British colony serves as a key financial hub with a
sound legal system and favorable tax regime?
a) London
b) Hong Kong
c) Tokyo
Answer: b
Explanation: Hong Kong, a former British colony, serves as a
key financial hub with a sound legal system and favorable tax regime.
5. Which city is famous for its derivative market, which began at the
Chicago Board of Trade?
a) Tokyo
b) Chicago
c) Frankfurt
Answer: b
Explanation: Chicago is famous for its derivative market,
which began at the Chicago Board of Trade.
6. Which financial hub is the capital of Japan and the headquarters of
many of the world’s largest investment banks?
a) Tokyo
b) Frankfurt
c) Shanghai
Answer: a
Explanation: Tokyo is the capital of Japan and the
headquarters of many of the world’s largest
investment banks.
7. Which European city is home to the European Central Bank and the
Deutsche Bundesbank?
a) Frankfurt
b) Zurich
c) London
Answer: a
Explanation: Frankfurt is home to the European Central Bank
and the Deutsche Bundesbank.
8. Which city is known for its ambition to become an international
financial center by 2020, as declared by the Chinese government?
a) Shanghai
b) Singapore
c) Hong Kong
Answer: a
Explanation: Shanghai
is known for its ambition to become an international financial center by
2020, as declared by the Chinese government.
Chapter 3 Part I
Homework
1.
What is LIBOR? SOFR? What is the primary
reason for replacing LIBOR with SOFR?
Part II - What Is Libor And Why Is It
Being Abandoned?
Miranda Marquit, Benjamin Curry Updated: Nov 7, 2022, 7:38pm
https://www.forbes.com/advisor/investing/what-is-libor/
Here's What
Went Wrong With Libor (youtube)
In class exercise
1.
What is LIBOR?
a)
A type of mortgage loan
b)
An interest rate benchmark
c)
A financial institution
Answer: b
Explanation:
LIBOR stands for the London Interbank Offered Rate, which is an interest rate
benchmark used to determine the interest rates on various financial
instruments, including mortgages, loans, and derivatives.
2.
Why is LIBOR often referred to as the "world's most important
number"?
a)
Because it determines the value of global currencies
b)
Because it is used by central banks to set monetary policy
c)
Because it helps determine the interest rate on trillions of dollars worth of
securities
Answer: c
Explanation:
LIBOR is often called the "world's most important number" because
it helps determine the interest rate on approximately $300 trillion worth of
financial securities, including mortgages, loans, and derivatives.
3.
What led to the scrutiny of the LIBOR system during the 2008 financial
crisis?
a)
Banks' profits being tied to LIBOR fluctuations
b)
Regulatory investigations into banks' credit worthiness
c)
The explosive growth of derivatives
Answer: a
Explanation:
During the 2008 financial crisis, banks' profits became increasingly tied to
LIBOR fluctuations, leading to a real incentive for banks to manipulate their
LIBOR submissions.
4.
How did banks manipulate their LIBOR submissions during the financial crisis?
a)
By accurately reporting their borrowing costs
b)
By submitting lower rates to appear more creditworthy
c)
By refusing to participate in the LIBOR system
Answer: b
Explanation:
Banks manipulated their LIBOR submissions during the financial crisis by
submitting lower rates to appear more creditworthy, even if it did not
accurately reflect their borrowing costs.
5.
What has been the regulatory response to the LIBOR scandal?
a)
Imposing fines on banks involved in the manipulation
b)
Abolishing the LIBOR system entirely
c)
Allowing banks to continue manipulating LIBOR
Answer: a
Explanation:
Regulatory authorities have imposed fines on banks involved in manipulating
LIBOR and have initiated the process of transitioning to alternative
benchmark rates.
LIBOR vs. SOFR :
Introduction, Scandals & Replacement : The Interest-Rate Benchmark
In class exercise
1. What
does LIBOR stand for?
a)
London Interbank Offered Rate
b)
London Interbank Option Rate
c)
London International Borrowing Rate
Answer: a
Explanation:
LIBOR stands for London Interbank Offered Rate.
2. How
many main currencies is LIBOR currently quoted for?
a) 3
b) 5
c) 7
Answer: b
Explanation:
LIBOR is currently quoted for five main currencies: US dollar, Euro, Japanese
yen, British pound, and Swiss franc.
3. What
does LIBOR serve as a global reference rate for?
a)
Long-term interest rate financial products
b)
Short-term interest rate financial products
c) Real
estate transactions
Answer: b
Explanation:
LIBOR serves as a global reference rate for various short-term interest rate
financial products.
4. How
many maturity periods does LIBOR cover?
a) 5
b) 7
c) 10
Answer: b
Explanation:
LIBOR covers seven different maturity periods ranging from overnight to one
year.
5. Who
administers LIBOR?
a)
Federal Reserve
b)
European Central Bank
c)
Intercontinental Exchange (ICE)
Answer: c
Explanation:
LIBOR is administered by the Intercontinental Exchange (ICE).
6. What
is the main risk associated with LIBOR?
a)
Interest rate volatility
b)
Alleged collusion among banks
c)
Fluctuations in currency exchange rates
Answer: b
Explanation:
The main risk associated with LIBOR is alleged collusion among major banks to
manipulate LIBOR rates in their favor.
7. What
scandal brought attention to the manipulation of LIBOR rates?
a)
Covid-19
b)
LIBOR scandal
c)
Dot-com bubble burst
Answer: b
Explanation:
The LIBOR scandal in 2008 brought attention to the manipulation of LIBOR
rates.
8. What
is one of the alternatives to LIBOR?
a) SOFR
b) SIPC
c)
S&P 500
Answer: a
Explanation:
One of the alternatives to LIBOR is SOFR, which stands for Secured Overnight
Financing Rate.
9.
Where does SOFR derive its rates from?
a)
Interbank loan market
b)
London Stock Exchange
c) US
Treasury repo market
Answer: c
Explanation:
SOFR derives its rates from the US Treasury repo market.
For more than 40 years, the London Interbank Offered Rate—commonly
known as Libor—was a key benchmark for setting the interest rates charged on
adjustable-rate loans, mortgages and corporate debt.
Over the last decade, Libor has been burdened by scandals and crises.
Effective January 2022, Libor will no longer be used to issue new loans in
the U.S. It is being replaced by the Secured Overnight Financing Rate (SOFR),
which many experts consider a more accurate and more secure pricing
benchmark.
Understanding Libor
Libor
provided loan issuers with a benchmark for setting interest rates on
different financial products. It was set each day by collecting estimates
from up to 18 global banks on the interest rates they would charge for
different loan maturities, given their outlook on local economic conditions. Libor was calculated in five currencies: UK
Pound Sterling, the Swiss Franc, the Euro, Japanese Yen and the U.S. Dollar.
The London Interbank Offered Rate was used to price adjustable-rate
mortgages, asset-backed securities, municipal bonds, credit default swaps,
private student loans and other types of debt. As of 2019, $1.2 trillion
worth of residential mortgage loans and $1.3 trillion of consumer loans had
been priced using Libor.
When
you applied for a loan based on Libor, a financial firm would take a Libor
rate and then tack on an additional percentage. Here’s how it worked for a private student
loan, based on the Libor three-month rate plus 2%. If the Libor three-month
rate was 0.22%, the base rate for the loan would be 2.22%. Other factors,
such as your credit score, income and the loan term, are also factored in.
While
Libor is no longer being used to price new loans, it will formally stick
around until at least 2023. One-week and two-month Libor have ceased being published, while
overnight, 1-month, 3-month, 6-month, and 12-month maturities will continue
to be published through June 2023.
With an adjustable-rate loan, your lender sets regular periods where it
makes changes to the rate you’re being charged. The lender referenced Libor
when adjusting the interest rate on your loan, changing how much you pay each
month.
How Is Libor Calculated?
Each day, 18 international banks submit their ideas of the rates they
think they would pay if they had to borrow money from another bank on the
interbank lending market in London.
To help guard against extreme highs or lows that might skew the
calculation, the Intercontinental Exchange (ICE) Benchmark Administration strips
out the four highest submissions and the four lowest submissions before
calculating an average.
It’s
important to note that Libor isn’t set on what banks actually pay to borrow
funds from each other. Instead, it’s based on their submissions related to
what they think they would pay. As a result, it’s possible for banks to
submit lower rates and manipulate Libor fairly easily.
In the past, a panel of bankers oversaw Libor in each currency, but
scandals exposing manipulation of Libor has led many national regulators to
identify alternatives to Libor.
Libor Scandals and the 2008 Financial Crisis
Libor is being phased out in large part because of the role it played
in worsening the 2008 financial crisis, as well as scandals involving Libor
manipulation among the rate-setting banks.
Libor and the 2008 Financial Crisis
The use and abuse of credit default swaps (CDS) was one of the major
drivers of the 2008 financial crisis. A very wide range of interrelated
financial companies insured risky mortgages and other questionable financial
products using CDS. Rates for CDS were set using Libor, and these derivative
investments were used to insure against defaults on subprime mortgages.
American International Group (AIG) was the biggest player in the CDS
disaster. The firm issued vast quantities of CDS on subprime mortgages and
countless other financial products, like mortgaged-backed securities. The
crash of the real estate market in 2007, followed by the even larger market
meltdown in 2008, forced AIG into bankruptcy, resulting in one of the largest
government bailouts in history.
Once AIG started falling apart, it became clear that failing subprime
mortgages and the securities built on top of them weren’t properly insured,
many banks became reluctant to lend to each other. Libor transmitted the
crisis far and wide since every day Libor rate-setting banks estimated higher
and higher interest rates. Libor rose, making loans more expensive, even as
global central banks rushed to slash interest rates.
With rates on trillions of dollars of financial products soaring day
after day, and fears about stunted bank lending reducing the flow of money
through the economy, markets crashed. Libor was only one of the many
factors that created the financial industry disasters of 2008, but its key
role in transmitting the crisis to all parts of the global economy has driven
many nations to seek safer alternatives.
Libor Manipulation
In 2012, extensive investigations into the way Libor was set
uncovered a widespread, long-lasting scheme among multiple banks—including
Barclays, Deutsche Bank, Rabobank, UBS and the Royal Bank of Scotland—to
manipulate Libor rates for profit.
Barclays was a key player in this complicated scam. Barclays would
submit its Libor estimates, claiming that it was lower than what other banks
actually charged it. Because a lower rate supposedly indicates a smaller risk
of default, it is considered a sign that a bank is in better shape than
another bank with a higher rate.
It wasn’t just Barclays, though. At UBS, one trader involved in Libor
setting, Thomas Hayes, managed to rake in hundreds of millions of dollars for
the bank over the course of three years. Hayes also colluded with traders at
the Royal Bank of Scotland on rigging Libor. UBS executives denied all
knowledge of what had been going on, although the ring managed to manipulate
rate submissions across multiple institutions.
SOFR Is Replacing Libor in the U.S.
It’s not just these scandals that undercut Libor. According to ICE, banks
have been changing the way they transact business, and, as a result, Libor
rate became a less reliable benchmark.
SOFR
is the main replacement for Libor in the United States. This benchmark is
based on the rates U.S. financial institutions pay each other for overnight
loans.
These
transactions take the form of Treasury bond repurchase agreements, otherwise
known as repos agreements. They allow banks to to meet liquidity and reserve
requirements, using Treasurys as collateral. SOFR comprises the weighted
averages of the rates charged in these repo transactions.
How Does the End of Libor Impact Your Loans?
Even if Libor doesn’t completely disappear as soon as expected,
there’s a good chance banks and other lenders will start looking for other
ways to determine market rates.
If you have an adjustable-rate loan, check to see if it’s based on
Libor. For loans based on Libor, find out what index your lender will be
switching to. While there might not be a set answer now, keep an eye on the
situation. A switch to a different index might mean a higher base rate in the
future.
In Class Exercise
1. What is the primary reason for the phase-out
of LIBOR?
a) Scandals and crises associated with LIBOR
b) Increased reliability of LIBOR rates
c) Higher demand for adjustable-rate loans
Answer:
a
Explanation: The primary reason for the phase-out of
LIBOR is the scandals and crises it has been associated with.
2. What is SOFR, the replacement for LIBOR, based
on?
a) Rates of international banks
b) Rates of US financial institutions for overnight loans
c) Rates of European financial institutions for long-term loans
Answer:
b
Explanation: SOFR, the replacement for LIBOR, is based
on the rates that US financial institutions pay each other for overnight
loans.
3. What event led to the increased scrutiny of
LIBOR and its manipulation?
a) Dot-com bubble burst
b) Pandemic Covid-19
c) 2008 financial crisis
Answer:
c
Explanation: The 2008 financial crisis led to increased
scrutiny of LIBOR and its manipulation.
4. How were LIBOR rates calculated?
a) Based on actual transaction rates
b) Based on estimates from 18 global banks
c) Based on rates set by central banks
Answer:
b
Explanation: LIBOR rates were calculated based on
estimates from up to 18 global banks on the interest rates they would charge
for different loan maturities.
5. What did AIG primarily use credit default
swaps (CDS) for?
a) Insuring against defaults on subprime mortgages
b) Investing in real estate
c) Funding government projects
Answer:
a
Explanation: AIG primarily used credit default swaps
(CDS) to insure against defaults on subprime mortgages.
6. What type of transactions form the basis of
SOFR?
a) Currency exchange transactions
b) Treasury bond repurchase agreements
c) Stock market transactions
Answer:
b
Explanation: SOFR is based on Treasury bond repurchase
agreements, also known as repo transactions.
7. Which of the following is NOT mentioned as a
financial product influenced by LIBOR?
a) Municipal bonds
b) Corporate bonds
c) Cryptocurrencies
Answer:
c
Explanation: Cryptocurrencies are not mentioned as a
financial product influenced by LIBOR.
8. What measures were taken to calculate LIBOR
rates more accurately?
a) Central banks set the rates directly
b) The Intercontinental Exchange (ICE) Benchmark Administration
eliminated extreme submissions
c) LIBOR rates were based on actual transactions rather than
estimates
Answer:
b
Explanation: The Intercontinental Exchange (ICE)
Benchmark Administration eliminated extreme submissions to help calculate
LIBOR rates more accurately.
Part II: Forex quote
6 Correlated
Currency Pairs by Investopedia (youtube)
1.
What is the base currency in the Euro/US Dollar currency pair?
a)
US Dollar
b)
Euro
c)
Swiss Franc
Answer: b
Explanation:
In the Euro/US Dollar pair, the Euro is the base currency. This means that
the exchange rate indicates how many US Dollars are needed to buy one Euro.
2.
Which currency pair tends to have a negative correlation with the US
Dollar/Swiss Franc pairing?
a)
Euro/US Dollar
b)
British Pound/US Dollar
c)
US Dollar/Swiss Franc
Answer: a
Explanation:
The Euro/US Dollar pair tends to have a negative correlation with the US
Dollar/Swiss Franc pair. This means that as one pair moves up, the other
tends to move in the opposite direction.
3.
What is the commonly used term for trading the US Dollar/Japanese Yen pair?
a)
Cable
b)
Swissy
c)
Gopher
Answer: c
Explanation:
The US Dollar/Japanese Yen pair is often referred to as "trading the
gopher" in forex trading slang.
4.
Which currency pair usually exhibits a positive correlation with the Euro/US
Dollar?
a)
US Dollar/Swiss Franc
b)
British Pound/US Dollar
c)
Euro/US Dollar
Answer: b
Explanation:
The British Pound/US Dollar pair usually exhibits a positive correlation with
the Euro/US Dollar pair.
5.
What is the nickname for the British Pound/US Dollar pairing?
a)
Cable
b)
Gopher
c)
Swissy
Answer: a
Explanation:
The British Pound/US Dollar pairing is commonly referred to as "trading
the cable" in forex trading.
6.
What currency is considered a safe haven during times of political unrest?
a)
US Dollar
b)
Euro
c)
Swiss Franc
Answer: c
Explanation:
The Swiss Franc is often considered a safe haven currency during periods of
political instability.
Live Forex Quotes & Currency Rates | Forexlive 2/2/2022
In Class Exercise
1.
What is the current exchange rate for the British Pound/US Dollar pair?
a)
1.26258
b)
1.26265
c)
1.26270
Answer: a
2.
What is the current exchange rate for the Euro/US Dollar pair?
a)
1.07830
b)
1.07835
c)
1.07840
Answer: a
3.
What is the current exchange rate for the USD/Yen pair?
a)
149.237
b)
160.929
c)
110.900
Answer: a
4.
What is the current exchange rate for the Euro/Japanese Yen pair?
a)
160.922
b)
160.935
c)
160.940
Answer: a
Explanation: EURJPY=EURUSD×USDJPY; EURJPY=1.0783 *
149.237 ≈ 160.922
5.
What is the current exchange rate for the GBP/Japanese Yen pair?
a)
188.425
b)
188.480
c)
188.279
Answer: a
Explanation:
GBPJPY=GBPUSD×USDJPY; GBPJPY=1.26259 * 149.237 ≈ 188.425
Quote Currency in Forex: Meaning and Examples
https://www.investopedia.com/terms/q/quotecurrency.asp
By ADAM HAYES Updated May
25, 2022 Reviewed by GORDON SCOTT Reviewed by Gordon Scott
What
Is a Quote Currency?
In
foreign exchange (forex), the quote currency, commonly known as the counter
currency, is the second currency in both a direct and indirect currency pair
and is used to determine the value of the base currency.
In
a direct quote, the quote currency is the foreign currency, while in an
indirect quote, the quote currency is the domestic currency.
The quote currency is listed after the base currency in the pair when
currency exchange rates are quoted. One can determine how much of the quote
currency they need to sell in order to purchase one unit of the first or base
currency.
KEY
TAKEAWAYS
·
The quote currency (counter currency) is
the second currency in both a direct and indirect currency pair and is used
to value the base currency.
·
Currency quotes show many units of the
quote currency they will need to exchange for one unit of the first (base)
currency.
·
In a direct quote, the quote currency is
the foreign currency, while in an indirect quote, the quote currency is the
domestic currency.
·
When somebody buys (goes long) a currency
pair, they sell the counter currency; if they short a currency pair, they
would buy the counter currency.
Understanding
Quote Currency
Understanding the quotation
and pricing structure of currencies is essential for anyone wanting to trade
currencies in the forex market. Market makers tend to trade specific currency
pairs in set ways, either direct or indirect, which means understanding the
quote currency is paramount.
A currency pair's exchange
rate reflects how much of the quote currency is needed to be sold/bought to
buy/sell one unit of the base currency. As the rate in a currency pair
increases, the value of the quote currency falls, whether the pair is direct
or indirect.
Most U.S. dollar (USD) pairs
hold the USD as the base currency. If the USD is not the base, it is a
reciprocal currency.
For example, the cross rate
between the U.S. dollar and the Canadian dollar is denoted as USD/CAD and is
a direct quote. This means that the CAD is the quote currency, while the USD
is the base currency. The CAD is used as a reference to determine the value
of one USD. From a U.S.-centric point of view, the CAD is a foreign currency.
On the other hand, the
EUR/USD denotes the cross rate between the euro and the U.S. dollar and is an
indirect quote. This means that the EUR is the base currency, and the USD is
the quote currency. Here, the USD is the domestic currency and determines the
value of one EUR.
Special
Considerations
Currency pairs—both base and
quote currencies—are affected by a number of different factors. Some of these
include economic activity, the monetary and fiscal policy enacted by central
banks, and interest rates.
Major currencies, such as
the euro and U.S. dollar, are more likely to be the base currency rather than
the quote currency in a currency pair, especially when it comes to trades in
exotic currencies.
The most commonly traded
currency pairs on the market in 2021 were:
EUR/GBP
EUR/USD
GBP/USD
USD/CHF
USD/JPY
As noted above, the first
currency in these pairings is the base currency while the second one (after
the slash) is the quote currency. In the GBP/USD pairing, the pound is the
base currency or the one that is being purchased while the dollar is the
quote currency. This is the one that is being sold.
Example
of a Quote Currency
Let's assume a trader wants
to purchase £400 using U.S. dollars. This would involve a trade using the
GBP/USD currency pair. In order to execute the trade, they need to figure out
how many USD (the quote currency) they need to sell in order to get £400.
The exchange rate for the
pair at the end of the trading day on June 3, 2021, was 1.4103. This means it
cost the trader $1.4103 to purchase £1. To complete the transaction on that
day, the trader had to sell 564.12 units of the quote currency in order to
get 400 units of the base currency or $564.12 for £400 = (400 x 1.4103).
Summary:
╔═════════════════════════════╗
║ Currency Exchange
Rates ║
║ Indirect Quote: EUR/USD ║
║
------------------------------------------------------------ ║
║ Base Currency: Euro
(EUR) ║
║ Quote Currency: US
Dollar (USD) ║
║ Exchange Rate: 1 EUR = 1.08 USD (2/11/2024)║
║
║
║ Direct Quote: USD/EUR ║
║
-------------------------------------------------------------║
║ Base Currency: US
Dollar (USD) ║
║ Quote Currency: Euro
(EUR) ║
║ Exchange Rate: 1 USD = 0.93 EUR (2/11/2024)║
║
║
║ Quote Currency: US
Dollar (USD) ║
║ Exchange Rate: 1 EUR = 1.08 USD (2/11/2024)║
║ ║
║ Direct Quote= 1/
Indirect Quote ║
║
║
╚═════════════════════════════╝
In Class Exercise
1. What is the quote currency
in the EUR/USD currency pair?
a) EUR
b) USD
c) GBP
Answer:
b
Explanation:
In the EUR/USD pair, the quote currency is the US Dollar (USD). It represents
the amount of USD needed to purchase one unit of Euro (EUR).
2. In a direct quote, what
is the quote currency?
a) Foreign currency
b) Domestic currency
c) Base currency
Answer:
a
Explanation:
In a direct quote, the quote currency is the foreign currency, while the base
currency is the domestic currency. The quote currency is the currency being sold
or bought.
3. Which currency pair
represents an indirect quote?
a) USD/JPY
b) GBP/USD
c) USD/EUR
Answer:
b
Explanation:
In an indirect quote, the quote currency is the domestic currency. In the
GBP/USD pair, the quote currency (USD) is the domestic currency, so it is an
indirect quote.
4. Which currency pair is a
direct quote?
a) EUR/GBP
b) USD/CHF
c) GBP/JPY
Answer:
c
Explanation:
In a direct quote, the base currency is the domestic currency and the quote
currency is the foreign currency. In the USD/CHF pair, the US Dollar (USD) is
the base currency, and the Swiss Franc (CHF) is the quote currency.
Therefore, USD/CHF is a direct quote.
6. What currency pair
represents the value of one Euro in US Dollars?
a) EUR/USD
b) USD/EUR
c) EUR/GBP
Answer:
a
Explanation:
In the EUR/USD pair, the value of one Euro is represented in US Dollars. It
shows how many US Dollars are needed to buy one Euro.
7. Which currency pair
represents the value of one British Pound in US Dollars?
a) GBP/USD
b) USD/GBP
c) GBP/EUR
Answer:
a
Explanation:
In the GBP/USD pair, the value of one British Pound is represented in US
Dollars. It shows how many US Dollars are needed to buy one British Pound.
8. What currency is the base
currency in the USD/CHF pair?
a) USD
b) CHF
c) EUR
Answer:
a
Explanation:
In the USD/CHF pair, the base currency is the US Dollar (USD). It represents
the currency being bought or sold.
First
Midterm Exam Study Guide Word
File
Multiple
Choice Questions (45*2.2=99, total 50 questions and 5 questions will not be
graded)
· Part I – Multilateral vs. Bilateral (questions 1-11)
· Part II – Current Account, Capital Account (questions 12-22)
· Part III – The History of Money (questions 23-29)
· Part IV: Bretton Woods Agreement and System (questions 30-41)
· Part V: Currency Pairs, Direct Quote vs. Indirect Quote, Base vs. Quote Currency (questions 42-50)
Chapter
4 Exchange Rate Determination
Part I: What determines the strength of a
currency?
Hint: The value of currency is determined by
demand and supply, unless it is manipulated by the government.
What Determines The Strength Of A Currency?
Q: What factors
determine the strength of a currency?
A: Currency trading is complicated by the fact that there are so many
factors involved. Not only are
there a number of country-specific variables that
go into determining a currency's strength, but there are also other benchmarks--other
currencies, for example, as well as commodities--against which a currency's
strength can be measured.
However,
three crucial factors are as follows:
1.
Interest rates. High interest rates help
promote a strong currency, because foreign investors can get a higher return
by investing in that country. However, the level of interest rates is
relative. You've probably noticed that interest rates on CDs, savings accounts and money market accounts are
very low right now. So are U.S. Treasury bond rates and the U.S. federal funds rate. Ordinarily,
this would weaken the U.S. dollar, except for the fact that interest rates
behind other major world currencies are also low.
3.
Stability. A strong government with a well-established
rule of law and a history of constructive economic policies are the
type of things that attract investment and thus promote a strong currency. In
the case of the U.S. dollar, its strength is further augmented by the fact
that commodities are generally traded in dollars, and many countries use the
dollar as a reserve currency.
In class exercise
1. What
are some of the factors that determine the strength of a currency according
to Richard Barrington?
a)
Interest rates, economic policies, and government stability
b)
Exchange rates, political stability, and government debt
c)
Inflation rates, trade balance, and consumer spending
Answer: a
Explanation:
According to Richard Barrington, interest rates, economic policies, and
government stability are crucial factors in determining the strength of a
currency.
2. How
do high interest rates affect a currency's strength?
a) High
interest rates weaken a currency because they attract foreign investment.
b) High
interest rates strengthen a currency because they attract foreign investment.
c) High
interest rates have no effect on a currency's strength.
Answer: b
Explanation:
High interest rates encourage foreign investors to invest in a country,
seeking higher returns, thus strengthening the currency.
3. What
role do economic policies play in promoting a strong currency?
a) Tight
fiscal discipline and anti-inflationary monetary policies promote a strong
currency.
b)
Loose fiscal policies and high inflation rates promote a strong currency.
c)
Economic policies have no impact on a currency's strength.
Answer: a
Explanation:
Economic policies, such as tight fiscal discipline and anti-inflationary
measures, contribute to a stable economic environment, which in turn promotes
a strong currency.
4. How
does stability contribute to currency strength?
a)
Political instability and economic uncertainty lead to a strong currency.
b)
Currency strength is not influenced by stability.
c)
Stable government and economic policies attract investment, promoting a
strong currency.
Answer: c
Explanation:
Stability in government and economic policies attracts investment, which
strengthens the currency due to increased confidence from investors.
5. Why
do governments aim for stability rather than outright currency strength?
a)
Strong currencies lead to increased trade competitiveness.
b) Weak
currencies lead to higher domestic inflation.
c)
Destabilizing fluctuations can harm the economy, so stability is preferred.
Answer: c
Explanation:
Governments prefer stability to avoid destabilizing fluctuations, which could
negatively impact the economy, even though outright currency strength may
have some advantages.
Main Factors that
Influence Exchange Rates (youtube, investopedia)
In class exercise
1.
What factor typically leads to a rise in a
country's currency value relative to others?
a)
Higher inflation rates
b)
Lower inflation rates
Answer: b
Explanation:
Lower inflation rates increase a country's purchasing power relative to
others, leading to a rise in its currency value.
2.
How do higher interest rates impact
exchange rates?
a)
They always lead to currency appreciation.
b)
They have no impact on exchange rates.
c)
They may lead to currency appreciation unless offset by high inflation or
other factors.
Answer: c
Explanation:
Higher interest rates generally attract foreign investment, potentially
leading to currency appreciation. However, if other factors like high
inflation counteract this effect, the impact on exchange rates may be
neutralized.
3.
Why are countries with large public deficits
less attractive to foreign investors?
a)
They tend to have stronger currencies.
b)
High debt can lead to inflation and lower currency value.
c)
They offer higher returns on investment.
Answer: b
Explanation:
Large public deficits often result in high levels of debt, which can lead to
inflation and subsequently lower the value of a country's currency, making it
less appealing to foreign investors.
4.
How do improving terms of trade affect a country's currency value?
a)
They always lead to currency appreciation.
b)
They may lead to currency appreciation unless offset by unfavorable factors.
c)
They cause currency depreciation.
Answer: a
Explanation:
Improving terms of trade mean a country's exports become more valuable relative
to its imports, leading to increased demand for its currency and thus
currency appreciation.
1.
What typically happens to a country's
currency during political turmoil?
a)
It strengthens due to increased confidence.
b)
It weakens due to decreased confidence.
c)
It remains unaffected.
Answer: b
Explanation:
Political turmoil often leads to uncertainty and decreased investor
confidence, resulting in a weakening of the country's currency.
6.
Which factor is considered a fundamental driver of exchange rates?
a)
Political stability
b)
Economic performance
c)
Social media trends
Answer: b
Explanation:
Economic performance, including factors such as GDP growth, employment rates,
and productivity, is a key determinant of exchange rates.
Please also read the
following article to learn more about how changes in demand and supply work
on exchange rate.
The foreign exchange market involves
firms, households, and investors who demand and supply currencies coming
together through their banks and the key foreign exchange dealers. Figure 1 (a)
offers an example for the exchange rate between the U.S. dollar and the
Mexican peso. The vertical axis shows the exchange rate for U.S.
dollars, which in this case is measured in pesos. The horizontal
axis shows the quantity of U.S. dollars being traded in the foreign exchange
market each day. The demand curve (D) for U.S. dollars intersects with the
supply curve (S) of U.S. dollars at the equilibrium point (E), which is an
exchange rate of 10 pesos per dollar and a total volume of $8.5 billion.
Figure 1. Demand
and Supply for the U.S. Dollar and Mexican Peso Exchange Rate. (a) The
quantity measured on the horizontal axis is in U.S. dollars, and the exchange
rate on the vertical axis is the price of U.S. dollars measured in Mexican
pesos. (b) The quantity measured on the horizontal axis is in Mexican pesos,
while the price on the vertical axis is the price of pesos measured in U.S.
dollars. In both graphs, the equilibrium exchange rate occurs at point E, at
the intersection of the demand curve (D) and the supply curve (S).
Figure 1 (b)
presents the same demand and supply information from the perspective of the
Mexican peso. The vertical axis shows the exchange rate for Mexican pesos,
which is measured in U.S. dollars. The horizontal axis shows the quantity of
Mexican pesos traded in the foreign exchange market. The demand curve (D) for Mexican
pesos intersects with the supply
curve (S) of Mexican pesos at the equilibrium point (E), which
is an exchange rate of 10 cents in U.S. currency for each Mexican peso and a
total volume of 85 billion pesos. Note that the two exchange rates
are inverses: 10 pesos per dollar is the same as 10 cents per peso (or $0.10
per peso). In the actual foreign exchange market, almost all of the
trading for Mexican pesos is done for U.S. dollars. What factors would cause
the demand or supply to shift, thus leading to a change in the equilibrium exchange rate? The answer
to this question is discussed in the following section.
Expectations
about Future Exchange Rates
One reason to demand a
currency on the foreign exchange market is the belief that the value of the
currency is about to increase. One reason to supply a currency—that is, sell it on the foreign exchange market—is the expectation that the value of the currency is about
to decline. For example, imagine that a leading business newspaper,
like the Wall Street Journal or
the Financial Times, runs an
article predicting that the Mexican peso will appreciate in value. The likely
effects of such an article are illustrated in Figure 2.
Demand for the Mexican peso shifts to the right, from D0 to D1, as investors become eager to purchase pesos.
Conversely, the supply of pesos shifts to the left, from S0 to S1, because investors
will be less willing to give them up. The result is that the equilibrium
exchange rate rises from 10 cents/peso to 12 cents/peso and the equilibrium
exchange rate rises from 85 billion to 90 billion pesos as the equilibrium
moves from E0 to
E1.
Figure 2. Exchange
Rate Market for Mexican Peso Reacts to Expectations about Future Exchange
Rates. An announcement that the peso exchange rate is likely to
strengthen in the future will lead to greater demand for the peso in the
present from investors who wish to benefit from the appreciation. Similarly,
it will make investors less likely to supply pesos to the foreign exchange
market. Both the shift of demand to the right and the shift of supply to the
left cause an immediate appreciation in the exchange rate.
Figure 2 also
illustrates some peculiar traits of supply and demand diagrams in the foreign
exchange market. In contrast to all the other cases of supply and demand you
have considered, in the foreign
exchange market, supply and demand typically both move at
the same time. Groups of participants in the foreign exchange market like
firms and investors include some who are buyers and some who are sellers. An
expectation of a future shift in the exchange rate affects both buyers and
sellers—that is, it affects both demand and supply
for a currency.
The shifts in demand and
supply curves both cause the exchange rate to shift in the same direction; in
this example, they both make the peso exchange rate stronger. However, the shifts
in demand and supply work in opposing directions on the quantity traded. In
this example, the rising demand for pesos is causing the quantity to rise
while the falling supply of pesos is causing quantity to fall. In this
specific example, the result is a higher quantity. But in other cases, the
result could be that quantity remains unchanged or declines.
This example also helps to
explain why exchange rates often move quite substantially in a short
period of a few weeks or months. When investors expect a country’s currency to strengthen in the future, they buy the
currency and cause it to appreciate immediately. The appreciation of the
currency can lead other investors to believe that future appreciation is
likely—and thus lead to even further appreciation.
Similarly, a fear that a currency might weaken
quickly leads to an actual weakening
of the currency, which often reinforces the belief that the currency is going
to weaken further. Thus, beliefs about the future path of exchange
rates can be self-reinforcing, at least for a time, and a large share of the
trading in foreign exchange markets involves dealers trying to outguess each
other on what direction exchange rates will move next.
In class exercise
Think about the changes in
demand and supply when the following changes occur. And draw demand and
supply curve to explain.
1)
Inflation goes up è currency
demand high or low? è currency
value up or down?
2) Real
interest rate goes up è currency demand high or low? è currency value up or down?
1)
Domestic residents’ income goes up è currency demand high or low? è currency value up or down?
· Current account goes up è currency demand high or low? è currency value up or down?
2)
Public debt
goes up è currency
demand high or low? è currency
value up or down?
3) Recession or crisis è currency demand high or low? è currency value up or down?
4) Other accidental events è currency demand high or low? è currency value up or down?
In class exercise
1. Why does an increase in
interest rates typically lead to a shift in demand for a currency?
a) Investors anticipate
lower returns on other investments.
b) Investors expect the
currency's value to decrease.
c) Investors seek higher
returns, leading to increased demand for the currency.
Answer: C
Explanation: Higher interest rates
attract investors seeking higher returns, leading to increased demand for the
currency.
2. What effect does an
increase in inflation usually have on a currency's demand?
a) Demand for the currency
decreases as purchasing power declines.
b) Demand for the currency
increases due to higher purchasing power.
c) Inflation has no impact
on currency demand.
Answer: a
Explanation: Higher inflation erodes
purchasing power, leading to decreased demand for the currency.
3. When a country
experiences an increase in current account deficit, what typically happens to
the demand for its currency?
a) Demand for the currency
rises as trade balance improves.
b) Demand for the currency
decreases due to higher borrowing needs.
c) Demand for the currency decreases
as imports exceed exports.
Answer: C
Explanation: An increase in current
account deficit signals higher imports than exports, leading to decreased
demand for the country's currency.
4. How does an increase in
government debt usually impact the demand for a country's currency?
a) Demand for the currency
rises due to increased government spending.
b) Demand for the currency
decreases due to concerns about fiscal stability..
c) Demand for the currency
decreases as investors become wary of inflation
Answer: B
Explanation: Higher government debt may
raise concerns about fiscal stability, leading to decreased demand for the
country's currency.
5. Why might an expectation
of currency depreciation lead to decreased demand for a currency?
a) Investors seek to benefit
from buying the currency at its current value.
b) Investors anticipate
higher returns on other investments.
c) Investors expect the
currency's value to decrease, leading to reduced demand. Answer: C
Explanation: Expectations of currency
depreciation may prompt investors to seek alternatives, reducing demand for
the currency.
6. What happens to the
demand for a currency when the country's economic performance improves?
a) Demand for the currency
decreases as investors lose confidence.
b) Demand for the currency
increases due to higher confidence in the economy.
c) Economic performance has
no impact on currency demand.
Answer: B
Explanation: Improved economic
performance often boosts investor confidence, leading to increased demand for
the currency.
7. How does political
instability typically affect the demand for a country's currency?
a) Demand for the currency
rises as investors seek safe-haven assets.
b) Demand for the currency
decreases due to uncertainty and risk.
c) Political instability has
no impact on currency demand.
Answer: B
Explanation: Political instability tends
to increase uncertainty and risk, leading to decreased demand for the
country's currency.
8. What effect does an
increase in trade surplus usually have on the demand for a country's
currency?
a) Demand for the currency
increases as exports increase relative to imports.
b) Demand for the currency
decreases as exports exceed imports.
c) Demand for the currency
rises due to increased trade activity.
Answer: A
Explanation: An increase in trade
surplus indicates higher exports relative to imports, boosting demand for the
country's currency.
9. How does a decrease in
foreign investment typically impact the demand for a country's currency?
a) Demand for the currency
decreases due to reduced confidence in the economy.
b) Demand for the currency
increases as investors seek higher returns.
c) Foreign investment has no
impact on currency demand.
Answer A
Explanation: A decrease in foreign
investment may signal reduced confidence in the country's economy, leading to
decreased demand for its currency.
10. What happens to the
demand for a currency when the country's central bank intervenes in the
foreign exchange market?
a) Demand for the currency
decreases due to central bank manipulation.
b) Demand for the currency
increases as investors respond to central bank actions.
c) Demand for the currency
may increase or decrease depending on market sentiment.
Answer: C
Explanation: Central bank interventions can
influence market sentiment, leading to varied responses in currency demand.
· If not yet, please watch the
following video. Supply and demand curves in foreign exchange by
Khan Academy (video)
Supply
and demand curves in foreign exchange (khan academy)
Part II: Fixed
exchange rate vs. floating exchange rate
Floating and
Fixed Exchange Rates- Macroeconomics (youtube)
In class exercise
1.
What is a floating exchange rate?
a)
An exchange rate controlled by the government.
b)
An exchange rate that fluctuates with the market.
c)
An exchange rate pegged to another currency.
Answer: B
Explanation:
A floating exchange rate is one that fluctuates with the market based on
supply and demand dynamics.
2.
What characterizes a fixed exchange rate?
a)
Fluctuations determined by market forces.
b)
Pegging of the rate to a commodity.
c)
Control by the government to maintain a steady rate.
Answer: C
Explanation:
In a fixed exchange rate system, the government intervenes to maintain a
stable exchange rate.
3.
Why might a government choose a fixed exchange rate policy?
a)
To stabilize currency fluctuations and promote certainty in trade.
b)
To allow market forces to determine the rate.
c)
To encourage speculative trading in the foreign exchange market.
Answer: A
Explanation:
Governments may opt for fixed exchange rates to provide stability for
businesses engaged in international trade.
4.
What is a key advantage of floating exchange rates?
a)
Stability in international trade.
b)
Flexibility to adjust to changing economic conditions.
c)
Government control over currency values.
Answer: B
Explanation:
Floating exchange rates allow for adjustment to economic changes without
government intervention.
5.
Which factor influences the exchange rate under a floating system?
a)
Market demand and supply.
b)
Government policies.
c)
International trade agreements.
Answer: A
Explanation:
Under floating exchange rates, the exchange rate is determined by market
forces of supply and demand.
6.
What role does government intervention play in a floating exchange rate
system?
a)
Government sets the exchange rate.
b)
Government does not intervene; rates are determined by the market. (
c)
Government controls all foreign exchange transactions.
Answer: B
Explanation:
In a floating exchange rate system, the government typically does not
intervene in determining exchange rates.
7.
Which scenario is more likely to occur under a fixed exchange rate regime?
a)
Sharp fluctuations in currency values.
b)
Complete freedom for currency markets to operate.
c)
Stable exchange rates maintained by government action.
Answer: C
Explanation:
Fixed exchange rates are characterized by stable currency values maintained
by government intervention.
8.
What factor influences a government's decision to adopt a fixed exchange
rate?
a)
Need for stability in international transactions.
b)
Desire for market-driven currency values.
c)
Preference for flexible exchange rate adjustments.
Answer: A
Explanation:
Governments may choose fixed exchange rates to provide stability and
certainty for international trade.
9.
What distinguishes a floating exchange rate from a fixed exchange rate?
a)
Government control over currency values.
b)
Flexibility versus stability in currency values.
c)
Pegging of the rate to another currency.
Answer: B
Explanation:
Floating exchange rates offer flexibility in currency values, while fixed
rates provide stability.
10.
What is a potential drawback of fixed exchange rates?
a)
Uncertainty in international trade.
b)
Inability to respond to economic shocks.
c)
Volatility in currency values.
Answer: B
Explanation:
Fixed exchange rates may limit a country's ability to adjust to economic
changes.
11.
What factor determines exchange rates under a fixed exchange rate system?
a)
Market demand and supply.
b)
International trade volumes.
c)
Government intervention and control.
Answer: C
Explanation:
Fixed exchange rates are determined by government policies and interventions.
How Are International
Exchange Rates Set?
https://www.investopedia.com/ask/answers/forex/how-forex-exchange-rates-set.asp
By
CAROLINE BANTON Updated March 04, 2021, Reviewed by GORDON SCOTT, Fact
checked by YARILET PEREZ
International
currency exchange rates display how much one unit of a currency can be
exchanged for another currency. Currency
exchange rates can be floating, in which case they change continually based
on a multitude of factors, or they can be pegged (or fixed) to another
currency, in which case they still float, but they move in tandem with the
currency to which they are pegged.
Knowing
the value of a home currency in relation to different foreign currencies
helps investors to analyze assets priced in foreign dollars. For example, for
a U.S. investor, knowing the dollar to euro exchange rate is valuable when
selecting European investments. A declining U.S. dollar could increase the
value of foreign investments just as an increasing U.S. dollar value could
hurt the value of your foreign investments.
KEY
TAKEAWAYS
·
Fixed exchange rate regimes are set to a
pre-established peg with another currency or basket of currencies.
·
A floating exchange rate is one that is
determined by supply and demand on the open market as well as macro factors.
·
A floating exchange rate doesn't mean
countries don't try to intervene and manipulate their currency's price, since
governments and central banks regularly attempt to keep their currency price
favorable for international trade.
·
Floating exchange rates are the most
common and became popular after the failure of the gold standard and the
Bretton Woods agreement.
Floating vs. Fixed Exchange
Rates
Currency
prices can be determined in two main ways: a floating rate or a fixed rate. A floating rate is determined by the open
market through supply and demand on global currency markets. Therefore, if
the demand for the currency is high, the value will increase. If demand is
low, this will drive that currency price lower. Of course, several
technical and fundamental factors will determine what people perceive is a
fair exchange rate and alter their supply and demand accordingly.
The currencies of most of
the world's major economies were allowed to float freely following the
collapse of the Bretton Woods system between 1968 and 1973. Therefore, most
exchange rates are not set but are determined by on-going trading activity in
the world's currency markets.
Factors That Influence
Exchange Rates
Floating rates are
determined by the market forces of supply and demand.
How much demand there is in relation to supply of a currency will determine
that currency's value in relation to another currency. For example, if the
demand for U.S. dollars by Europeans increases, the supply-demand
relationship will cause an increase in the price of the U.S. dollar in
relation to the euro. There are countless geopolitical and economic
announcements that affect the exchange rates between two countries, but a few of the most common include interest
rate changes, unemployment rates, inflation reports, gross domestic product
numbers, manufacturing data, and commodities.
A fixed or pegged rate is
determined by the government through its central bank. The rate is set
against another major world currency (such as the U.S. dollar, euro, or yen).
To maintain its exchange rate, the government will buy and sell its own
currency against the currency to which it is pegged.Some
countries that choose to peg their currencies to the U.S. dollar include
China and Saudi Arabia.
Short-term
moves in a floating exchange rate currency reflect speculation, rumors,
disasters, and everyday supply and demand for the currency. If supply
outstrips demand that currency will fall, and if demand outstrips supply that
currency will rise. Extreme short-term
moves can result in intervention by central banks, even in a floating rate
environment. Because of this, while most major global currencies are
considered floating, central banks and governments may step in if a nation's
currency becomes too high or too low.
A currency that is too high
or too low could affect the nation's economy negatively, affecting trade and
the ability to pay debts. The government or central bank will attempt to
implement measures to move their currency to a more favorable price.
Macro Factors
More
macro factors also affect exchange rates. The 'Law of One Price' dictates that in a world of international
trade, the price of a good in one country should equal the price in another.
This is called purchasing price parity (PPP). If prices get out of whack, the
interest rates in a country will shift—or else the
exchange rate will between currencies. Of course, reality doesn't always
follow economic theory, and due to several mitigating factors, the law of one
price does not often hold in practice. Still, interest rates and relative prices will influence exchange rates.
Another macro factor is the
geopolitical risk and the stability of a country's government. If the
government is not stable, the currency in that country is likely to fall in
value relative to more developed, stable nations.
Generally,
the more dependent a country is on a primary domestic industry, the stronger
the correlation between the national currency and the industry's commodity
prices.
There
is no uniform rule for determining what commodities a given currency will be
correlated with and how strong that correlation will be. However, some
currencies provide good examples of commodity-forex relationships.
Consider
that the Canadian dollar is positively correlated to the price of oil.
Therefore, as the price of oil goes up, the Canadian dollar tends to
appreciate against other major currencies. This is because Canada is a net
oil exporter; when oil prices are high, Canada tends to reap greater revenues
from its oil exports giving the Canadian dollar a boost on the foreign
exchange market.
Another
good example is the Australian dollar, which is positively correlated with
gold. Because Australia is one of the world's biggest gold producers, its
dollar tends to move in unison with price changes in gold bullion. Thus, when
gold prices rise significantly, the Australian dollar will also be expected
to appreciate against other major currencies.
Maintaining Rates
Some
countries may decide to use a pegged exchange rate that is set and maintained
artificially by the government. This rate will not fluctuate intraday and may
be reset on particular dates known as revaluation dates. Governments of
emerging market countries often do this to create stability in the value of
their currencies. To keep the pegged
foreign exchange rate stable, the government of the country must hold large
reserves of the currency to which its currency is pegged to control changes
in supply and demand.
In class exercise
1. How do governments intervene in a
floating exchange rate system if necessary?
a) By setting fixed exchange rates
b) By pegging their currency to a basket of currencies
c) By manipulating interest rates and implementing
foreign exchange controls
Answer: C
Explanation: Governments may intervene in a floating exchange rate
system through measures such as manipulating interest rates and implementing
foreign exchange controls to stabilize their currency's value.
2. How does the Law of One Price influence exchange
rates?
a) It dictates that exchange rates should remain fixed.
b) It suggests that the price of a good in one country
should equal the price in another, affecting interest rates or exchange
rates.
c) It determines the value of a currency based on
international trade agreements.
Answer: B
Explanation: The Law of One Price suggests that if prices get out of
alignment, interest rates or exchange rates will adjust to restore
equilibrium in international trade.
3. What commodity is the Canadian dollar positively
correlated with?
a) Gold
b) Oil
c) Wheat
Answer: B
Explanation: The Canadian dollar is positively correlated with the
price of oil due to Canada's significant oil exports.
4. Why do governments of emerging market countries often
use a pegged exchange rate system?
a) To create stability in the value of their currencies
b) To encourage market speculation
c) To maintain flexible exchange rates
Answer: A
Explanation: Governments of emerging market countries may use a
pegged exchange rate system to stabilize the value of their currencies and
promote economic stability.
5. How do governments maintain stability in a pegged
exchange rate system?
a) By allowing market forces to determine exchange rates
b) By holding large reserves of the currency to which
their currency is pegged
c) By implementing foreign exchange controls
Answer: B
Explanation: Governments maintain stability in a pegged exchange
rate system by holding significant reserves of the currency to which their
currency is pegged, allowing them to control supply and demand.
The Impossible Trinity
or "The Trilemma"
– can a country controls its interest rates, exchange
rates, and capital flow simultaneously?
Impossible
Trinity (youtube)
A - set a fixed exchange rate between its currency and
another while allowing capital to flow freely across its borders,
B - allow capital to flow freely and set
its own monetary policy, or
C - set its own monetary policy and maintain
a fixed exchange rate.
The Impossible Trinity or "The
Trilemma", in which two policy positions are possible. If a nation were
to adopt position a, for example,
then it would maintain a fixed exchange rate and allow free capital flows,
the consequence of which would be loss of monetary sovereignty.
The Impossible Trinity - 60 Second
Adventures in Economics (5/6) (video)
The impossible trinity (also
known as the trilemma) is a concept in international
economics which states that it is
impossible to have all three of the following at the same time:
· free capital movement
(absence of capital controls)
· an
independent monetary policy
It
is both a hypothesis based on the uncovered interest rate
parity condition, and a finding from empirical studies where governments
that have tried to simultaneously pursue all three goals have failed. The
concept was developed independently by both John Marcus Fleming in
1962 and Robert Alexander Mundell in
different articles between 1960 and 1963.
Policy
choices
According to the impossible trinity, a central bank can only
pursue two of the above-mentioned three policies simultaneously. To see why,
consider this example:
Assume that world interest rate is at 5%. If the home central bank tries
to set domestic interest rate at a rate lower than 5%, for example at 2%,
there will be a depreciation pressure on the home currency, because
investors would want to sell their low yielding domestic currency and buy
higher yielding foreign currency. If the central bank also wants to have free
capital flows, the only way the central bank could prevent depreciation of
the home currency is to sell its foreign currency reserves. Since foreign
currency reserves of a central bank are limited, once the reserves are
depleted, the domestic currency will depreciate.
Hence, all three of the policy objectives
mentioned above cannot be pursued simultaneously. A central bank has to forgo one of the three objectives.
Therefore, a central bank has three policy combination options.
Options
In terms of the diagram above (Oxelheim, 1990), the options are:
·
Option (a): A stable exchange rate and free capital
flows (but not an independent monetary policy because setting a domestic
interest rate that is different from the world interest rate would undermine
a stable exchange rate due to appreciation or depreciation pressure on the
domestic currency).
·
Option (b): An independent monetary policy and free
capital flows (but not a stable exchange rate).
·
Option (c): A stable exchange rate and independent
monetary policy (but no free capital flows, which would require the use
of capital controls.
Currently, Eurozone members have chosen
the first option (a) while most other countries have opted for the second one
(b). By contrast, Harvard
economist Dani Rodrik advocates
the use of the third option (c) in his book The Globalization Paradox, emphasizing
that world GDP grew fastest during the Bretton Woods era when capital
controls were accepted in mainstream economics. Rodrik also argues that the
expansion of financial globalization and the free movement of
capital flows are the reason why economic crises have become more frequent in
both developing and advanced economies alike. Rodrik has also developed the
"political trilemma of the world economy", where
"democracy, national sovereignty and global economic
integration are mutually incompatible: we can combine any two of the
three, but never have all three simultaneously and in full."
(from
Wikipedia)
In class
exercise
1. What
is the Impossible Trinity in economics?
a) The idea
that a government can choose fixed interest rates, free capital movements,
and set its own interest rate simultaneously
b) A set of
three economic policies that every country must follow
c) A theory
suggesting that economic growth is impossible in the modern era
Answer: a
Explanation: The Impossible Trinity states
that a government can only choose two out of three options: fixed interest
rates, free capital movements, and the ability to set its own interest rate.
2) Which
country has chosen free capital movement and fixed interest rates?
a) UK
b) Singapore
c) China
Answer: b
Explanation: The example mentions that
Singapore has chosen free capital movement and fixed interest rates.
3) What
happens when a country tries to implement all three conditions of the
Impossible Trinity?
a) It achieves
stable economic growth
b) It faces
unsustainable challenges due to contradictions
c) It
experiences reduced inflation rates
Answer: b
Explanation: The example demonstrates that trying
to maintain all three conditions leads to contradictions and challenges.
4) What is the
primary consequence of a country losing autonomy over its interest rates?
a) Increased
economic stability
b) Currency
appreciation
c) Inability
to set its own monetary policy
Answer: c
Explanation: Losing autonomy over interest
rates means the country cannot independently set its monetary policy.
5) According
to the Impossible Trinity, what are the three choices a government cannot make
simultaneously?
a) Fixed
interest rates, economic stability, and capital controls
b) Free
capital movements, stable currency, and low inflation
c) Fixed
interest rates, free capital movements, and the ability to set its own
interest rate
Answer: c
Explanation: The Impossible Trinity
specifies that a government can only choose two out of these three options.
6) What
happens when a country tries to lower interest rates in a fixed exchange rate
system?
a) Increased
demand for its currency
b) Appreciation
of its currency
c)
Intervention by central banks
Answer: c
Explanation: In a fixed exchange rate
system, attempting to lower interest rates may lead to central bank
intervention.
7) Why do
governments and central banks intervene in a floating exchange rate
environment?
a) To
stabilize interest rates
b) To prevent
extreme short-term moves in currency values
c) To
influence macroeconomic factors
Answer: b
Explanation: Governments and central banks
intervene to avoid extreme fluctuations in currency values in a floating
exchange rate environment.
5)
According to the Impossible Trinity, how
many policy positions are possible for a central bank?
a) One
b) Two
c) Three
Answer: b
Explanation: The Impossible Trinity suggests that
a central bank can only pursue two out of the three policy objectives
mentioned simultaneously.
6)
What happens if a central bank sets its
domestic interest rate lower than the world interest rate in a free capital
flow environment?
a)
Depreciation pressure on the domestic currency
b)
Appreciation pressure on the domestic currency
c) Stability
in the exchange rate
Answer: a
Explanation: Setting a lower domestic
interest rate than the world interest rate leads to depreciation pressure on
the domestic currency due to investors selling the low-yielding domestic
currency.
7)
What policy measure corresponds to Option
(a) in the Impossible Trinity?
a)
Implementation of a currency board system
b) Adoption of
an independent monetary policy
c)
Establishment of free capital flows
Answer: a
Explanation: Option (a) refers to
maintaining a stable exchange rate and free capital flows while forfeiting an
independent monetary policy. A currency board system, where a country pegs
its currency to another at a fixed rate and ensures convertibility,
exemplifies this policy measure.
11) Which policy stance aligns with Option (b)
in the Impossible Trinity?
a) Enabling
free capital flows and stability in the exchange rate
b)
Implementing an independent monetary policy and allowing free capital flows
c)
Prioritizing a stable exchange rate and independent monetary policy
Answer: b
Explanation: Option (b) involves
maintaining an independent monetary policy while enabling free capital flows,
relinquishing the objective of a stable exchange rate.
12) What
strategy corresponds to Option (c) in the Impossible Trinity?
a) Imposing
capital controls and maintaining an independent monetary policy
b) Enacting
free capital flows and stability in the exchange rate
c) Employing a
stable exchange rate and an independent monetary policy
Answer: a
Explanation: Option (c) entails ensuring a
stable exchange rate and an independent monetary policy while restricting
free capital flows, often through the imposition of capital controls.
Summary
Key Terms (Lesson
summary: the foreign exchange market (article) | Khan Academy)
|
Key term |
Definition |
|
foreign exchange market |
a market in which one currency is exchanged for another
currency; for example, in the market for Euros, the Euro is being bought and
sold, and is being paid for using another currency, such as the yen. |
|
demand for currency |
a description of the willingness to buy a currency based on
its exchange rate; for example, as the exchange rate for Euros increases, the
quantity demanded of Euros decreases. |
|
appreciate |
when the value of a currency increases relative to another
currency; a currency appreciates when you need more of another currency to
buy a single unit of a currency. |
|
depreciate |
when the value of a currency decreases relative to another
currency; a currency depreciates when you need less of another currency to
buy a single unit of a currency. |
|
floating exchange rates |
when the exchange rate of currencies are determined in free
markets by the interaction of supply and demand |
·
Why the demand
for a currency is downward sloping
When the
exchange rate of a currency increases, other countries will want less of that
currency. When a currency appreciates (in other words, the exchange rate
increases), then the price of goods in the country whose currency has
appreciated are now relatively more expensive than those in other countries.
Since those goods are more expensive, less is imported from those countries,
and therefore less of that currency is needed.
·
The
equilibrium exchange rate is the interaction of the supply of a currency and
the demand for a currency
As in any
market, the foreign exchange market will be in equilibrium when the quantity
supplied of a currency is equal to the quantity demanded of a currency. If
the market has a surplus or a shortage, the exchange rate will adjust until
an equilibrium is achieved.
|
Economic Factor |
Increase |
Impact on Demand for Peso |
Impact on Supply of Peso |
Impact on Peso |
|
Economic Growth |
↑ |
↑ |
↓ |
Appreciation |
|
Interest Rate |
↑ |
↑ |
↓ |
Appreciation |
|
Inflation |
↑ |
↓ |
↑ |
Depreciation |
|
Political Uncertainty |
↑ |
↓ |
May ↑ |
Depreciation |
|
Public Debt |
↑ |
↓ |
May ↑ |
Depreciation |
|
Current Account |
↑ |
↓ |
May ↑ |
Depreciation |
|
Recession |
↑ |
↓ |
↑ |
Depreciation |
|
Economic Factor |
Decrease |
Impact on Demand for Peso |
Impact on Supply of Peso |
Impact on Peso |
|
Economic Growth |
↓ |
↓ |
↑ |
Depreciation |
|
Interest Rate |
↓ |
↓ |
↑ |
Depreciation |
|
Inflation |
↓ |
↑ |
↓ |
Appreciation |
|
Political Uncertainty |
↓ |
↑ |
↓ |
Appreciation |
|
Public Debt |
↓ |
↑ |
↓ |
Appreciation |
|
Current Account |
↓ |
↑ |
↓ |
Appreciation |
Quiz on Factors Influencing Currency Value
(FYI only)
<Special
Topic: Argentina’s Dollarization Plan>
Argentina faces $1.1 billion debt repayment
deadline as IMF protests simmer
By Adam
Jourdan and Miguel Lo Bianco, January 27, 2022
BUENOS
AIRES, Jan 27 (Reuters) - Argentina is
facing deadlines for nearly $1.1 billion in debt repayments to the
International Monetary Fund (IMF) by Tuesday amid uncertainty over
whether the South American country will pay and tense talks to revamp around
$40 billion in loans.
The
grains-producing country, which has been battling currency and debt crises
for years, is due to pay back $730
million to the IMF on Friday and another $365 million on Tuesday though
officials have not confirmed plans to pay.
Cabinet
Chief Juan Manzur said there was "political decisiveness and eagerness
to pay" the IMF, according to official news outlet Telam.
The IMF
did not immediately respond to a request for comment on the looming payments.
That
has hit sovereign bond prices, some of which have tumbled to below 30 cents
on the dollar. More hard-left politicians within the ruling Peronist
coalition have also started hardening their rhetoric against the IMF.
"What we are proposing is not only to stop
paying the debt and break with the IMF, but to restructure the entire economy
according to the needs of the majority," said Celeste Fierro as she
marched in the city outside the central bank building.
Fierro, like others in the march, said the
country should not pay back its IMF debts: "We believe in ... breaking
with the IMF and ignoring this debt, which is a scam."
Vilma
Ripol, another marcher, said the payments should be suspended and that
Congress should investigate the debt
to avoid a repeat of the 2001 economic crisis.
"It was a disaster in 2001 that took us
years to recover and we had paid,"
she said. "We kept paying and our society kept on going down. Enough
already."
In class
exercise
1.
What is Argentina facing regarding its debt repayment to the IMF?
a) A
$1.1 billion debt repayment deadline.
b) A
$730 million repayment deadline.
c) A
$40 billion loan restructuring deadline.
Answer: a
Explanation: The article states that Argentina is facing deadlines for nearly $1.1
billion in debt repayments to the IMF by Tuesday, with $730 million due on
Friday and another $365 million due on Tuesday.
2)
What is the response of some hard-left politicians within Argentina's ruling
Peronist coalition to the IMF debt repayment?
a) They
advocate for paying the debt to the IMF in full.
b) They
propose restructuring the entire economy according to the needs of the
majority.
c) They
support continued payments but with stricter conditions.
Answer: b
Explanation: The article mentions that some hard-left politicians within the
ruling Peronist coalition have started hardening their rhetoric against the
IMF, proposing to restructure the entire economy according to the needs of
the majority rather than paying back the IMF debt.
3)
What do the protesters in Argentina believe regarding the IMF debt?
a) They
advocate for continued payments to the IMF.
b) They
support suspending payments temporarily and renegotiating the terms.
c) They
propose ignoring the debt and breaking with the IMF.
Answer: c
Explanation: The article quotes one protester as saying, "What we are
proposing is not only to stop paying the debt and break with the IMF, but to
restructure the entire economy according to the needs of the majority."
This indicates a belief among the protesters in ignoring the debt and
breaking ties with the IMF.
The
Economic Crisis in Argentina | Explained (youtube)
In class exercise
1.
When did Argentina receive the largest loan package ever from the IMF?
a)
2017
b)
2018
c)
2019
Answer: b
Explanation:
In 2018, Argentina received a $50 billion loan package from the IMF, which
was the largest in IMF history.
2.
What is one of the persistent challenges facing Argentina despite IMF
intervention?
a)
Trade surplus
b)
Budget surplus
c)
Currency crisis
Answer: c
Explanation:
Despite IMF intervention, Argentina continues to face a currency crisis, with
the peso losing more than half its value against the dollar.
3.
How much did Argentina raise its interest rates to combat inflation?
a)
Over 20%
b)
Over 40%
c)
Over 60%
Answer: c
Explanation:
Argentina raised its interest rates to over 60% from 20% in early 2018 to
combat inflation.
4.
What triggered a run on banks in Argentina?
a)
Stock market crash
b)
Increase in government spending
c)
Economic issues
Answer: c
Explanation:
Economic issues triggered a run on banks in Argentina, with people
withdrawing money daily to buy US dollars.
5.
What is one criticism of the government's use of IMF bailout funds?
a) Use of funds to support the exchange rate
b)
Lack of transparency in fund allocation
c) Over-reliance on IMF support
Answer: a
Explanation:
Critics argue that the government's use of IMF bailout funds to support the
exchange rate is flawed and may hinder Argentina's ability to repay its
debts.
6.
What is capital flight?
a) Movement of wealth out of a country
b) Increase in foreign investment
c)
Government subsidies for exports
Answer: a
Explanation:
Capital flight refers to the movement of wealth out of a country, which
exacerbates economic problems.
7.
What is the significance of the IMF's preferred creditor status?
a)
It prioritizes government spending
b)
It ensures repayment to other lenders first
c)
It ensures repayment to the IMF ahead of other lenders
Answer: c
Explanation:
The IMF's preferred creditor status means it will be prioritized for
repayment over other lenders if Argentina defaults.
8.
How has the IMF responded to Argentina's economic challenges?
a)
By withdrawing support
b)
By closely monitoring the situation
c)
By providing additional loans
Answer: b
Explanation:
The IMF closely monitors Argentina's situation but has allowed the government
space to address its issues.
9.
What is the main concern regarding Argentina's long-term stability?
a)
Inflation
b)
Exchange rates
c)
Ability to attract investment
Answer: c
Explanation:
Argentina's ability to attract investment is a concern for its long-term
stability, especially given its economic challenges.
10.
What percentage of its value did the peso lose against the dollar during the
crisis?
a)
Less than 20%
b)
More than 50%
c)
Exactly 50%
Answer: b
Explanation:
The peso lost more than half its value against the dollar during the crisis.
11.
What measure is Argentina taking to address inflation?
a)
Raising interest rates
b)
Lowering interest rates
c)
Implementing price controls
Answer: a
Explanation:
Argentina raised interest rates to combat inflation.
Trump-admiring
populist Milei wins in Argentina, edging the country closer to a dollarized
economy
PUBLISHED MON, NOV 20 20236:40 AM ESTUPDATED MON, NOV 20 20239:04 AM EST
KEY POINTS
·
Argentina’s Javier
Milei vowed to deliver on his radical economic policies shortly after
resoundingly winning the country’s presidential
runoff.
·
The far-right libertarian outsider has
pledged to dollarize the economy, abolish the country’s
central bank and privatize the pension system.
·
“We
have the determination to put Argentina on its feet and move forward,” Milei said shortly after his victory, according to a
translation.
Argentina’s Javier Milei, a far-right political outsider often
compared to former U.S. President Donald Trump, vowed to deliver on his radical economic policies shortly after
winning the country’s presidential runoff.
Milei,
whose term will run from Dec. 10 through to the end of 2027, staged a
resounding win in Sunday’s vote by a
wider-than-expected margin.
He
received roughly 56% of the vote, according to provisional results,
comfortably beating Peronist Economy Minister Sergio Massa, who conceded
after receiving just over 44%.
The
shock result leaves Latin America’s third-largest
economy in uncharted territory.
Proud
libertarian Milei, 53, has previously described himself as an “anarcho capitalist” and at one
point on the campaign trail even wielded a chainsaw to symbolize his intent
to cut state spending.
Among
some of his proposed policies, Milei
has pledged to dollarize the
economy, abolish the country’s central bank and privatize the pension system.
“We
have the determination to put the fiscal accounts in check. We have the
determination to fix the problems of the central bank. We have the determination
to put Argentina on its feet and move forward,” Milei
said shortly after his victory, according to a translation.
“Today,
we return to the path that made this country great,” he
added.
The
challenges facing Milei’s presidency are significant,
however — particularly given that the country is once
again in the grip of a profound economic crisis.
The
purchasing power of the South American nation has been ravaged by an annual inflation rate of
more than 140%, while 2 in 5 Argentines now live in poverty
and key agricultural areas have been hit by a historic drought.
“Governability
is going to be really tough for him,” Nicholas
Watson, managing director of Teneo, told CNBC’s “Street Signs Europe” on Monday. “We could be in for a roller coaster ahead.”
“If
he really goes through with the kind of ‘shock therapy’
that he’s talking about, we would expect to see
public appetite for that begin to wane potentially quite quickly,” Watson continued.
“Dollarization?
I think they are going to kick that into the long grass. Reform of the
central bank? I mean he talked about blowing the central bank up, his schtick
is with a chainsaw … I mean, some of that is just no
longer realistic.”
Asked
whether investors could expect sky-high inflation to start to come down after
the vote, Watson replied, “Inflation might go up
because the distortions and imbalances of the economy are so intense and so
widespread that addressing one thing means perhaps creating problems
somewhere else.”
‘Dollarization
is feasible and it’s desirable’
If
put into practice, Milei’s dollarization plan would
see Argentina give up the peso as its currency and use the U.S. dollar
instead.
Ecuador
and Panama are two notable examples of countries that have previously
dollarized their economies, but no country of Argentina’s
size has previously shifted to the U.S. dollar.
Advocates
of the proposal say the switch could help the country tame runaway inflation
and bring an end to its boom-and-bust cycle. Critics, however, say the move
would strip the country of its national sovereignty and dent Argentina’s ability to influence the economy through moves such as
interest rate changes.
Argentina:
Steve Hanke says many arguments against dollarization are ‘rubbish’
“The
key problem in Argentina since 1876 has been the peso,”
Steve Hanke, professor of applied economics at Johns Hopkins University, told
CNBC’s “Street Signs Asia” on Monday.
“One
currency crisis after another. One recession after another. Defaults on debt — one right after another. They have had three defaults on
sovereign debt since the year 2000. And the current inflation rate, I just
measured it today, it’s 220% in Argentina,” he added.
“It’s all tangled up with the central bank and the peso. So,
Milei has the right idea. You’ve got to dollarize and
many of these arguments against dollarization are absolute rubbish. This idea
that somehow, they don’t have enough dollars to
dollarize is ridiculous.”
Hanke
said he had not been a formal part of Milei’s
campaign, but had been in close contact with his technical team and described
himself as an “informal advisor”
on issues such as dollarization.
“Dollarization
is feasible and it’s desirable,”
Hanke said, saying the next steps would need to be akin to “a
precision drill.”
He
added, “We’re talking about a
very precise operation. So, if it is done right, it will be a huge economic
boom in Argentina. Very positive.”
Likelihood of immediate
dollarization ‘remains remote’
Jimena
Blanco, head of Americas at Verisk Maplecroft, noted that Milei will need to
deliver significant structural reforms if he is to make good on his promises
including dollarizing the economy and scrapping the central bank.
“The
former, however, requires dollars that the central bank currently lacks and,
therefore, the probability of immediate dollarisation remains remote,” said said in a research note.
Why
China has its eye on Latin America
“In
the immediate term, we expect Milei would announce a tough fiscal, monetary
and FX policy to begin stabilizing the economy and reduce inflation with the
aim of transitioning towards dollarisation. And while peso-denominated
bonds would take a hit, market expectations might improve over the
medium-term horizon.”
In class exercise
1.
What political ideology is Javier Milei associated with?
a)
Far-left
b)
Far-right
c)
Centrist
Answer: b
Explanation:
The article describes Javier Milei as a far-right political outsider, often
compared to former U.S. President Donald Trump.
2.
What did Milei pledge to do regarding Argentina's currency?
a)
Introduce a new digital currency
b)
Strengthen the peso
c)
Dollarize the economy
Answer: c
Explanation:
Milei pledged to dollarize the economy, replacing the peso with the U.S.
dollar.
3.
What is one of Milei's proposed policies?
a)
Nationalizing banks
b)
Privatizing the pension system
c)
Increasing government spending
Answer: b
Explanation:
Among Milei's proposed policies is the privatization of the pension system.
4.
What major economic challenge is Argentina currently facing?
a) Annual inflation rate of over 140%
b)
Trade surplus
c) High unemployment
Answer: a
Explanation:
Argentina is facing a profound economic crisis, including an annual inflation
rate of over 140%.
5.
What is one criticism of Milei's plan to dollarize the economy?
a)
It would increase national sovereignty
b)
It would decrease reliance on foreign currency
c)
It would strip the country of its national sovereignty
Answer: c
Explanation:
Critics argue that dollarizing the economy would strip the country of its
national sovereignty.
6.
Who supports Milei's dollarization plan?
a)
Sergio Massa
b)
Steve Hanke
c)
Javier Milei
Answer: b
Explanation:
Steve Hanke, professor of applied economics at Johns Hopkins University, supports
Milei's dollarization plan.
7.
What key problem in Argentina does Hanke identify?
a) The peso's history of instability
b)
High unemployment rates
c) Lack of foreign investment
Answer: a
Explanation:
Hanke identifies the key problem in Argentina as the peso's history of
instability.
8.
What is the likelihood of immediate dollarization according to Jimena Blanco?
a)
Highly likely
b)
Remote
c)
Certain
Answer: b
Explanation:
Jimena Blanco notes that the likelihood of immediate dollarization remains
remote due to structural challenges and lack of sufficient dollars.
9.
Which countries are cited as examples of successful dollarization?
a)
Brazil and Argentina
b)
Ecuador and Panama
c)
Venezuela and Colombia
Answer: b
Explanation:
Ecuador and Panama are cited as examples of countries that have successfully
dollarized their economies.
10.
What term is used to describe Milei's proposed economic approach?
a)
Shock therapy
b)
Incrementalism
c)
Status quo
Answer: a
Explanation:
Milei's proposed economic approach is described as "shock therapy"
by Nicholas Watson.
11.
What is one concern raised about Milei's plan to abolish the central bank?
a)
It would increase government control over the economy
b)
It would enhance government control over the banking system
c)
It would lead to instability in the financial sector
Answer: c
Explanation:
Critics express concerns that abolishing the central bank could lead to
instability in the financial sector.
12.
What term is used to describe Milei's proposed economic policies?
a)
Incremental
b)
Radical
c)
Conservative
Answer: b
Explanation:
Milei's proposed economic policies are described as radical in the article.
Exclusive: Argentine
President Milei Says There’s ‘No Plan B’ for Economy | WSJ (youtube)
In class exercise
1.
What is the main reason Argentina is considering dollarization?
A)
To stabilize its currency and attract investments
B)
To increase its trade relations with China
C)
To strengthen its alliance with other Latin American countries
Answer: A
Explanation:
Argentina is considering dollarization to stabilize its currency and attract
investments.
2.
How much debt does Argentina owe?
A)
Over 50 billion dollars
B)
Nearly 41 billion dollars
C)
Less than 30 billion dollars
Answer B
Explanation:
The video states that Argentina owes nearly 41 billion dollars.
3.
What is the timeframe mentioned for the Argentine people to see signs that
the plan is working?
A)
About 3 years
B)
Less than 6 months
C)
About 2 years
Answer: C
Explanation:
The Argentine people may need to wait about 2 years to see signs that the
plan is working.
4.
What is Milei’s stance on having a Plan B?
A)
There is no Plan B
B)
Plan B involves negotiating with China
C)
Plan B is under consideration
Answer: A
5.
What is Milei's position on privatization?
A)
Privatization is unnecessary
B)
Everything that can be privatized will be privatized
C)
Privatization should be avoided
Answer: B
Explanation:
Milei expresses a strong intention to privatize everything that can be
privatized.
6.
What is Milei's view on adopting the dollar as currency?
A)
Opposed
B)
Indifferent
C)
Favorable
Answer: C
7.
What is the speaker's stance on negotiating with China?
A)
Unwilling
B)
Open-minded
C)
Ambivalent
Answer: A
Explanation:
Milei is unwilling to negotiate with China.
8.
What is the speaker's opinion on supporting Israel?
A)
Opposed
B)
Neutral
C)
Strongly supportive
Answer: C
Explanation:
Milei expresses strong support for Israel in the video.
9.
How does Milei characterize Argentina's relationship with China?
A)
Hostile and confrontational
B)
Not strategic but commercially important
C)
Strongly allied against communism
Answer: B
Explanation:
Milei mentions that Argentina's relationship with China as not strategic but
commercially important.
10.
What is the speaker's view on Argentina's alliance with the BRICS countries?
A)
Rejects being part of the BRICS alliance
B)
Emphasizes the importance of the alliance
C)
Considers it strategically vital for Argentina
Answer: A
11.What
is essential for the success of their plan for Argentina?
A)
Doing things well without negotiation
B)
Engaging in diplomatic alliances
C)
Implementing multiple backup plans
Answer: A
Explanation:
Milei emphasizes the importance of doing things well without negotiation.
12.
What does the speaker imply about their political alignment regarding
freedom?
A)
Prioritizes security over individual freedoms
B)
Adapts their stance on freedom based on geopolitical factors
C)
Always supports freedom, regardless of the circumstances
Answer: C
Explanation:
Milei implies that they always support freedom, regardless of the
circumstances.
Part IV: In Class
Exercise
Class Exercise1:
Chicago bank expects the exchange rate of the
NZ$ to appreciate from $0.50 to $0.52 in 30 days.
— Chicago bank can borrow $20m on a
short term basis.
— Currency Lending
Rate Borrowing
rate
$ 6.72% 7.20%
NZ$ 6.48% 6.96%
Question: If Chicago bank anticipate NZ$ to appreciate,
how shall it trade? (refer to ppt)
Answer:
◦ NZ$ will
appreciate, so you should buy NZ$ now and sell later. Borrow $à convert
to NZ$ today à lend it for 30 days à convert to $ 30 days
later àpayback the $ loan.
◦ Convert
the borrowed $ to NZ$ today. So your NZ$ worth: $20m / 0.50 $/NZ$=40m NZ$.
◦ Lend NZ$
for 6.48% * 30/360=0.54% and get
40m NZ$ *(1+0.54%)=40,216,000 NZ$ 30 days
lateè at new rate $0.52/1NZ$, 40,216,000 NZ$ equals t 40,216,000
NZ$*$0.52/1NZ$ = $20,912,320
◦ Your
borrowed $20m should be paid back for
20m *(1+7.2%* 30/360)=$20.12m.
◦ So the
profit is:
$20,912,320 - $20.12m =$792,320, a pure
profit from thin air!
Class Exercise 2:
Blue Demon Bank expects that the Mexican peso
will depreciate against the dollar from its spot rate of $.15 to $.14 in 10 days.
The following interbank lending and borrowing rates exist:
Lending
Rate Borrowing Rate
U.S.
dollar 8.0% 8.3%
Mexican
peso 8.5% 8.7%
Assume that Blue Demon
Bank has a borrowing capacity of either $10 million or 70 million pesos in
the interbank market, depending on which currency it wants to borrow.
a. How
could Blue Demon Bank attempt to capitalize on its expectations without using
deposited funds? Estimate the profits that could be generated from this
strategy.
b. Assume
all the preceding information with this exception: Blue Demon Bank expects
the peso to appreciate from its present spot rate of $.15 to $.17 in 30 days.
How could it attempt to capitalize on its expectations without using
deposited funds? Estimate the profits that could be generated from this
strategy.
Answer:
Part a: Blue Demon Bank can capitalize on its expectations
about pesos (MXP) as follows:
1. Borrow
MXP70 million
2. Convert
the MXP70 million to dollars:
a. MXP70,000,000 × $.15
= $10,500,000
3. Lend
the dollars through the interbank market at 8.0% annualized over a 10 day
period. The amount accumulated in 10 days is:
a. $10,500,000 × [1
+ (8% × 10/360)] = $10,500,000 × [1.002222] = $10,523,333
4. Convert
the Peso back to $ at $.14 / peso:
a. $10,523,333
/ $.14 / MXP = MXP 75,166,664
5. Repay
the peso loan. The repayment amount on the peso loan is:
a. MXP70,000,000 × [1
+ (8.7% × 10/360)] =
70,000,000 × [1.002417]=MXP70,169,167
6. The
arbitrage profit is:
a. MXP
75,166,664 - MXP70,169,167 = MXP 4,997,497
7. Convert
back to at $0.14 / MXP
a. We
get back MXP 4,997,497 * $0.14 / MXP = $699,649.6 (solution)
Part b: Blue Demon Bank can capitalize on its expectations
as follows:
1. Borrow
$10 million
2. Convert
the $10 million to pesos (MXP):
a. $10,000,000/$.15
= MXP66,666,667
3. Lend
the pesos through the interbank market at 8.5% annualized over a 30 day
period. The amount accumulated in 30 days
is:
a. MXP66,666,667 × [1
+ (8.5% × 30/360)] = 66,666,667 × [1.007083] =
MXP67,138,889
4. Repay
the dollar loan. The repayment amount on the dollar loan is:
a. $10,000,000 × [1
+ (8.3% × 30/360)] = $10,000,000 × [1.006917] =
$10,069,170
5. Convert
the pesos to dollars to repay the loan. The amount of dollars to be received
in 30 days (based on the expected spot rate of $.17) is:
a. MXP67,138,889 × $.17
= $11,413,611
HW chapter 4 - Due with the
second mid term exam
Question
1. Choose between increase / decrease.
US Inflation goes up, $ will
________increase / decrease____________in value__.
US Real interest rate goes
up, $ will ________increase / decrease___________ in value__.
US Current account goes up,
$ will ________increase / decrease________ in value__.
US Recession or crisis, $
will ________increase / decrease________ in value__.
For each scenario, please
draw a demand and supply curve to support your conclusion.
Question 2: Suppose you
observe the following exchange rates: €1 = $.7; £1 = $1.40;
and €2.20 = £1.00. Starting with $1,000,000, how can you make money?(Answer: get £ first. Your profit is
$100,000)
Question 3:
Suppose you start with $100
and buy stock for £50 when the exchange rate is £1 = $2. One year later, the
stock rises to £60. You are happy with your 20 percent return on the stock, but
when you sell the stock and exchange your £60 for dollars, you find that the
pound has fallen to £1 = $1.75. What is your return to your initial
investment of $100? (Answer: 5%)
Question 4:
Baylor Bank believes the New
Zealand dollar will depreciate over the next five days from $.52 to $.5. The
following annual interest rates apply:
Currency Lending
Rate Borrowing
Rate
Dollars 5.50% 5.80%
New
Zealand dollar
(NZ$) 4.80% 5.25%
Baylor
Bank has the capacity to borrow either NZ$11 million or $5 million. If Baylor
Bank’s forecast if correct, what will its dollar profit be from speculation
over the five day period (assuming it does not use any of its existing
consumer deposits to capitalize on its expectations)? (Answer: 0.44 million NZ$ profit)
Question 5: Based on class discussion on
Argentina’s Dollarization Plan, answer the following questions (optional, for
extra credits opportunities)
·
What are the main economic challenges
Argentina is facing that led to the consideration of a dollarization plan?
·
How does dollarization differ from
Argentina's current monetary policy?
·
What are some potential advantages of
adopting the dollar as Argentina's official currency?
·
What are the potential drawbacks or risks
associated with implementing a dollarization plan in Argentina?
·
How do you think the adoption of the
dollar would impact Argentina's economy in the short term versus the long
term?
For
reference:
· How
Argentines Live With Inflation (youtube)
· The
Economic Crisis in Argentina | Explained (youtube)
·
Exclusive: Argentine
President Milei Says There’s ‘No Plan B’ for Economy | WSJ (youtube)
· The
Economic Crisis in Argentina | Explained (youtube)
Question
6: Quiz on Factors Influencing Currency Value
(FYI only)
Chapter
5 Currency Derivatives
For class discussion: Assume that you are an
importer for seafood from Japan. This special seafood is only available in the
summer. How can you hedge against the exchange rate risk?
Hint:
|
Hedging Strategy |
Description
|
|
Forward Contracts |
Enter into agreements with a bank or financial institution to
lock in a specific exchange rate for future transactions, protecting
against adverse exchange rate movements. |
|
Options Contracts |
Purchase contracts granting the right (but not obligation) to
exchange currency at a predetermined rate on or before a specified date,
offering flexibility with limited downside risk. |
|
Currency Swaps |
Exchange cash flows in different currencies through
agreements, such as swapping domestic currency for Japanese yen at a fixed
rate, mitigating exchange rate fluctuations. |
|
Natural Hedging |
Offset currency exposure by aligning revenue or expenses in
Japanese yen, naturally hedging against exchange rate risk through matching
currency inflows and outflows.
|
Part 1- Forward market vs. Future market
Forward contract introduction
(video, khan academy)
In class
exercise
1. What is a forward contract?
a) A contract to buy or sell an asset at a
predetermined price on a future date.
b) A contract to buy or sell an asset at the
current market price.
c) A contract to buy or sell an asset with
flexible terms.
Answer: a
Explanation: A forward
contract is an agreement to buy or sell an asset at a specified price on a
future date, providing protection against future price fluctuations.
2. Which hedging strategy involves exchanging cash
flows in different currencies?
a) Forward Contracts
b) Currency Swaps
c) Options Contracts
Answer: b
Explanation: Currency
swaps involve exchanging cash flows in different currencies to mitigate
exchange rate fluctuations.
3. How do options contracts differ from forward
contracts?
a) Options contracts involve the obligation to
transact, while forward contracts do not.
b) Options contracts provide the right, but not
the obligation, to transact at a predetermined price, while forward contracts
entail an obligation.
c) Forward contracts provide greater flexibility
compared to options contracts.
Answer: b
Explanation: Options
contracts give the holder the right, but not the obligation, to buy or sell
an asset at a predetermined price, while forward contracts involve an
obligation to transact at a specified price on a future date.
4. What is the primary concern faced by the apple
farmer and the pie chain?
a) Inconsistent quality of apples
b) Fluctuating prices of apples
c) Shortage of labor during harvest season
Answer: b
5. What strategy do the apple farmer and the pie
chain adopt to mitigate price volatility?
a) Options trading
b) Currency swaps
c) Forward contracts
Answer: c
Explanation: The video
describes how both parties agree to transact at a specified price, known as a
forward contract, to mitigate the impact of price fluctuations on their
businesses.
6. What is the agreed-upon price per pound in the
forward contract?
a) $0.10
b) $0.20
c) $0.30
Answer: b
Explanation: The video
mentions that the pie chain agrees to buy one million pounds of apples at the
harvest for $0.20 a pound, providing both parties with predictability and
stability.
7. Why does the pie chain find the forward
contract beneficial?
a) It provides certainty and predictability in
pricing, enabling them to make a decent profit.
b) It allows them to speculate on future apple
prices.
c) It ensures they can purchase apples at the
lowest market price.
Answer: a
Explanation: The video
states that regardless of the market price, the pie chain can ensure they
will pay $0.20 a pound, allowing them to make a decent profit and plan their
operations effectively.
8. How does the forward contract benefit the apple
farmer?
a) It allows for flexible pricing based on market
conditions.
b) It guarantees a price that covers costs and
ensures financial stability.
c) It exposes the farmer to greater price
volatility.
Answer: b
Explanation: The video
explains that at $0.20 a pound, the farmer can cover costs, pay rent,
employees, and feed his family, providing financial stability amidst price
fluctuations.
9. What does the term "forward contract"
refer to?
a) A contract to buy or sell an asset immediately
at the current market price.
b) An agreement to buy or sell an asset at a
predetermined price on a future date.
c) A contract allowing for the exchange of assets
with flexible terms.
Answer: b
Explanation: The video
describes a forward contract as an agreement between the apple farmer and the
pie chain to transact at a specified price after the harvest, providing
stability in pricing.
10. How does the forward contract mitigate risk
for both parties?
a) By providing certainty in transaction prices,
thus avoiding financial losses.
b) By allowing for speculative trading.
c) By increasing exposure to market fluctuations.
Answer: a
Explanation: The forward
contract ensures that both parties can predict and plan for transaction
prices, reducing the risk of financial losses associated with market
fluctuations.
11. What is the primary disadvantage of not using
a forward contract for the apple farmer and the pie chain?
a) Lack of control over apple quality
b) Inability to negotiate prices with customers
c) Exposure to unpredictable and fluctuating apple
prices
Answer: c
Explanation: Without a
forward contract, both parties face the risk of financial instability due to
unpredictable fluctuations in apple prices, as described in the passage.
Futures introduction (video,
khan academy)
In Class Exercise
1. What term describes
the risk that the other party won't be able to uphold their end of the
contract?
a) Market risk
b) Counterparty risk
c) Operational risk
Answer: b
Explanation: Counterparty risk refers to the risk
that the other party in a contract will default on their obligations.
2. What option do
parties have if they want to exit a future contract they entered into?
a) They can cancel the
contract unilaterally.
b) They can only wait
until the contract expires.
c) They can sell their
obligation to someone else.
Answer: c
Explanation: Parties can mitigate their exposure to a
forward contract by selling their obligation to another party on an exchange.
3. How does
standardizing future contracts help mitigate counterparty risk?
a) By reducing the need
for individualized contracts
b) By increasing the
complexity of contracts
c) By introducing more variability
in contract terms
Answer: a
Explanation: Standardized contracts
reduce counterparty risk by providing a uniform framework for trading, making
it easier to match buyers and sellers on an exchange.
4. Who guarantees the
performance of standardized forward contracts on the exchange?
a) The government
b) The exchange operator
c) The parties involved
in the contract
Answer: b
Explanation: The exchange operator typically
guarantees the performance of standardized forward contracts to alleviate
counterparty risk and ensure the smooth functioning of the market.
5. What do standardized
forward contracts become known as?
a) Customized contracts
b) Derivatives
c) Futures
Answer: c
Explanation: Standardized forward contracts traded on
an exchange are referred to as futures contracts.
6. How do standardized
futures contracts differ from forward contracts?
a) They are more complex
b) They involve higher
transaction costs
c) They are traded on an
exchange and are more standardized
Answer: c
Explanation: Standardized futures
contracts are traded on an exchange and follow uniform specifications, making
them more accessible and liquid compared to one-off forward contracts.
7. How does the
introduction of standardized futures contracts benefit smaller farmers?
a) It allows them to
transact in smaller increments
b) It increases
transaction costs
c) It limits their
ability to access the market
Answer: a
Explanation:
Standardized futures contracts enable smaller farmers to participate in the
market by allowing them to transact in smaller, more manageable quantities.
8. What term describes
agreements to transact at a future date for a certain quantity of an
underlying asset, standardized and traded on an exchange?
a) Futures contracts
b) Spot contracts
c) Options contracts
Answer: a
9. What term describes
the risk that one party in a contract will default on their obligations?
a) Market risk
b) Credit risk
c) Operational risk
Answer: b
Explanation: Credit risk, also known as default risk,
refers to the risk that one party in a contract will fail to meet their
obligations.
1. Difference between the two?
Futures Contracts Compared
to Forwards (video)
Forward contract:
· Privately
negotiated;
· Non-transferable;
· customized term;
· carried credit
default risk;
· fully dependent
on counterparty;
· Unregulated.
Futures Market Explained
(Video)
Future contract:
· Quoted
in public market
· Actively
traded
· Standardized
contract
· Regulated
· No
counterparty risk
1. What is the
primary purpose of futures and forward contracts?
a) Speculating
on future price movements
b) Locking in
prices for physical transactions
c) Investing
in physical commodities
Answer: b
Explanation: Both futures and forward contracts
allow buyers and sellers to agree on a price for an underlying asset at a
future date, providing price stability for physical transactions.
2. In which
century did the agricultural futures market gain prominence?
a) 19th
century
b) 17th
century
c) 21st
century
Answer: a
Explanation: The agricultural futures
market became significant in the mid-19th century due to the need for
efficient risk management mechanisms in increasingly complex trading
environments.
3. How are
futures contracts traded compared to forward contracts?
a) Privately
negotiated
b) Through
centralized clearinghouses
c) On an open
market anonymously
Answer: c
Explanation: Futures contracts are traded on open
markets anonymously, providing equal transparency for all participants,
unlike forward contracts, which are negotiated privately between two parties.
4. What asset
classes can futures contracts encompass?
a) Equities,
commodities, and currencies
b) Bonds, real
estate, and derivatives
c) Stocks,
mutual funds, and options
Answer: a
Explanation: Futures contracts can cover a
wide range of asset classes, including equities (stocks), commodities (such
as agricultural products), and currencies (forex).
5. What
advantage do futures contracts offer traders in terms of market participation?
a) Limited
trading hours
b) Direct
participation in market moves without physical commodity ownership
c) Restricted
access to market information
Answer: b
Explanation: Traders can use futures
contracts to participate directly in market movements without needing to own
the physical commodity, providing greater flexibility and accessibility.
6. Which
contract type is standardized and traded on an exchange?
a) Forward
contracts
b) Options
contracts
c) Futures
contracts
Answer: c
Explanation: Futures contracts are
standardized and traded on exchanges, facilitating liquidity and providing
transparency for market participants.
7. What risk
does a forward contract carry that a futures contract does not?
a) Market risk
b)
Counterparty risk
c) Regulatory
risk
Answer: b
Explanation: Forward contracts are
privately negotiated and carry counterparty risk since they depend on the
reliability of the contracting parties, unlike futures contracts, which are
guaranteed by the exchange clearinghouse.
8. How are
futures contracts cleared?
a) By the
exchange clearinghouse
b) Through
private negotiations
c) Through
direct peer-to-peer transactions
Answer: a
Explanation: Futures contracts are cleared
by the exchange clearinghouse, which guarantees the performance of the
contracts, mitigating counterparty risk.
9. What
advantage do standardized futures contracts offer compared to customized
forward contracts?
a) Higher
transaction costs
b) Reduced
liquidity
c)
Standardization and liquidity
Answer: c
Explanation: Standardized futures contracts offer
greater liquidity and efficiency compared to customized forward contracts due
to their uniform specifications and trading on exchanges.
10. Which
contract type requires negotiation between two parties?
a) Forward contracts
b) Futures
contracts
c) Options
contracts
Answer: a
Explanation: Forward contracts require
negotiation between two parties to agree on terms such as price, quantity,
and delivery date, unlike futures contracts, which are standardized and
traded on exchanges.
11. How do
futures contracts allow traders to participate in various markets?
a) By offering
limited asset classes
b) By
providing direct participation without physical commodity ownership
c) By
restricting market access
Answer: b
Explanation: Futures contracts allow
traders to participate directly in various markets without needing to own the
physical commodity, providing greater market access and flexibility.
12. What risk
is associated with forward contracts but not futures contracts?
a) Market risk
b) Credit risk
c) Regulatory
risk
Answer: b
Explanation: Forward contracts carry credit
risk since they depend on the reliability of the contracting parties, unlike
futures contracts, which are guaranteed by the exchange clearinghouse.
13. How are
futures contracts regulated?
a) By
government agencies overseeing exchanges
b) By
individual parties involved in the contract
c) Through
self-regulation by market participants
Answer: a
Explanation: Futures contracts are regulated by
government agencies overseeing exchanges to ensure market integrity and
investor protection.
14. What has
the expansion of futures contracts allowed traders to access?
a) Only
agricultural commodities
b) Various
unique markets and asset classes
c) Exclusively
physical commodities
Answer: b
Explanation: The expansion of futures
contracts has allowed traders to access various unique markets and asset
classes beyond agricultural commodities, including equities, currencies, and
interest rates.
(FYI)
F = forward rate
S = spot rate
r1 = simple interest rate of the term currency
r2 = simple interest rate of the base currency
T = tenor (calculated to the appropriate day count conversion)
For Example (FYI): ABC Company,
located in Jacksonville, needs 1,000,000 Brazilian Real within a six-month
timeframe. At present, the prevailing exchange rate stands at 1 US Dollar
equating to 5 Brazilian Real. Conversely, XYZ Company in Brazil needs $200,000
within the same six-month period. Both entities have reached an agreement on
a forward contract to facilitate the conversion between US Dollars and
Brazilian Real in six month. Acting as an intermediary, the Bank of
Jacksonville proposes a forward exchange rate for the Brazilian Real. What is
the forward exchange rate set by the Bank of Jacksonville for the Brazilian
Real?
Solution:
·
ABC in Jacksonville
deposits $200,000 in the Bank of Jacksonville for 6 months at a 5% annual
interest rate. After 6 months, the total amount becomes:
$200,000 * (1 + 2.5%) = $205,000.
·
XYZ in Brazil
deposits 1,000,000 Brazilian Real in the Bank of Brazil for 6 months at a 14%
annual interest rate. After 6 months, the total amount becomes:
1,000,000 Real * (1 + 7%) = 1,070,000 Real.
·
After 6 months, the
equation for the forward exchange rate is as follows:
$205,000 * Forward exchange rate = 1,070,000 Real
·
So, the forward rate
(F) is calculated as follows:
Forward rate (F) = 1,070,000 Real / $205,000 = 5.22 Real
per US Dollar.
Or refer to https://www.jufinance.com/irp
(chapter 7,
Interest rate Parity)
2. Future market
Margin
account and margin call
Benefits of Futures:
Margin (video)
In Class Exercise
1.
What does margin refer to in the context of securities trading?
a)
The amount of money you borrow to buy securities
b)
The amount of money you deposit to open a futures position
c)
The percentage of the notional value of a futures contract
Answer: a
Explanation:
In securities trading, margin refers to the money borrowed as a partial down
payment to buy and own stocks, bonds, or ETFs.
2.
How does futures margin differ from securities margin?
a)
Futures margin is a down payment to buy commodities, while securities margin
is borrowed money for stock purchases
b)
Futures margin represents a smaller percentage of the contract value compared
to securities margin
c)
Futures margin requires ownership of the underlying commodity, while
securities margin does not
Answer: b
Explanation:
Futures margin typically represents a smaller percentage of the notional
value of the contract compared to securities margin, which can be up to 50%
of the purchase price.
3.
What happens if the funds in your account drop below the maintenance margin
level?
a)
You receive a margin call to add more funds immediately
b)
Your position is automatically liquidated
c)
You can reduce your position to match the remaining funds in your account
Answer: a
Explanation:
If your account falls below the maintenance margin level, you'll receive a
margin call to add more funds to bring it back up to the initial margin
level.
4.
What is the purpose of initial margin in futures trading?
a)
It represents the minimum amount required to maintain an open position
b)
It ensures traders have sufficient funds to initiate a futures position
c)
It protects against market volatility and price fluctuations
Answer: b
Explanation:
Initial margin is the amount of funds required by the exchange to initiate a
futures position, ensuring traders have enough funds to enter into the
contract.
5.
How does a margin call affect a trader?
a)
It results in automatic liquidation of the trader's position
b)
It requires the trader to add more funds to meet margin requirements
c)
It reduces the size of the trader's position to match available funds
Answer: b
Explanation:
A margin call requires the trader to add more funds to their account to meet
margin requirements and avoid potential liquidation.
6.
What determines the margin requirements in futures trading?
a)
The size of the trader's initial deposit
b)
Market conditions and the clearinghouse's margin methodology
c)
The broker's discretion and negotiation with the trader
Answer: b
Explanation:
Margin requirements in futures trading are influenced by market conditions
and the clearinghouse's margin methodology, which may adjust based on
volatility and risk.
7.
How does futures margin differ from a down payment in securities trading?
a)
Futures margin represents ownership of the underlying commodity
b)
Futures margin is a smaller percentage of the contract value
c)
Futures margin is deposited with the broker to open a position, not as a down
payment
Answer: c
Explanation:
Futures margin is deposited with the broker when opening a position, serving
as a security deposit, whereas a down payment in securities trading is
borrowed money used to purchase securities.
8.
What happens if a trader cannot meet a margin call?
a)
The broker reduces the trader's position automatically
b)
The trader's account is frozen until sufficient funds are added
c)
The trader's position may be liquidated automatically
Answer:
c
Explanation:
If a trader cannot meet a margin call, their position may be liquidated
automatically to cover losses and meet margin requirements.
9.
How does understanding futures margin help traders maximize capital
efficiencies?
a)
By reducing the percentage of contract value required for margin
b)
By allowing traders to initiate positions with smaller deposits
c)
By managing risk and avoiding potential liquidation scenarios
Answer: c
Explanation:
Understanding futures margin helps traders manage risk and avoid potential
liquidation scenarios, maximizing capital efficiencies in futures trading.
10.
What role does the exchange clearinghouse play in futures margin?
a)
Setting margin requirements for individual traders
b)
Guaranteeing contract performance and ensuring margin compliance
c)
Providing leverage to traders to initiate larger positions
Answer: b
Explanation:
The exchange clearinghouse guarantees contract performance and ensures margin
compliance in futures trading, mitigating counterparty risk and maintaining
market integrity.
What Is Margin
Call? | FXTM Learn Forex in 60 Seconds
(Video)
In Class Exercise
1.
What triggers a Margin Call in trading?
a)
Opening a new position
b)
Falling below the Margin Call percentage
c)
Closing a winning position
Answer: b
Explanation:
A Margin Call is triggered when a trader's margin level falls below the
Margin Call percentage, indicating that they need to deposit more money or
close losing positions to free up margin.
2.
How is Margin Call percentage determined?
a)
It is fixed for all traders
b)
It is determined by market conditions
c)
It can be found in the Account Specifications of the trading account
Answer: c
Explanation:
The Margin Call percentage is determined by the broker and can be found in
the Account Specifications of the trading account.
3.
What does the Margin Call warning indicate to traders?
a)
That they need to deposit more money or close losing positions
b)
That they have successfully closed losing positions
c)
That their trading strategy is performing well
Answer: a
Explanation:
The Margin Call warning indicates to traders that they need to deposit more
money or close losing positions to prevent reaching the Stop Out level.
4.
How is Margin Level calculated?
a)
Equity divided by Used Margin
b)
Equity minus Used Margin
c)
Used Margin divided by Equity
Answer: a
Explanation:
Margin Level is calculated by dividing Equity by Used Margin and multiplying
by a hundred.
5.
What happens if a trader's Margin Level decreases to 40%?
a)
They receive a Margin Call
b)
They achieve a high level of leverage
c)
They successfully hedge their positions
Answer: a
Explanation:
If a trader's Margin Level decreases to 40%, they will receive a Margin Call,
indicating the need to take action to avoid potential liquidation.
6.
What is the purpose of keeping an eye on Margin Level?
a)
To calculate potential profits
b)
To identify trading opportunities
c)
To avoid receiving a Margin Call
Answer: c
Explanation:
Keeping an eye on Margin Level helps traders avoid receiving a Margin Call by
ensuring they maintain sufficient margin to cover their positions.
7.
Where can traders find information about the Margin Call percentage?
a)
In trading newsletters
b)
In the Account Specifications of the trading account
c)
On social media platforms
Answer: b
Explanation:
Information about the Margin Call percentage can be found in the Account
Specifications of the trading account provided by the broker.
8.
What should traders do when they receive a Margin Call warning?
a)
Increase their position sizes
b)
Deposit more money or close losing positions
c)
Ignore the warning and continue trading
Answer: b
Explanation:
Traders should deposit more money or close losing positions when they receive
a Margin Call warning to prevent potential liquidation.
9.
What is the purpose of the Margin Call notification?
a)
To inform traders about potential trading opportunities
b)
To congratulate traders on their successful trades
c)
To alert traders about the need to deposit more money or close positions
Answer: c
Explanation:
The Margin Call notification alerts traders about the need to deposit more
money or close positions to free up margin and avoid potential liquidation.
10.
When does a trader usually receive a Margin Call?
a)
When their Margin Level falls below the Margin Call percentage
b)
When their positions are profitable
c)
When they achieve a high level of leverage
Answer: a
Explanation:
A trader usually receives a Margin Call when their Margin Level falls below
the Margin Call percentage, indicating the need to take action to avoid
potential liquidation.
CME (Chicago Merchandise Exchange)
EURO FX PRICES for 3/2/2024
https://www.barchart.com/futures/quotes/E6*0/all-futures
|
Contract |
Last |
Change |
Open |
High |
Low |
Previous |
Volume |
Open Interest |
Time |
|
E6Z28
(Dec '28) |
1.16330s |
0.00165 |
N/A |
1.1633 |
1.1633 |
1.16165 |
N/A |
N/A |
3/1/2024 |
|
E6Z27
(Dec '27) |
1.14685s |
0.00215 |
N/A |
1.14685 |
1.14685 |
1.1447 |
N/A |
N/A |
3/1/2024 |
|
|
1.13070s |
0.0027 |
N/A |
1.1307 |
1.1307 |
1.128 |
N/A |
N/A |
3/1/2024 |
|
E6Z25
(Dec '25) |
1.11445s |
0.00315 |
0 |
1.11445 |
1.11445 |
1.1113 |
0 |
1 |
3/1/2024 |
|
E6Z24
(Dec '24) |
1.09735s |
0.00365 |
1.0946 |
1.09735 |
1.0933 |
1.0937 |
23 |
1,981 |
3/1/2024 |
|
E6Y00
(Cash) |
1.08433 |
0.00035 |
1.08387 |
1.08482 |
1.08385 |
1.08398 |
15,980 |
N/A |
21:18 CT |
|
E6U28
(Sep '28) |
1.15925s |
0.00175 |
N/A |
1.15925 |
1.15925 |
1.1575 |
N/A |
N/A |
3/1/2024 |
|
E6U27
(Sep '27) |
1.14280s |
0.0023 |
N/A |
1.1428 |
1.1428 |
1.1405 |
N/A |
N/A |
3/1/2024 |
|
E6U26
(Sep '26) |
1.12670s |
0.00285 |
N/A |
1.1267 |
1.1267 |
1.12385 |
N/A |
N/A |
3/1/2024 |
|
E6U25
(Sep '25) |
1.11030s |
0.0033 |
N/A |
1.1103 |
1.1103 |
1.107 |
N/A |
2 |
3/1/2024 |
|
E6U24
(Sep '24) |
1.09300s |
0.0038 |
1.0889 |
1.093 |
1.08885 |
1.0892 |
25 |
1,639 |
3/1/2024 |
|
E6N24
(Jul '24) |
1.09010s |
0.00385 |
0 |
1.0901 |
1.0901 |
1.08625 |
0 |
0 |
3/1/2024 |
|
E6M28
(Jun '28) |
1.15510s |
0.0019 |
N/A |
1.1551 |
1.1551 |
1.1532 |
N/A |
N/A |
3/1/2024 |
|
E6M27
(Jun '27) |
1.13880s |
0.00245 |
N/A |
1.1388 |
1.1388 |
1.13635 |
N/A |
N/A |
3/1/2024 |
|
E6M26
(Jun '26) |
1.12265s |
0.00295 |
N/A |
1.12265 |
1.12265 |
1.1197 |
N/A |
N/A |
3/1/2024 |
https://www.barchart.com/futures/quotes/E6M24/overview
In Class Exercise
1. What is the current price of Euro FX
Jun '24?
a) 1.09015
b) 1.09025
c) 1.09030
Answer:
C
2. What is the volume of contracts traded?
a) 343
b) 15,997
c) 62
Answer: a
Explanation: 62, as it represents the volume of
contracts traded.
3. What is the open interest for Euro FX
Jun '24?
a) 343
b) 15,997
c) 62
Answer:
b
Explanation: Open interest refers to the total number
of outstanding contracts that are held by market participants at the end of
each trading day. It provides insight into the level of activity or liquidity
in the market for a particular futures or options contract.
4. What is the tick size for Euro FX
contracts?
a) 0.00005 points
b) $6.25 per contract
c) $125,000
Answer:
a
5. What is the trading hours for Euro FX
contracts?
a) 5:00 p.m. - 4:00 p.m. (Sun-Fri) (Settles
2:00 p.m.) CST
b) 4:00 p.m. - 5:00 p.m. (Sun-Fri)
(Settles 5:00 p.m.) CST
c) 2:00 p.m. - 5:00 p.m. (Sun-Fri)
(Settles 2:00 p.m.) CST
Answer:
a
6. What is the contract size for Euro FX
contracts?
a) EUR 125,000
b) $125,000
c) EUR 6.25
Answer:
a
7. What is the margin/maintenance
requirement for Euro FX contracts?
a) $2,310/2,100
b) $6.25
c) $125,000
Answer:
a
8. When is the Expiration Date for Euro FX
Jun '24 contracts?
a) 06/17/24
b) 105 days from now
c) 2:00 p.m. CST
Answer:
a
Part 2 - Calculating Futures Contract Profit or Loss
Short and long position
and payoff (video)
In class exercise
1.
What is the primary purpose of traders engaging in the futures market?
a) To
speculate on price movements
b) To
avoid potential losses
c) To
secure long-term investments
Answer:
a
Explanation:
Traders typically enter the futures market to speculate on price movements
and make a profit.
2. What
does the WTI crude oil futures contract represent?
a) The
expected value of 100 barrels of oil
b) The
expected value of 1,000 barrels of oil
c) The
expected value of 10,000 barrels of oil
Answer:
b
Explanation: The WTI
crude oil futures contract represents the expected value of 1,000 barrels of
oil.
3. How
do traders use futures contracts to hedge against potential losses?
a) By
speculating on price movements
b) By
avoiding market volatility
c) By
locking in future prices
Answer:
c
Explanation:
Traders use futures contracts to hedge
against potential losses by locking in future prices.
4.
What is the primary factor influencing profit or loss in the futures market?
a)
Market sentiment
b)
Economic indicators
c)
Price movements
Answer:
c
Explanation: Price
movements are the primary factor influencing profit or loss in the futures
market.
5. Why
is understanding contract specifications important for traders?
a) To
determine profit and loss calculations
b) To
comply with regulatory requirements
c) To
predict market trends
Answer:
a
Explanation:
Understanding contract specifications helps traders accurately determine
profit and loss calculations.
For a long position， its payoff:
Value at maturity (long
position) = principal * (
spot exchange rate at maturity – settlement price)
Value at maturity (short
position) = -principal * (
spot exchange rate at maturity – settlement price)
Note: In the
calculator, principal is called contract size
Example:
Suppose a trader enters into a currency
futures contract to buy 10,000 euros (contract size) at a specified exchange
rate of 1.2000 USD/EUR. The settlement price at the time of entering the
contract is also 1.2500 USD/EUR. The maturity date of the contract is in
three months.
Long Position:
· At maturity, the spot exchange rate is
1.2500 USD/EUR.
· Using the formula for a long position's
payoff:
· Value at maturity (long position) =
Principal * (Spot exchange rate at maturity - Settlement price)
· = 10,000 euros * (1.2500 USD/EUR - 1.2000
USD/EUR)
· = 10,000 euros * 0.0500 USD/EUR
· = 500 USD
· Therefore, the trader receives a payoff of
500 USD from the long position.
Short Position:
· At maturity, the spot exchange rate is
still 1.2500 USD/EUR.
· Using the formula for a short position's
payoff:
· Value at maturity (short position) =
-Principal * (Spot exchange rate at maturity - Settlement price)
· = -10,000 euros * (1.2500 USD/EUR - 1.2000
USD/EUR)
· = -10,000 euros * 0.0500 USD/EUR
· = -500 USD
· Therefore, the trader has to pay 500 USD
as the payoff for the short position.
In
summary, for a long position, the trader benefits from a favorable movement
in the exchange rate, resulting in a positive payoff. Conversely, for a short
position, the trader incurs losses when the exchange rate moves against their
position, leading to a negative payoff.
Exercise 1: Amber
sells a March futures contract and locks in the right to sell 500,000 Mexican
pesos at $0.10958/Ps (peso). If the spot exchange rate at maturity is
$0.095/Ps, the value of Amber’s position on settlement is?
Answer:
-500000*(0.095-0.10958). With this futures contract, Amber should sell 500,000
Mexican pesos to the buyer at $0.10958/ Ps. The market price at maturity is
$0.095/Ps, so Amber can buy 500,000 Mexican pesos at $0.095/Ps, and then sell
to the buyer at $0.10958/ Ps. So Amber wins!
Exercise 2: Amber
purchases a March futures contract and locks in the right to sell 500,000
Mexican pesos at $0.10958/Ps (peso). If the spot exchange rate at maturity is
$0.095/Ps, the value of Amber’s position on settlement is?
Answer:
500000*(0.095-0.10958). With this futures contract, Amber should buy 500,000
Mexican pesos from the seller at $0.10958/ Ps. The market price at maturity
is $0.095/Ps, so Amber can buy 500,000 Mexican pesos at $0.10958/ Ps for
something that worth only $0.095/ Ps. So Amber lost money!
Exercise 3: Amber
sells a March futures contract and locks in the right to sell 500,000 Mexican
pesos at $0.10958/Ps (peso). If the spot exchange rate at maturity is
$0.11/Ps, the value of Amber’s position on settlement is?
Answer:
-500000*(0.11-0.10958). With this
futures contract, Amber should sell 500,000 Mexican pesos to the buyer at
$0.10958/ Ps. The market price at maturity is $0.11/Ps, so Amber can buy
500,000 Mexican pesos at $0.11/Ps, and then sell to the buyer at $0.10958/
Ps. So Amber lost money!
Exercise 4: Amber
purchases a March futures contract and locks in the right to sell 500,000
Mexican pesos at $0.10958/Ps (peso). If the spot exchange rate at maturity is
$0.11/Ps, the value of Amber’s position on settlement is?
Answer: 500000*(0.11-0.10958). With
this futures contract, Amber should buy 500,000 Mexican pesos from the seller
at $0.10958/ Ps. The market price at maturity is $0.11/Ps, so Amber can buy
500,000 Mexican pesos at $0.10958/ Ps, for something that worth $0.11/ Ps. So
Amber wins!
Exercise 5: You
expect peso to depreciate on 4/4. So you sell peso future contract (6/17) on
4/4 with future rate of $0.09/peso. And on 6/17, the spot rate is $0.08/peso.
Calculate the value of your position on settlement
HW of chapter 5 part I (Due with the second mid-term)
1. Consider
a trader who opens a short futures position. The contract
size is £62,500; the maturity is six months, and the settlement price is
$1.60 = £1; At maturity, the price (spot rate) is $1.50 = £1. What is his
payoff at maturity?
(Answer: £6250)
2. Consider
a trader who opens a long futures position. The contract size is £62,500; the maturity
is six months, and the settlement price is $1.60 = £1; At maturity, the price
(spot rate) is $1.50 = £1. What is his payoff at maturity?
(Answer: -£6250)
3. Consider
a trader who opens a short futures position. The contract
size is £62,500, the maturity is six months, and the
settlement price is $1.40 = £1; At maturity, the price (spot rate) is $1.50 =
£1. What is his payoff at maturity?
(Answer: -£6250)
4.
Consider a trader who opens a long futures
position. The contract size is
£62,500, the maturity is six months, and the
settlement price is $1.40 = £1; At maturity, the price (spot rate) is $1.50 =
£1. What is his payoff at maturity?
5.
What is Euro Futures
contract? What is Micro Euro Futures Contract? Please refer to the articles
at
6. Watch this video and explain the following
concepts.
Understanding Futures Margin
| Fundamentals of Futures Trading Course
· What is margin account?
· What is mark to market?
· What is initial margin?
· What is maintenance margin?
· What is margin call?
· How is margin call triggered?
· What will happen after a margin call is
received?
7. Watch the following video, CBOE Digital President on Spot Bitcoin ETF, Derivatives
at https://www.youtube.com/watch?v=xENwajeNBKg,
on Bloomberg, and answer the following one of the following questions:
·
What potential impact could the approval of a spot Bitcoin ETF
have on the overall sentiment of the cryptocurrency market?
·
How does the existence of a spot Bitcoin ETF open up
investment opportunities for institutional players like pension funds and
Article RIA based funds?
·
Explain the role of derivatives, contracts, options, and
futures in the cryptocurrency market ecosystem, especially in the presence of
a spot ETF.
Chicago Mercantile Exchange (CME) (FYI)
By JAMES CHEN Updated June 20, 2021
https://www.cmegroup.com/markets/products.html#assetClass=sg-48&cleared=Options
video https://www.youtube.com/watch?v=poRK317iMZ4
What Is the Chicago Mercantile Exchange?
The Chicago Mercantile Exchange (CME), colloquially known as the
Chicago Merc, is an organized exchange for the trading of futures and
options. The CME trades futures, and in most cases options, in the sectors of
agriculture, energy, stock indices, foreign exchange, interest rates, metals,
real estate, and even weather.
CME was originally called the Chicago Butter and Egg Board and
was used for trading agricultural products, such as wheat and corn.
In the 1970s the CME added financial futures, followed shortly
by precious metals, Treasuries, and other assets.
In 2007, the CME merged with the Chicago Board of Trade to
create CME Group, one of the world's largest financial exchange operators.
CME Group now owns several other exchanges in different cities.
Nowadays, CME is also known for trading unusual commodities like
Bitcoin futures and weather derivatives.
Understanding the Chicago Mercantile Exchange (CME)
Founded in 1898, the Chicago Mercantile Exchange began life as
the "Chicago Butter and Egg Board" before changing its name in
1919. It was the first financial exchange to "demutualize" and
become a publicly traded, shareholder-owned corporation in 2000.
The CME launched its first futures contracts in 1961 on frozen
pork bellies. In 1969, it added financial futures and currency contracts
followed by the first interest rate, bond, and futures contracts in 1972.
Creation of CME Group
In 2007, a merger with the Chicago Board of Trade created the
CME Group, one of the largest financial exchanges in the world. In 2008, the
CME acquired NYMEX Holdings, Inc., the parent of the New York Mercantile
Exchange (NYMEX) and Commodity Exchange, Inc (COMEX). By 2010, the CME
purchased a 90% interest in the Dow Jones stock and financial indexes.
The CME grew again in 2012 with the purchase of the Kansas City
Board of Trade, the dominant player in hard red winter wheat. And in late
2017, the Chicago Mercantile Exchange began trading in Bitcoin futures.
According to the CME Group, on average it handles 3 billion
contracts worth approximately $1 quadrillion annually. In 2021 CME Group
ended open outcry trading for most commodities, although outcry trading
continues in the Eurodollar options pit. Additionally, the CME Group operates
CME Clearing, a leading central counterparty clearing provider.
CME Futures and Risk Management
With uncertainties always present in the world, there is a
demand that money managers and commercial entities have tools at their
disposal to hedge their risk and lock in prices that are critical for
business activities. Futures allow sellers of the underlying commodities to
know with certainty the price they will receive for their products at the
market. At the same time, it will enable consumers or buyers of those
underlying commodities to know with certainty the price they will pay at a
defined time in the future.
While these commercial entities use futures for hedging,
speculators often take the other side of the trade hoping to profit from
changes in the price of the underlying commodity. Speculators assume the risk
that the commercials hedge. A large family of futures exchanges such as the
CME Group provides a regulated, liquid, centralized forum to carry out such
business. Also, the CME Group provides settlement, clearing, and reporting
functions that allow for a smooth trading venue.
CME is one of the only
regulated markets for trading in Bitcoin futures.
CME Regulation
CME is regulated by the Commodity Futures Trading Commission,
which oversees all commodities and derivatives contracts in the United
States. The CFTC is responsible for oversight of brokers and merchants,
conducts risk surveillance of derivatives trades, and investigates market
manipulation and other abusive trade practices. It also regulates trading in
virtual assets, such as Bitcoin.
Chicago Mercantile Exchange vs. Chicago Board of Trade
The Chicago Board of Trade (CBOT) is another Chicago-based
futures exchange, founded in 1848. The CBOT originally focused on
agricultural products, such as wheat, corn, and soybeans; it later expanded
to financial products such as gold, silver, U.S. Treasury bonds, and energy.
The CME merged with the CBOT in 2006, in a move approved by shareholders of
both organizations.
Example of Chicago Mercantile Exchange
Most commodities can be traded anywhere, but there's one you can
only trade at the CME: weather. CME is the only futures exchange to offer
derivatives based on weather events, allowing traders to bet on cold
temperatures, sunshine, or rainfall. In 2020, the CME traded as many as 1,000
weather-related contracts per day, with a total annual volume of over $1
billion.
Euro FX
Futures Contract Specs
(http://www.cmegroup.com/trading/fx/g10/euro-fx_contract_specifications.html)
|
Contract Unit |
125,000 euro |
||
|
Trading Hours |
Sunday - Friday 6:00 p.m. - 5:00 p.m. (5:00 p.m. - 4:00 p.m.
Chicago Time/CT) with a 60-minute break each day beginning at 5:00 p.m.
(4:00 p.m. CT) |
||
|
Minimum Price Fluctuation |
Outrights: .00005 USD per EUR increments ($6.25 USD). |
||
|
Product Code |
CME Globex: 6E |
||
|
Listed Contracts |
Contracts listed for the first 3 consecutive months and 20
months in the March quarterly cycle (Mar, Jun, Sep, Dec) |
||
|
Settlement Method |
Deliverable |
||
|
Termination Of Trading |
9:16 a.m. Central Time (CT) on the second business day
immediately preceding the third Wednesday of the contract month (usually
Monday). |
||
|
Settlement Procedures |
Physical Delivery |
||
|
Position Limits |
|||
|
Exchange Rulebook |
|||
|
Block Minimum |
|||
|
Price Limit Or Circuit |
|||
|
Vendor Codes |
|||
Million
Dollar Pips The Life Of A
Day Trader
https://www.youtube.com/watch?v=unM_0Vh00K4
Foreign Exchange Market
https://www.youtube.com/watch?v=-qvrRRTBYAk
Bearish option strategies example onoptionhouse
Option Strategy graphs
Future Trading Guide
Futures
- Mechanics of the Futures Market
https://www.youtube.com/watch?v=1jA7c1_Jtvg
Cboe Digital Launches Margined Bitcoin
and Ether Futures, Announces Successful First Trade (FYI)
January
12, 2024
CHICAGO, Jan.
12, 2024 /PRNewswire/ -- Cboe Digital announced it
successfully launched margined Bitcoin and Ether
futures and completed its first margined Bitcoin futures
trade. With support from Blockfills, DV Trading LLC, Jump Trading Group,
Marex, Toa Capital Partners and Wedbush in executing these trades, Cboe
Digital becomes the first U.S. regulated crypto native
exchange and clearinghouse to offer both spot and leveraged derivatives
trading on a single platform.
"As
an exchange and clearinghouse, this is a significant milestone for Cboe
Digital and its vision to unify the crypto spot and futures
market," said John Palmer, President of Cboe Digital. "The future
of crypto is
at an exciting juncture and as more investors look to participate in this
asset class, we expect to see greater demand for derivatives to help manage
their crypto exposures,
hedge risk and enhance capital and operational efficiencies. We are grateful
for the hard work from our intermediaries, partners and team members that got
us here and look forward to continuing working with them to help drive the
market's growth."
"We
believe transparent and U.S. regulated markets drive customer demand for
these products and Marex was keen to support its customers from the
outset," said Thomas Texier, Head of Clearing at Marex. "Cboe
Digital's margin futures launch will help bring competitive technology and
innovative solutions to the crypto spot
and leveraged derivatives markets."
"As a
market maker with industry leading risk controls, we are pleased to be
working with a high-quality exchange such as Cboe Digital whose focus is to
enable broader institutional participation and adoption of cryptocurrencies,"
said Jake Moore of Toa Capital Group. "Cboe Digital's offer in providing
secure access to regulated futures markets is key to maturing this nascent
asset class."
"Cboe
Digital has been influential in helping facilitate the creation of a
transparent well-regulated crypto spot
and derivatives market," said Bob Fitzsimmons at Wedbush
Securities. "We look forward to continued collaboration in this
market and congratulate Cboe Digital on this exciting next step."
Following
its launch of financially settled margined contracts on Bitcoin and
Ether, Cboe Digital plans to expand its product suite to include physically
delivered products, pending regulatory approval. Significantly, Cboe Digital's
unified spot and derivatives trading platform is designed to allow customers
to easily access both markets. Operating this integral exchange and
clearinghouse model also enables Cboe Digital to potentially bring more
unique and groundbreaking offerings to the crypto markets.
For more
information about the new margined Bitcoin and Ether
futures, visit Cboe Digital's website here.
What is a Bitcoin Futures ETF? (FYI)
https://www.cftc.gov/LearnAndProtect/AdvisoriesAndArticles/BitcoinFuturesETF.html
A bitcoin futures exchange-traded fund (ETF) issues publicly traded
securities that offer exposure to the price movements of bitcoin futures
contracts.
Here’s how it works: An investment company creates a subsidiary that
acts as a commodity pool. The pool in turn trades bitcoin futures contracts
typically in an effort to mimic the spot price of bitcoin. But there are
costs involved like “roll premiums” and management fees, among others. Plus,
futures contracts don’t track spot prices exactly, so returns may never be as
high as, or in sync with, spot market prices.
Let's Break it Down…
Bitcoin is considered a commodity and is the underlying asset in
bitcoin futures contracts.
Bitcoins that sell for cash are said to trade on the “spot” market. With
limited exceptions, the bitcoin spot market is not regulated by the CFTC or
the SEC.
Bitcoin futures contracts — like other commodity futures contracts
such as corn futures, market index futures, or gold futures — are regulated
by the CFTC and must trade on CFTC-regulated exchanges.
Bitcoin and bitcoin futures can be highly volatile. Leverage created
by futures contracts can significantly amplify both gains and losses.
Futures contracts are standardized, time-limited contracts that
convey the right to buy or sell the underlying asset at some point in the
future. The contracts do not convey ownership in the asset itself. As
contracts approach expiration, they must be settled or traded for new
contracts. Many times, the selling prices of expiring contracts are below the
purchase prices of contracts expiring further in the future. This situation
is known as contango and means that traders suffer a small loss, or “pay a
roll premium,” when contracts are routinely rolled from the expiring month to
a future month.
ETFs are investment companies regulated by the SEC. The shares issued
by the ETF are securities that must be registered with the SEC. Like mutual
funds, ETFs have stated investment objectives and use professional money
managers to meet those objectives. In the case of managed commodity futures
funds, though, investment companies commonly set up subsidiaries that serve
as commodity pools.
A commodity pool is an investment trust or similar entity that trades
commodity futures contracts for the benefit of investors. The CFTC regulates
commodity trading advisors and commodity pool operators—the people who make
trading decisions and run the pools, respectively.
Management fees and other expenses also must be paid. In the case of
managed commodity futures funds, there is the management of the subsidiary
commodity pool to consider as well as the management of the parent investment
company.
The Bottom Line:
Regulated doesn’t mean risk-free. The risks and returns of a bitcoin
futures ETF will differ from the risks and returns of buying bitcoin on the
spot market, or when trading bitcoin futures.
Before investing:
·
Make a plan.
·
What’s your individual risk tolerance? How much
can you afford to risk (and how much could you afford to lose)?
·
How does this investment fit into your overall
portfolio?
Learn the markets.
·
Understand how the spot and futures markets
function, and how they could impact your investment.
·
Consider how roll premiums, management fees, and
expenses will affect overall performance.
Know
the risks.
·
Review
disclosure documents carefully and monitor market risks that could cause
prices to rise and fall.
·
How
much of your ETF investment will go into bitcoin futures contracts and how
much would be held in other assets?
·
Can
the commodity pool operator make changes to the announced trading strategy,
and under what circumstances? Can changes be made without notifying
participants?
Chapter 5 Part II: Call and Put Option
1. What is Call and put
option? Difference between the two?
American call option (video, khan academy)
IN Class Exercise
1. What does the term "out of the money"
mean in options trading?
a) The option has expired
b) The option's strike price is below the current
stock price (for call options)
c) The option's strike price is above the current
stock price (for call options)
Answer: c
Explanation: An option is
considered "out of the money" if exercising it would not be
profitable at the current stock price.
2. What advantage does buying an option offer in
terms of capital requirement?
a) Requires less capital upfront compared to
buying the stock directly
b) Requires more capital upfront compared to
buying the stock directly
c) Requires the same amount of capital as buying
the stock directly
Answer: a
Explanation: Buying an
option typically requires paying only the option premium, which is lower than
the cost of buying the stock directly.
3. In which scenario would an option holder incur
a loss?
a) When the stock price exceeds the strike price
b) When the option expires worthless
c) When the stock price falls below the strike
price plus the premium paid
Answer: c
Explanation: An option
holder incurs a loss if the stock price falls below the strike price plus the
premium paid for the option.
4. What does it mean if an option is "in the
money"?
a) The option has expired
b) Exercising the option would result in a profit
c) Exercising the option would result in a loss
Answer: b
Explanation: An option is
"in the money" if exercising it would result in a profit at the
current stock price.
5. What is the primary difference between American
and European options?
a) American options can only be exercised on the
expiration date
b) European options can only be exercised before
the expiration date
c) American options can be exercised anytime
before the expiration date
Answer: c
Explanation: The primary
difference is that American options allow for exercise at any time before
expiration, while European options can only be exercised on the expiration
date.
6. What is the significance of the strike price in
options trading?
a) It represents the current market price of the
stock
b) It determines the profit or loss upon
exercising the option
c) It indicates the expiration date of the option
contract
Answer: b
Explanation: The strike
price is the price at which the option holder can buy (for call options) or
sell (for put options) the underlying asset upon exercising the option.
7. What happens to the option premium if the
volatility of the underlying stock increases?
a) The option premium decreases
b) The option premium remains unchanged
c) The option premium increases
Answer: c
Explanation: Increased
volatility generally leads to higher option premiums to compensate for the
greater uncertainty in the underlying stock's price movements.
8. How does time remaining until expiration affect
the value of an option?
a) The option value decreases as expiration
approaches
b) The option value increases as expiration
approaches
c) The option value remains constant regardless of
time remaining
Answer: a
Explanation: Option value
tends to decrease as expiration approaches due to diminishing time value.
9. What is the maximum potential loss for an
option buyer?
a) Limited
to the option premium paid
b)
Unlimited
c) Limited to the difference between the stock
price and the strike price
Answer: a
Explanation: The maximum
potential loss for an option buyer is limited to the premium paid for the
option.
10. What factor primarily determines the
profitability of an option trade?
a) The
level of interest rates
b) The volume of options contracts traded
c) The direction of the stock price movement
Answer: c
Explanation: The
profitability of an option trade primarily depends on whether the stock price
moves in the anticipated direction relative to the option's strike price.
American put option (video, khan academy)
In Class Exercise
1. What option does an investor have if they
believe a stock's price will decrease but don't want to short it?
a) Buy a call option
b) Buy a put option
c) Buy the stock
Answer: b
Explanation: A put option
gives the holder the right to sell the stock at a specified price, providing
a way to profit from a stock price decrease without shorting the stock.
2. What distinguishes an American put option from
a European put option?
a) American put options can only be exercised on
the expiration date
b) European put options can only be exercised on
the expiration date
c) American put options can be exercised anytime
before the expiration date
Answer: c
Explanation: American put
options allow the holder to exercise the option at any time before
expiration, while European put options can only be exercised on the expiration
date.
3. What right does a put option grant to the
holder?
a) The right to sell the stock at a specified
price
b) The right to buy the stock at a specified price
c) The right to sell the option contract
Answer: a
Explanation: A put option
gives the holder the right to sell the stock at a specified price, known as
the strike price.
4. What happens if the stock price declines and
the put option is exercised?
a) The investor buys the stock at the market price
b) The investor sells the stock at the strike
price
c) The investor sells the option contract
Answer: b
Explanation: If the stock
price declines, the put option holder exercises the option to sell the stock
at the strike price, realizing a profit.
5. How does the risk of loss differ between shorting
a stock and buying a put option?
a) Shorting a stock has unlimited loss potential,
while buying a put option has limited loss potential.
b) Shorting a stock has limited loss potential,
while buying a put option has unlimited loss potential.
c) Both shorting a stock and buying a put option
have unlimited loss potential.
Answer: a
Explanation: Shorting a
stock can lead to unlimited losses if the stock price rises significantly,
whereas the maximum loss for buying a put option is limited to the premium
paid for the option.
6. What happens if the stock price exceeds the
strike price of the put option?
a) The investor exercises the option
b) The investor sells the option contract
c) The investor lets the option expire
Answer: c
Explanation: If the stock
price exceeds the strike price of the put option, it becomes worthless, and
the investor lets it expire without exercising it.
7. What is the primary purpose of buying a put
option?
a) To profit from a decrease in the stock price
b) To profit from an increase in the stock price
c) To generate income from dividends
Answer: a
Explanation: The primary
purpose of buying a put option is to profit from a decrease in the stock
price by selling the stock at a higher strike price.
8. What happens to the value of a put option if
the volatility of the underlying stock increases?
a) Increases
b) Decreases
c) Remains unchanged
Answer: a
Explanation: Increased
volatility generally leads to higher option premiums, including put options,
to compensate for the greater uncertainty in the stock's price movements.
9. How does the expiration date impact the value
of a put option?
a) The option value increases as expiration
approaches
b) The option value decreases as expiration
approaches
c) The option value remains constant regardless of
expiration
Answer: b
Explanation: Option value
tends to decrease as expiration approaches due to diminishing time value.
10. What is the maximum loss for an investor
buying a put option?
a) Limited to the premium paid for the option
b) Limited to the difference between the strike
price and the stock price
c) Unlimited
Answer: a
Explanation: The maximum
loss for an investor buying a put option is limited to the premium paid for
the option.
11. What does it mean if a put option is "in
the money"?
a) The option has expired
b) Exercising the option would result in a loss
c) Exercising the option would result in a profit
Answer: c
Explanation: A put option
is "in the money" if the stock price is below the strike price,
making exercising the option profitable.
12. How does buying a put option differ from
shorting a stock in terms of obligations?
a) Buying a put option has no obligations, while
shorting a stock requires borrowing and selling shares.
b) Both buying a put option and shorting a stock
have obligations to buy the stock at a specified price.
c) Both buying a put option and shorting a stock
have obligations to sell the stock at a specified price.
Answer: a
Explanation: Buying a put
option gives the holder the right but not the obligation to sell the stock at
a specified price, while shorting a stock involves borrowing and selling
shares with an obligation to buy them back.
Call payoff diagram (video, khan academy)
https://www.youtube.com/watch?v=MZQxeQYQCUg
Put payoff diagram (video, khan academy)
https://www.youtube.com/watch?v=VST_U297pH0
In Class Exercise
1. What does a payoff diagram depict in options
trading?
a) The profit and loss at expiration
b The value of the option at expiration
c) The historical price movements of the
underlying stock
Answer: a
Explanation: A payoff
diagram illustrates the profit or loss at option expiration based on the
price of the underlying stock.
2. What is the primary purpose of a payoff diagram
in options trading?
a) To predict future stock price movements
b) To determine the fair value of an option
c) To visualize the potential profit or loss at
option expiration
Answer: c
Explanation: A payoff
diagram helps traders visualize the potential profit or loss at option
expiration based on different stock price scenarios.
2. Calculate the payoff for
both call and put?
· For call: Profit = Spot rate – strike
price – premium; if option is exercised (when spot rate > strike price)
Or, Profit
= -premium, if option is not exercised (expired when spot
rate < strike
price)
In general, profit = max((spot rate – strike price -
premium), -premium ) ---------- Excel syntax
Excel payoff diagram for
call and put options (very helpful, FYI only)
(Thanks to Dr. Greene http://www2.gsu.edu/~fncjtg/Fi8000/dnldpayoff.htm)
Calculator of Call and
Put Option
1.
Jim is a speculator . He
buys a British pound call option with a strike of $1.4 and a December
settlement date. Current spot price as of that date is $1.39. He pays a
premium of $0.12 per unit for the call option. Just before the expiration
date, the spot rate of the British pound is $1.41.At that time, he exercises
the call option and sells the pounds at the spot rate to a bank. One option
contract specifies 31,250 units. What is Jim’s profit or loss? Assume Linda
is the seller of the call option. What is Linda’s profit or loss?
(refer to ppt.
Answer:
Spot rate is
$1.41, Jim’s total profit: (1.41-1.4-0.12)*31250=(-0.11)*31250
Spot rate is
$1.39, Linda’s total profit: 0.12*31250
Spot rate is $1.41,
Linda’s total profit: -((1.41-1.4-0.12)*31250)=0.11*31250
*** the loss
of taking the long position of the option is just the gain of taking the
short position. It is a zero sum game.
· For put: Profit = strike price - Spot rate –
premium, if option is exercised (when spot rate < strike price)
2.
A speculator bought a put option (Put premium
on £ = $0.04 / unit, X=$1.4, One contract specifies £31,250 )
He exercise the option shortly
before expiration, when the spot rate of the pound was $1.30. What is his
profit? What is the profit of the seller? (refer to ppt) When spot rate was $1.5, what are the profits of
seller and buyer?
Answer:
Spot rate is
$1.50, option buyer’s total profit: -0.04*31250
Spot rate is
$1.30, option seller’s total profit: -(1.4 - 1.3 – 0.04) *31250
Spot rate is
$1.50, option seller’s total profit: 0.04*31250
*** the loss
of taking the long position of the option is just the gain of taking the
short position. It is a zero sum game.
www.jufinance.com/option_diagram
Summary
|
Strike Price <
Current Price |
Strike Price = Current Price |
Strike Price > Current Price |
|
Call Option: In the
Money |
Call Option: At the
Money |
Call Option: Out of the
Money |
|
Put Option: Out of the
Money |
Put Option: At the
Money |
Put Option: In the
Money |
Payoff for Call
Option (X = Strike, S = Current Price):
·
In the Money: S - X
·
At the Money: 0
·
Out of the Money: 0
Payoff
for Put Option (X = Strike, S = Current Price):
·
In the Money: X - S
·
At the Money: 0
·
Out of the Money: 0
How To Buy and Sell Bitcoin
Options
Learn what it takes to buy
and sell Bitcoin options
By ALEX LIELACHER Updated
February 11, 2024, Fact checked by SUZANNE KVILHAUG
https://www.investopedia.com/how-to-buy-and-sell-bitcoin-options-7378233
Bitcoin options are financial derivatives that enable
investors to speculate on the price of the digital currency with leverage or
hedge their digital asset portfolios. Available on both
traditional derivatives exchanges and on crypto trading platforms, Bitcoin
options have emerged as a popular investment product among advanced crypto
traders.
KEY TAKEAWAYS
· Bitcoin options are financial derivatives contracts
that allow you to buy or sell Bitcoin at a predetermined price on a specific
future date.
· Trading Bitcoin and other cryptocurrency options
works much the same as other options, except they're typically less liquid.
· There are some trading platforms and crypto
exchanges where you can trade Bitcoin options; but you'll need to set up and
fund an account first.
· Trading Bitcoin options is riskier and more complex
than trading spot Bitcoin, which is itself risky and speculative.
· Traders should conduct as much research as possible
(including consulting with a financial advisor) before trading Bitcoin
options, and must select a reputable reputable crypto derivatives exchange
with strong security for their trades.
· Understanding Bitcoin Options
Options are financial
derivatives contracts that give holders the right but not the obligation to
buy or sell a predetermined amount of an asset at a specified price, and at a
specific date in the future.
In the case of Bitcoin options, the underlying asset is the
cryptocurrency Bitcoin (BTC). While the
cryptocurrency options market is still fairly new, you can already trade
Bitcoin and Ethereum options on a handful of traditional securities exchanges
and crypto trading platforms.
Traders who wish to
gain exposure to Bitcoin now have additional choices. The 11 recently launched spot Bitcoin exchange-traded funds (ETFs),
which were approved by the U.S. Securities and Exchange Commission in January
2024, each offer a basket of cryptocurrency securities and can be traded on
Cboe BZX, NYSE Arca, and Nasdaq.
From a technical
point of view, cryptocurrency options and options contracts on assets like
stocks, indexes, or commodities function in essentially the same way.
However, crypto options are generally
less liquid than options on leading stock indexes or commodities like gold.
That’s a result of the crypto markets still being a lot smaller than
traditional investment markets.
European vs. American
There are two main
types of options contracts: European and American. The key difference between
the two is that European-style options can only be exercised at expiration,
while American-style options can be exercised at any time up until the expiry
date.
ITM vs. ATM vs. OTM
An options position
can either be in the money, at the money, or out of the money.
· An in-the-money (ITM) option refers to the situation
when the option has intrinsic value. If you exercised an in-the-money option
you would profit. For call options, this is when the market price is higher
than the strike price. Put options are in-the-money when the market price is
below the strike price.
· An out-of-the-money (OTM) option refers to a situation
when you would lose money if you exercised the option, meaning the option
currently has no intrinsic value. In the case of call options, this is when
the market price is lower than the strike price. For put options, this is
when the market price is higher than the strike price.
· An at-the-money (ATM) option is currently trading at
the strike price.
Calls vs. Puts
You can either buy a call or a put option. A call gives the
holder the right to buy the underlying asset, while a put option gives the
holder the right to sell the underlying asset.
Whether you buy or
sell a Bitcoin put option or call option depends on whether you want to
speculate on a rising or falling price or whether you are looking to hedge
crypto exposure.
Physical vs. Cash Settle
Options can either be cash settled or physically settled. For example, if you trade cocoa options, you could—if the options
contract determines it—receive shipments of cocoa once the options contract
expires.
When bitcoin options are settled physically, the bitcoin is
transferred between the two parties. When cash settlement is used, the
parties would exchange dollars or another currency.
Investing in cryptocurrencies, decentralized finance
(DeFi), and initial coin offerings (ICOs) is highly risky and speculative, and the markets can be extremely
volatile. Consult with a qualified professional before making any
financial decisions.
Options Are Riskier Than Spot Trading
Trading Bitcoin options is generally riskier than buying
and selling Bitcoin in the spot market.
For example, suppose you buy a call option on Bitcoin with
a strike price of $35,000 and an expiry date that is three months away. If
the price of Bitcoin doesn’t surpass $35,000 by the expiration date, you will
lose the options premium (the price you paid for the option) in full.
Options Are More Complex Than Spot Trading
When trading Bitcoin
options, the price of Bitcoin is not the only factor affecting the value of
options contracts. There are several key factors that affect the value of the
options you buy or sell, but time decay is by far the most critical. That’s
because as the time moves closer to the expiry date, the value of an options
contract decreases because the time remaining to trade or exercise the options
diminishes.
The Bitcoin Options Market Is Less Established
While Bitcoin options
can be found on traditional securities exchanges, like the Chicago Mercantile
Exchange (CME), and on dedicated crypto trading platforms, the BTC options market is still quite
young and doesn’t have the deep liquidity found in mature options markets. This
can affect price slippage, especially in options with longer maturities.
HW
Chapter 5 Part II (Due with the
second mid term exam)
4. You purchase a put option
on Swiss francs for a premium of $.05, with an exercise price of $.50. The
option will not be exercised until the expiration date, if at all. If the
spot rate on the expiration date is $.58,
how much is the payoff of this long option? And your profit? (And
also, please draw the payoff diagram to both the long and short put option
holders, optional, for extra credits. www.jufinance.com/option_diagram).
(Answer: -$0.05; 0)
5. Optional assignment for critical thinking: Set up a
practice account at https://www.cmegroup.com/education/practice.html
and click on the “trading simulator” to start trading on the future market.
Choose a specific future contract, such as euro future contract expired in
March, and you can start the game.
6. Critical Thinking questions (optional):
·
What
factors determine the price of Bitcoin options?
·
What
risks are associated with trading Bitcoin options?
·
Can
Bitcoin options potentially enhance portfolio diversification by offering
exposure to Bitcoin with controlled risk?
Chapter 7 Interest Rate Parity
Interest rate
parity calculator https://www.jufinance.com/irp/
In class exercises
1. Locational arbitrage
Exercise 1: Bank1
–
bid Bank1-ask Bank2-bid
Bank2-ask
£ in
$: $1.60 $1.61 $1.62 $1.63
How can you arbitrage?
Answer: Buy pound at bank1’s ask price and sell pound at bank2’s bid
price. Profit is $0.01/pound
For instance, with $1,610, you can buy £
at bank 1 @ $1.61/£ and get back £1,000.
Then, you can sell £ at bank 2 @ $1.62/£
and get back $1,620, and make a profit of $10.
Pound is cheaper in bank 1 but more
expensive in bank 2. Therefore, you can arbitrage.
Hint: Always buy from dealer at ask
price, and sell to dealer at bid price.
Bank1
–
bid Bank1-ask Bank2-bid
Bank2-ask
£ in
$: $1.6 $1.61 $1.61 $1.62
How can you arbitrage?
(Answer: Buy pound at bank1’s ask price and sell pound at
bank2’s bid price. No Profit )
For instance, with $1,610, you can buy £
at bank 1 @ $1.61/£ and get back £1,000.
Then, you can sell £ at bank 2 @ $1.61/£
and get back $1,610, and make a profit of $0.
Pound is cheaper in bank 1 but more
expensive in bank 2. However, there is a bid ask spread, or fees charged by
dealers. So no arbitrage opportunities.)
Hint: Always buy from dealer at ask
price, and sell to dealer at bid price.
Exercise 2: If you start with $10,000 and conduct one round
transaction, how many $ will you end up with ?
(Answer: ($10000
/ 0.64($/NZ$)) – the amount obtained from north bank.
($10000 / 0.64($/NZ$)) * 0.645
($/NZ$) = $10078.13)
Hint: Always buy from dealer at ask
price, and sell to dealer at bid price.
2. Triangular arbitrage
Exercise 1: £ is quoted at $1.60. Malaysian Rinnggit (MYR)
is quoted at $0.20 and the cross exchange rate is £1 = MYR 8.1. How can you
arbitrage?
Answer: Either $ è MYR è £ è $, or $ è £ è MYR è $, one way or another, you should make money. In this
case, it is the latter one. Imagine you have $1,600 è 1,000
Approach one: Yes, $ è GBP è MYR è $ could make a profit of $20.
Approach two: No, $ è MYR è GBP è $ does not work.
Interest rate parity (IRP)
· The interest rate parity implies that the
expected return on domestic assets = the exchanged rate adjusted expected
return on foreign currency assets.
IRP is based on that “Investors cannot earn
arbitrage profits” by
- Borrow an amount in a currency with a lower interest
rate.
- Convert the borrowed amount into a currency with a
higher interest rate.
- Invest the proceeds in an interest-bearing instrument
in this higher-interest-rate currency.
- Simultaneously hedge exchange risk by buying a forward
contract to convert the investment proceeds into the first (lower
interest rate) currency.
For discussion:
Assume the current spot rate of GBP is 1.5$/£. Interest rate in US is 5% and Interest rate
is UK is 10%. Shall you invest in US for 5% or shall you invest in UK for a
higher return?
***Answer***: It should make no difference at all! Please
explain.
Invest in US, return = 5%. Invest in UK,
return = 5% as well. Why?
You can borrow at 5% in US, then convert
to GBP at 1.5$/GBP, then deposit in US for 10%, convert back to $ at the
forward rate, and this forward rate would be 1.4318$/GBP, then your return
would be 5%.
$1500 è 1000 GBP è1100 GBP one year later è 1100 GBP * (1.4318$/GBP) =$1574.98, we start from
$1500, and 1574.98/1500-1 = 5% of return
Forward
rate = 1.4318 $/GBP. Why?
The
returns for either approach should both equal to 5%.
So
invest in US, by the end of the year, the account value = $1500 *(1+5%)
Invest
in UK, 1000 GBP *(1+10%) * Forward rate
Both
investments should provide the same returns to investors, since the financial
market is efficient è
no arbitrage opportunity
$1500
*(1+5%) =1000 GBP *(1+10%) * Forward rate è
Forward rate = $1500 *(1+5%) / 1000 GBP *(1+10%) = 1.4318$/GBP
Equation of IRP:
or 
S$/¥:
spot rate how many $ per ¥. ¥ is the base currency and $ is quoted currency
F$/¥:
forward rate;
So, F = S
*(1+ interest rate of quoted currency) / (1+ interest rate of base currency)
Why?
Deposit in ¥
@ the ¥’s rate and then convert back to F (forward rate)
= Convert to $ at spot rate and deposit at
$’s rate
So, (1+rate¥)*F
= S* (1+rate$) è F = S*
(1+rate$) /((1+rate¥)
Or,
S¥/$:
spot rate how many ¥ per $. ¥ is the base $ quoted
F¥/$:
forward rate;
So, F = S
*(1+ interest rate of quoted currency) / (1+ interest rate of base currency)
Why?
Deposit in $
@ the $’s rate and then convert back to F (forward rate)
= Convert to ¥ at spot rate and deposit at
¥’s rate
So, (1+rate$)*F
= S* (1+rate¥) è F = S*
(1+rate¥) /((1+rate$)
Or,
The basic equation for calculating
forward rates with the U.S. dollar as the base currency is:
Forward Rate = Spot Rate * [(1 +
Interest Rate of quoted currency) / (1 + Interest Rate of based
currency)]
Spot rate:
¥/$, or USD/YEN (Yen is quoted and $ is based)
Or,
Forward Rate = Spot
Rate * ( Interest Rate of quoted
currency - Interest Rate of based currency +1 )
Implications of IRP Theory
·
If IRP theory holds, then it can negate the possibility of
arbitrage. It means that even if investors invest in domestic or foreign
currency, the ROI will be the same as if the investor had originally invested
in the domestic currency.
·
When domestic interest rate is below foreign interest
rates, the foreign currency must trade at a forward discount. This is applicable
for prevention of foreign currency arbitrage.
·
If a foreign currency does not have a forward discount or
when the forward discount is not large enough to offset the interest rate
advantage, arbitrage opportunity is available for the domestic investors. So,
domestic investors can sometimes benefit from foreign investment.
·
When domestic rates exceed foreign interest rates, the
foreign currency must trade at a forward premium. This is again to offset
prevention of domestic country arbitrage.
·
When the foreign currency does not have a forward premium
or when the forward premium is not large enough to nullify the domestic
country advantage, an arbitrage opportunity will be available for the foreign
investors. So, the foreign investors can gain profit by investing in the
domestic market.
https://www.tutorialspoint.com/international_finance/interest_rate_parity_model.htm
Exercise 1: i$ is
8%; iSF is 4%; If spot rate S
=0.68 $/SF, then how much is F90 (90 day forward rate)?
Answer:
S =0.68 $/SF è CHF/USD = 0.68, so CHF is base currency and
USD is the quoted currency.
So, F = 0.68*(1+8%/4) / (1+4%/4) = 0.6867
$/CHF (or CHF/USD = 0.6867)
Exercise 2: i$ is
8%; iyen is 4%; If spot rate S =
0.0094 $/YEN, then how much is F180 (180 day forward rate)?
Answer:
S = 0.0094 $/YEN, so $ is the quoted
currency, Yen is the base currency.
F = S *(1+
interest rate of quoted currency) / (1+ interest rate of base)è F=0.0094*(1+8%/2)/(1+4%/2) = 0.0096 $/YEN
Exercise 3: i$ is 4% and i£ is
2%. S is $1.5/£ and F is $2/£. Does IRP hold? How can you arbitrage? What is
the forward rate in equilibrium?
Answer:
S = $1.5/£, so $ is the quoted currency,
£ is the base currency.
F = S *(1+
interest rate of quoted currency) / (1+ interest rate of base)è F=(1.04/1.02)*1.5 = $1.529/£, F at $2/£
is too high.
When F=$2/£, what can US investors do to make arbitrage profits?
For example, US investor
·
can borrow 1,000 $, and pay back
$1,040 a year later.
·
Convert to £ now at spot rate and get $1,000/1.5$/£ = 666.67 £
·
deposit in UK @ 2%
·
so one year later, get back
666.67 £*(1+2%)=680£
·
convert to $ at F rate
·
so get back 680 £ * 2$/£ =
$1,360
·
So the investor can make a
profit of 1,360 -1040 = $320 profit.
The forward rate is set too high. It
should be set around $1.529/£, so that the arbitrage opportunity will be
eliminated.
Exercise 4: i$ is 2%
and i£ is 4%. S is $1.5/£ and F is $1.1/£.
Does IRP hold? How can you arbitrage? What is the forward rate in
equilibrium?
Answer:
S = $1.5/£, so $ is the quoted currency,
£ is the base currency.
F = S *(1+
interest rate of quoted currency) / (1+ interest rate of base)è F=(1.02/1.04)*1.5 = $1.471/£, so F at
$1.1/£ is too low.
When F=$1.1/£, what can US investors do to make arbitrage profits?
For example, US investor
·
can borrow 1,000 $, and pay back
$1,040 a year later.
·
Convert to £ now at spot rate and get $1,000/1.5$/£ = 666.67 £
·
deposit in UK @ 4%
·
so one year later, get back
666.67 £*(1+4%)=693.33£
·
convert to $ at F rate
·
so get back 680 £ * 1.1$/£ =
$762.67
·
So the investor will lose
money: $762.67 -1040 = -247.33, a loss.
The forward rate is set too low. It
should be set around $1.471/£.
SO US investors should let this CIA (covered
interest rate arbitrage) go, but UK investor could consider borrow money in
UK to generate risk free profits. So the trade by UK investors will force
forward rate to drop to its equilibrium price based on IRP.
Homework chapter 7 (due with final)
1. Suppose
that the one-year interest rate is 5.0 percent in the United States and 3.5
percent in Germany, and the one-year forward exchange rate is $1.3/€. What
must the spot exchange rate be? (Hint: the question is asking for the
spot rate, given forward rate. ~~ $1.2814/€ ~~)
2. Imagine that can
borrow either $1,000,000 or €800,000 for one year. The one-year interest rate
in the U.S. is i$ = 2%
and in the euro zone the one-year interest rate is i€ =
6%. The one-year forward exchange rate is $1.20 = €1.00; what must the spot
rate be to eliminate arbitrage opportunities? (1.2471$/€. It does not
matter whether you borrow $ or euro)
3. Image that the future
contracts with a value of €10,000 are available. The information
of one year interest rates, spot rate and forward rate available are as
follows.
Question: profits that you
can make with one contract at maturity?
Exchange
rate Interest
rate APR
So($/€) $1.45=€1.00 Interest
rate of $ 4%
F360($/€) $1.48=€1.00 Interest
rate of € 3%
Hint: The future contract is available, so you
can buy 10,000 euro in the future to buy the
futures contract. So at present, you can
borrow €9,708.3 (=10,000 euro /
1.03) euro and use the money 360 days later to purchase the future contract
of €10,000, since € interest rate is 3%. Let’s see you can make money or not.
Convert €9,708.3 to $ at spot rateè get back €9,708.3
*1.45 $/€= $14,077.67 è deposit at US @4% interest rate, and get back
$14,077.67 *(1+4%) = $14,640.78 è convert at F rate, and get back $14,640.78 / 1.48 $/€ =9,892.417 euro
, less than 10,000 euro è so this round of trading is not a good
idea.
However, if the F rate is $1.46/euro or even less, then you can get
back $14,640.78 / 1.46 $/€ > 10,000 euro, so you can do better by doing so
than simply depositing money in euro with 3% interest rate.
4. Image that you find
that interest rate per year is 3% in Italy. You also realize that the spot
rate is $1.2/€ and forward rate (one year maturity) is $1.18/€.
Question: Use IRP to calculate the interest rate per year in
US. (1.28%)
5) Suppose
the exchange rates for three currencies - US dollars (USD), Euros (EUR), and
British pounds (GBP) - are as follows:
·
1 USD = 0.85 EUR
·
1 EUR = 0.75 GBP
· 1 USD = 0.63 GBP
Assume that there
are no transaction costs or other barriers to arbitrage.
Questions: a) Is there an
opportunity for triangular arbitrage starting with US dollars (USD)? If so,
what is the potential profit and how would you execute it?
b) What effect would
this arbitrage have on the exchange rates between the three currencies?
Hint: a) There is an
opportunity for triangular arbitrage starting with USD. To execute the
arbitrage, an investor would use the three exchange rates to create a
triangular loop that begins and ends with the same currency. The investor
would do the following:
Buy EUR with USD:
Convert 1 USD to EUR at the rate of 1 USD = 0.85 EUR.
Buy GBP with EUR:
Convert the €0.85 to GBP at the rate of 1 EUR = 0.75
GBP.
Buy USD with GBP:
Convert the £0.6375 to USD at the rate of 1 USD = 0.63 GBP
Calculate the profit:
The profit from this transaction is the difference between the initial and
final USD amounts, which is …
b) This arbitrage
would have the effect of increasing the demand for GBP and decreasing the
demand for USD and EUR in the London market, while increasing the demand for
USD and EUR and decreasing the demand for GBP in the New York and Frankfurt
markets. This would cause the exchange rates to adjust until the profit
opportunity from the arbitrage is eliminated. Specifically, the USD/EUR rate
in New York would decrease, the EUR/GBP rate in London would increase, and
the USD/GBP rate in Frankfurt would decrease.
6. Suppose the exchange
rates for US$/GBP, GBP/JPY, and JPY/US$ are 1.25, 150, and 0.008,
respectively. Is there an opportunity for triangular arbitrage? Why or why
no?
Hint: Try convert
US$1 into GBP, then into JPY, and finally back into US$.
Starting with US$1,
we can buy 0.8 GBP by exchanging it at the rate of 1 US$/1.25 GBP. Then, we
can use the 0.8 GBP to buy JPY at the rate of 1 GBP/150 JPY, which gives us
120 JPY. Finally, we can convert the 120 JPY back into US$ by exchanging it
at the rate of 1 JPY/0.008 US$, which gives us US$,,,,,
Chapter
8 Purchasing Power Parity
1) Purchasing power parity (PPP)
Purchasing power parity (cartoon) https://www.youtube.com/watch?v=i0icL5zlQww
|
|
|
·
A
theory which states that exchange rates between currencies are in
equilibrium when their purchasing power is the same in each of the two
countries. ·
This
means that the exchange rate between two countries should equal the ratio
of the two countries' price level of a fixed basket of goods and services. ·
When
a country's domestic price level is increasing (i.e., a country experiences
inflation), that country's exchange rate must depreciated in order to
return to PPP. ·
The
basis for PPP is the "law of one price": In the absence of transportation and
other transaction costs, competitive markets will equalize the price of an
identical good in two countries when the prices are expressed in the same
currency. |
|
In Class Exercise 1. According to Purchasing Power Parity (PPP)
theory, exchange rates between currencies are in equilibrium when: a) Their exchange rates are fixed b) Their purchasing power is the same in each
country c) They are determined solely by supply and
demand Answer:
b Explanation: PPP theory suggests that
exchange rates should adjust so that a given basket of goods and services
costs the same in different countries when expressed in a common currency. 2. What does the "law of one price"
state in the context of Purchasing Power Parity? a) Prices of identical goods in different
countries will always be the same b) Prices of goods can vary widely even in
competitive markets c) In competitive markets, prices of identical
goods in different countries will equalize when expressed in the same
currency Answer:
c Explanation: The "law of one
price" suggests that in the absence of transportation and other
transaction costs, identical goods should have the same price when
expressed in the same currency. 3. When a country experiences inflation, what
happens to its exchange rate according to Purchasing Power Parity? a) It depreciates b) It appreciates c) It remains unchanged Answer:
a Explanation: Inflation in a country
implies that its currency's purchasing power decreases relative to other
currencies, so its exchange rate must depreciate to maintain equilibrium
under PPP. 4. What is the main concept behind Purchasing
Power Parity? a) Equal distribution of wealth among nations b) Equilibrium in exchange rates based on
purchasing power equality c) Fixed exchange rates between currencies Answer:
b Explanation: The main idea of PPP is that
exchange rates should adjust so that the purchasing power of different
currencies is equalized. 5. Which statement accurately describes the
relationship between inflation and exchange rates under Purchasing Power
Parity? a) High inflation leads to currency appreciation b) Low inflation leads to currency depreciation c) Inflation differential leads to exchange rate
adjustments Answer:
c Explanation: Differences in inflation
rates between countries prompt adjustments in exchange rates to maintain
PPP. 6. Which condition is necessary for the
"law of one price" to hold true? a) Absence of transportation and transaction
costs b) Government intervention in markets c) Fluctuating exchange rates Answer:
a Explanation: The "law of one
price" assumes no barriers to trade like transportation costs,
tariffs, or other transaction costs that could impede price equalization. 7. What does PPP suggest about the long-term
movement of exchange rates? a) They will remain constant b) They will fluctuate randomly c) They will tend to move towards PPP
equilibrium over time Answer:
c Explanation: PPP posits that exchange
rates will adjust over the long term to reflect changes in relative price
levels between countries. 8. How does PPP theory view deviations from
equilibrium exchange rates? a) As temporary and insignificant b) As persistent and significant c) As irrelevant to international trade Answer:
b Explanation: PPP theory acknowledges that
deviations from equilibrium exchange rates can persist over time and have
significant implications for international trade and investment flows. |
2) The Law of one price THEORY:
All else being equal
(no transaction costs), a product’s price should be the same in all markets
So price in $ sold in US =
price in $ sold in Japan after conversion to $ from ¥
P$ = P ¥ * Spot Rate $/¥
Where
the price of the product in US dollars (P$), multiplied by the
spot exchange rate (S, dollar per yen), equals the price of the
product in Japanese yen (P¥)
Or, S = P$/ P ¥
|
https://www.jufinance.com/ppp
|
|
· No. · Exchange rate movements in the short term are
news-driven. · Announcements about interest rate changes, changes in perception
of the growth path of economies and the like are all factors that drive
exchange rates in the short run. · PPP, by comparison, describes the long
run behaviour of exchange rates. · The economic forces behind PPP will eventually equalize
the purchasing power of currencies. This can take many years, however. A
time horizon of 4-10 years would be typical. · What else? Your opinion? |
4)
How to calculate PPP? ---- Use big mac index
· PPP states that the spot exchange rate is determined by
the relative prices of similar basket of goods.
· The simplest way to calculate purchasing power parity
between two countries is to compare the price of a "standard" good
that is in fact identical across countries.
· Every year The Economist magazine
publishes a light-hearted version of PPP: its "Hamburger
Index" that compares the price of a McDonald's hamburger around the
world. More sophisticated versions of PPP look at a large number of goods and
services.
· One of the key problems is that people in different
countries consumer very different sets of goods and services, making it
difficult to compare the purchasing power between countries.
· For class discussion: can we use bitcoin as another goods
to calculate PPP?
Using Hamburgers to Compare Wealth
- Big mac index explained video
Question: Can you use Big Mac Index as evidence to
determine whether or not a currency is under-valued? Or over-valued?
Market Edge: Peso 'undervalued' vs dollar based on
'Big Mac Index,' says The Economist (video)
|
|
|
The
currencies listed below are compared to the US Dollar. A green bar
indicated that the local currency is overvalued by the percentage figure
shown on the axis; the currency is thus expected to depreciate against the
US Dollar in the long run. A red bar indicates undervaluation of the local
currency; the currency is thus expected to appreciate against the US Dollar
in the long run (based
on old data) |
The
currencies listed below are compared to the Euro.
|
|
|
Math equation: ef= Ih-
If or ((1+ Ih)/(1+If)
-1= ef; ef: change in exchange rate
(1+ 9%) /(1+5%)
-1 = ef = 4% , and 1£=1.6$, so the new
rate of £ =1.6*(1+4%) = 1.66 $/£.
Or use the calculator at: https://www.jufinance.com/ife/
Let's
consider an example where a product costs £1 in the UK and $1.6 in the US. If
there's a 5% increase in prices in the UK, the new price becomes £1 * (1 +
5%). Simultaneously, with a 9% inflation rate in the US, the new price in the
US should be $1.6 * (1 + 9%).
According
to the theory of Purchasing Power Parity (PPP), these adjusted prices should
reflect the same purchasing power across currencies. Thus, we can equate the
new prices and solve for the new exchange rate:
·
New Price in UK = £1 * (1 + 5%)
·
New Price in US = $1.6 * (1 + 9%)
To
find the new exchange rate:
New
Exchange Rate = New Price in US / New Price in UK
Substituting
the values:
New
Exchange Rate = ($1.6 * (1 + 9%)) / (£1 * (1 + 5%))
This
simplifies to:
·
New Exchange Rate = $1.6 * (1 + 9%) / (£1
* (1 + 5%))
·
New Exchange Rate = $1.6 * 1.09 / (£1 *
1.05)
·
New Exchange Rate = $1.744 / £1.05
·
New Exchange Rate ≈ $1.66 per £
So,
based on PPP theory, the new exchange rate would be approximately $1.66 per
£.
Example
2: 1£=1.6$. US inflation rate is 5%. UK
inflation is 9%. What will happen? Calculate the new exchange rate using the
PPP equation.
ef = Ih – If, Ih=
5%, If =9%, so ef =
5%-9% = -4%, so the old rate is that 1£=1.6$. The new rate should be 4%
lower. So new rate is that 1£=1.6*(1-4%) = 1.54$
Or, https://www.jufinance.com/ife/
Let's
reconsider the scenario with the US experiencing a 5% inflation rate and the
UK facing a 9% inflation rate. In this case, the new prices in both countries
would adjust accordingly:
·
Original price in the UK: £1
·
Original price in the US: $1.6
After
a 9% inflation rate in the UK and a 5% inflation rate in the US:
·
New price in the UK = £1 * (1 + 9%)
·
New price in the US = $1.6 * (1 + 5%)
According
to the theory of Purchasing Power Parity (PPP), these adjusted prices should
be equalized by the exchange rate:
New
Exchange Rate = New Price in US / New Price in UK
Substituting
the values:
New
Exchange Rate = ($1.6 * (1 + 5%)) / (£1 * (1 + 9%))
This
simplifies to:
·
New Exchange Rate = $1.6 * (1 + 5%) / (£1
* (1 + 9%))
·
New Exchange Rate = $1.6 * 1.05 / (£1 *
1.09)
·
New Exchange Rate = $1.68 / £1.09
·
New Exchange Rate ≈ $1.54 per £
So,
based on PPP theory, the new exchange rate would be approximately $1.54 per
£.
Homework
– No homework for Chapter 8
Second Midterm Exam (chapters 4, 5, 7, 8) – on 4/9/2024
Study guide – All Calculation Questions, similar to In
Class Exercises and Homework
Review 4/4/2024 in Class
Review
Video
Chapter 11: Managing Transaction Exposure
What Is Transaction Exposure?
Transaction
exposure is the level of uncertainty businesses involved in international
trade face. Specifically, it is the risk that currency
exchange rates will fluctuate after a firm has already undertaken a
financial obligation. A high level of vulnerability to shifting exchange
rates can lead to major capital losses for these international businesses.
One way that firms can limit their exposure to changes in the exchange rate
is to implement a hedging strategy. Through hedging
using forward rates, they may lock
in a favorable rate of currency exchange and avoid exposure to risk.
Risks
of Transaction Exposure
The danger of transaction
exposure is typically one-sided. Only the business that completes a
transaction in a foreign currency may feel the vulnerability. The entity that
is receiving or paying a bill using its home currency is not subjected to the
same risk. Usually, the buyer agrees to buy the product using foreign money.
If this is the case, the hazard comes it that foreign currency should
appreciate, costing the buyer to spend more than they had budgeted for the
goods.
Key
Takeaways
- The
level of risk companies involved in international trade face.
- A
high level of exposure to fluctuating exchange rates can lead to major
losses for firms.
- The
risk of transaction exposure is typically one-sided.
Real
World Example of Transaction Exposure
Suppose that a United
States-based company is looking to purchase a product from a company in
Germany. The American company agrees to negotiate the deal and pay for the
goods using the German company's currency, the euro. Assume that when
the U.S. firm begins the process of negotiation, the value of the euro/dollar
exchange is a 1-to-1.5 ratio. This rate of exchange equates to one euro being
equivalent to 1.50 U.S. dollars (USD).
Once the agreement is
complete, the sale might not take place immediately. Meanwhile, the exchange
rate may change before the sale is final. This risk of change is transaction
exposure. While it is possible that the values of the dollar and the euro may
not change, it is also possible that the rates could become more or less
favorable for the U.S. company, depending on factors affecting the currency
marketplace. More or less favorable rates could result in changes to
the exchange rate ratio, such as a more favorable 1-to-1.25 rate or
a less favorable 1-to-2 rate.
Regardless of the change in
the value of the dollar relative to the euro, the Belgian company experiences
no transaction exposure because the deal took place in its local
currency. The Belgian company is not affected if it costs the U.S. company
more dollars to complete the transaction because the price was set
as an amount in euros as dictated by the sales agreement.
(https://www.investopedia.com/terms/t/transactionexposure.asp)
Types of foreign exchange exposure
Transaction Exposure – measures changes in the value of
outstanding financial obligations incurred prior to a change in exchange
rates but not to be settled until after the exchange rate changes
Operating (Economic)Exposure – also called economic exposure, measures the
change in the present value of the firm resulting from any change in expected
future operating cash flows caused by an unexpected change in exchange rates
Translation Exposure – also called accounting exposure,
is the potential for accounting derived changes in owner’s equity to occur
because of the need to “translate” financial statements of foreign
subsidiaries into a single reporting currency for consolidated financial
statements
Tax Exposure – the tax consequence of foreign exchange exposure varies by
country, however as a general rule only realized foreign
losses are deductible for purposes of calculating income taxes
\
What
is transaction exposure
Example of transaction exposure
— Purchasing or selling on credit
goods or services when prices are stated in foreign currencies
— Borrowing or lending funds when
repayment is to be made in a foreign currency
— Being a party to an unperformed
forward contract and
— Otherwise acquiring assets or
incurring liabilities denominated in foreign currencies
How to reduce the transaction exposure risk?
1. 1. Forward (Future) Market Hedge
2. 2.
Money Market Hedge
3. 3.
Options Market Hedge: call and put
· To hedge a
foreign currency payable buy calls on the currency.
· To hedge a
foreign currency receivable buy puts on the currency.
Exercise
1: Hedging currency
payable
A
U.S.–based importer of Italian bicycles
· In
one year owes €100,000 to an Italian supplier.
· The
spot exchange rate is $1.18 = €1.00
· The
one year forward rate is $1.20 = €1.00
· The
one-year interest rate in Italy is i€ =
5%
· The
one-year interest rate in US is i$ = 8%
— Call option exercise
price is $1.2/ € with premium of $0.03.
How to
hedge the currency payable risk
a. With
forward contract?
b. With
money market?
c. With
call option? Can we use put option?
Answer: Need €100,000
one year from now to pay the payable and plan to hedge the risk of overpaying
for the payable one year from now.
1) With
forward contract:
Buy the
one year forward contract @$1.20 = €1.00. So need
100,000€*1.2$/€ = $120,000
one year from now. So the company needs to come up with $120k for this
payable obligation.
2) With
money market:
Need €100,000 one year from now, and the rate is 5% in Italy, so
can deposit €100,000/(1+5%) = €95238.10
now.
For
this purpose, need to convert from € to
$: €95238.10*$1.18 /€=$112380.98.
Imagine
the company does not have that much of cash and it borrows @8%. So one year
from now, the total $ required to pay back to the banks is: $112380.98 *(1+8%)
= $121371.43. So the company needs to come up
with $121371.43for this payable obligation.
Summary: Borrow
$112380.98 @8% and convert to €95238.10 at present;
One year later, the company can get the €100,000 and
needs to pay back to the bank a total of $121371.43.
3) With
call option:
Imagine
the rate one year later is $1.25/€. So should
exercise the call option and the cost one year later should be
€100,000
*(1.2+0.03) $/€ = $123000, lower than the actual cost
without the call option. So $123k is the most that the company needs to
prepare for this payable obligation. USING CALL OPTION, THE ACTAUL PAYMENT
COULD BE A LOT LESS, DEPENDING ON THE ACTAUL EXCHANGE RATE ONE YEAT LATER.
Exercise
2: Hedging currency receivable
(refer to the PPT of chapter 11 for answers)
· A
U.S.–based exporter of US bicycles to Swiss
distributors
· In
6 months receive SF200,000 from an Swiss distributor
· The
spot exchange rate is $0.71 = SF1.00
· The
6 month forward rate is $0.71 = SF1.00
· The
one-year interest rate in Swiss is iSF = 5%
· The
one-year interest rate in US is i$ = 8%
· Put
option exercise price is $0.72/ SF with premium of $0.02.
How to
hedge the currency payable risk
a. With
forward contract?
b. With
money market?
c. With
call option? Can we use put option?
Answer: Will
receive SF200000 six month from now as receivable and plan to
hedge the risk of losing value in the receivable six month from now.
1) With
forward contract:
Sell
the one year forward contract @$0.71 = €1.00. So get
200,000SF * 0.71$/SF = $142,000 six month from now. So the company could
receive $142k with forward contract.
2) With
money market:
Get
SF200000 six month from now, and the rate is 5% in Swiss (or 2.5% for six
months), so can borrow SF 200,000/(1+2.5%) = SF195121.95 now.
And can
convert @ spot rate to SF195121.95 * 0.71$/SF = $138536.59. This is
the money you have now.
So six
month from now, the total you have in the bank is: $138536.59*(1+4%) =
$144078.05. And you can use the SF200000 receivable to pay back the
loan. So the company could receive $144078.05 with money
market.
Summary: Borrow SF195121.95
@5% at present; six month later, the company can get
the SF200,000 receivable and payback the loan. Meanwhile, convert
the borrowed SF to $ and deposit in US banks @ 8%.
3) With
put option: With SF200000 received six month later, need
to converting it back to $. So can buy put option which allows to sell SF for
$ at the exercise price $0.72/ SF.
Imagine
the rate one year later is $0.66/ SF. So should exercise the put option
and the total amount of $ six month later should be SF
200,000 *(0.72-0.02) $/ SF = $140000. So $140k is the LEAST that
the company CAN OBTAIN. USING PUT OPTION, THE ACTAUL INCOME COULD
BE A LOT MORE, DEPENDING ON THE ACTAUL EXCHANGE RATE ONE YEAT LATER.
Homework of Chapter 11 (due with final)
1. Suppose that your company will be
billed £10 million payable in one year. The money market interest
rates and foreign exchange rates are given as follows. How to hedge the risk
for parable using forward contract. How to hedge the risk using money market?
How to hedge risk using call option?
|
Call option exercise price The U.S. one-year interest
rate: |
$1.46/ €
with premium of $0.03 6.10% per annum |
|
The U.K. one-year interest rate: |
9.00% per annum |
|
The spot exchange rate: |
$1.50/£ |
|
The one-year forward exchange rate |
$1.46/£ |
(Answer: With forward contract: $14.6
million; Money market: $14.6million; Call option: $14.9million)
2. Suppose that your company will be billed
£10 million receivable in one year. The money market interest
rates and foreign exchange rates are given as follows. How to hedge the risk
for parable using forward contract. How to hedge the risk using money market?
How to hedge risk using put option?
|
put option exercise price The U.S. one-year interest
rate: |
$1.46/ €
with premium of $0.03 6.10% per annum |
|
The U.K. one-year interest rate: |
9.00% per annum |
|
The spot exchange rate: |
$1.50/£ |
|
The one-year forward exchange rate |
$1.46/£ |
(Answer: With forward contract: $14.6 million; Money market: $14.6million; Put option: $14.3million)
Question 3: Multiple Choice Questions
1.
What is the primary purpose of hedging receivables and payables?
a)
To eliminate exchange rate risk
b)
To eliminate interest rate risk
c)
To generate profits
d)
To reduce tax liabilities
Answer: a) To eliminate exchange rate
risk
2.
Which of the following is NOT a method of hedging receivables and payables?
a)
Forward contracts
b)
Options contracts
c)
Future contacts
d)
Money market
wer: c) Spot contracts
3.
What is a receivable?
a)
A payment that is owed to a company by its customers
b)
A payment that a company owes to its suppliers
c)
A payment that a company makes to its shareholders
d)
A payment that a company makes to its employees
Answer: a) A payment that is owed to
a company by its customers
4.
What is the primary risk associated with receivables in international
finance?
a)
Credit risk
b)
Exchange rate risk
c)
Interest rate risk
d)
Regulatory risk
Answer: b) Exchange rate risk
5.
What is a payable?
a)
A payment that a company owes to its suppliers
b)
A payment that is owed to a company by its customers
c)
A payment that a company makes to its shareholders
d)
A payment that a company makes to its employees
Answer: a) A payment that a company
owes to its suppliers
6.
Which of the following is a method of hedging payables in international
finance using call options?
a)
Buying a call option to sell the underlying currency
b)
Buying a call option to buy the underlying currency
c)
Buying a put option to sell the underlying currency
d)
Buying a put option to buy the underlying currency
Answer: b) Buying a call option to
buy the underlying currency
7.
Which of the following is a benefit of using call options to hedge payables?
a)
Unlimited potential gains
b)
Limited potential losses
c)
Guaranteed fixed exchange rate
d)
No premium payment required
Answer: b) Limited potential losses.
8.
Which of the following is a method of hedging receivables in international
finance using put options?
a)
Buying a call option to sell the underlying currency
b)
Buying a call option to buy the underlying currency
c)
Buying a put option to sell the underlying currency
d)
Buying a put option to buy the underlying currency
Answer: d) Buying a put option to buy
the underlying currency
9.
Which of the following is a benefit of using put options to hedge
receivables?
a)
Unlimited upside potential
b)
Limited downside risk
c)
Fixed exchange rate
d)
No premium payment required
Answer: b) Limited downside risk
10.
Which of the following is a method of hedging payables in international
finance using a forward contract?
a)
Selling the underlying currency forward
b)
Buying the underlying currency forward
c)
Buying a put option on the underlying currency
d)
Selling a call option on the underlying currency
Answer: b) Buying the underlying
currency forward
11.
Which of the following is a benefit of using a forward contract to hedge payables?
a)
No premium payment required
b)
Unlimited upside potential
c)
Fixed exchange rate
d)
Limited downside risk
Answer: c) Fixed exchange rate
12.
Which of the following is a disadvantage of using a forward contract to hedge
payables?
a)
Requires payment of a premium
b)
Limited upside potential
c)
Unlimited downside risk
d)
Exposure to counterparty risk
Answer: d) Exposure to counterparty
risk
Chapter 18 Long Term Debt Financing
- Interest rate swap
ppt
Intro:
• All
firms—domestic or multinational, small or large,
leveraged, or unleveraged—are sensitive to interest rate movements in
one way or another.
• The
single largest interest rate risk of the nonfinancial firm (our focus in this
discussion) is debt service
– The
multicurrency dimension of interest rate risk for the MNE is a complicating
concern.
• The
second most prevalent source of interest rate risk for the MNE lies in its
portfolio holdings of interest-sensitive securities
Example: Consider a firm
facing three debt strategies
– Strategy #1: Borrow $1
million for 3 years at a fixed rate
– Strategy #2: Borrow $1
million for 3 years at a floating rate, LIBOR + 2% to be reset annually
(LIBOR: London Interbank Offered Rate,)
– Strategy #3: Borrow $1
million for 1 year at a fixed rate, then renew the credit annually
– Although the lowest cost of
funds is always a major criterion, it is not the only one
• Strategy #1 assures itself
of funding at a known rate for the three years
– Sacrifices the ability to
enjoy a fall in future interest rates for the security of a fixed rate of
interest should future interest rates rise
• Strategy #2 offers what #1
didn’t, flexibility (and, therefore, repricing risk)
– It too assures funding for
the three years but offersrepricing risk
when LIBOR changes
– Eliminates credit risk as
its spread remains fixed
• Strategy #3 offers more
flexibility but more risk;
– In the second year the firm
faces repricing and credit
risk, thus the funds are not guaranteed for the three years and neither is
the price
– Also, firm is borrowing on
the “short-end” of the yield curve which is typically upward sloping—hence,
the firm likely borrows at a lower rate than in Strategy #1
Volatility, however, is far greater on the short-end
than on the long-end of the yield curve.
What is
interest rate swap?
Swaps are contractual agreements to exchange or swap a
series of cash flows
– Whereas a forward rate
agreement or currency forward leads to the exchange of cash flows on just one
future date, swaps lead to cash flow exchanges on several future dates
• If the agreement is to swap
interest payments—say, fixed for a floating—it is termed an interest
rate swap
– Most commonly,
interest rate swaps are associated with a debt service, such
as the floating-rate loan described earlier
– An agreement between two
parties to exchange fixed-rate for floating-rate financial obligations is
often termed a plain vanilla swap
– This type of swap forms
the largest single financial derivative market in the world.
Why
Interest-rate Swaps Exist
• If company A (B)
wants a floating- (fixed-) rate loan, why doesn’t it just do it from the
start? An explanation commonly put forward is comparative
advantage!
• Example: Suppose that two
companies, A and B, both wish to borrow $10MM for 5 years and have been
offered the following rates:
Fixed Floating
Company
A 10% 6
month LIBOR+0.3%
Company
B 11.2% 6month
LIBOR+1.0%
Note:
·
Company A anticipates the
interest rates to fall in the future and prefers a floating rate loan. However, company A can get a better deal in
a fixed rate loan.
·
On the contrary, company B
anticipates the interest rates to rise and therefore prefers a fixed rate
loan. Company B’s comparative advantage is in getting a floating rate loan.
·
So both companies could be
better off with a interest rate swap contract.
– The difference between the
two fixed rates (1.2%) is greater than the difference between the two
floating rates (0.7%)
• Company B has a comparative
advantage in floating-rate markets
• Company A has a comparative
advantage in fixed-rate markets
• In fact, the combined
savings for both firms is 1.2% - 0.70% = 0.50%
Solution:
A: Receive fixed rate 10.5% from B, pay LIBOR + 0.55% to B, and
pay 10% to bank
è
Final outcome: A could pay the
debt at 10% interest rate to the bank with the10.5% interest received from Bè leaving A
with 0.5% under A’s control.
è
Since A needs to pay B at
LIBOR + 0.55% and A has kept 0.5% previously
è
A’s net result = LIBOR + 0.55%
- 0.5% = LIBOR + 0.05% = LIBOR + 0.05%
è
A anticipates the rates to go
down and prefers to pay at a flexible rate.
è
Eventually, A gets LIBOR +
0.05%, better than the rate A could obtain from the bank directly which is
LIBOR + 0.3%, so A would benefit from this interest rate swap deal.
B: Receive
LIBOR + 0.55% from A, pay 10.5% to A,
and pay LIBOR + 1% to bank
è
Final outcome: B could pay the
debt at LIBOR + 1% interest rate to
the bank with the LIBOR + 0.55%
interest received from Aè leaving B with -0.45%.
è
Since B needs to pay A at
10.5% and B still have -0.45% debt previously
è
B’s net result = 10.5% + 0.45%
= 10.95%
è
B anticipates the rates to go
up and prefers to pay at a fixed rate.
è
Eventually, B gets 10.95%,
better than the rate B could obtain from the bank directly which is 11.2%, so
B would benefit from this interest rate swap deal.
Plain vanilla swap: An agreement between two
parties to exchange fixed-rate for floating-rate financial obligations
Homework of
chapter 18 (due with final, optional)
1.
How did
Goldman Sacks help Greece to cover its debt using currency swap? (Hint: Goldman Sachs helped the Greek government to mask the
true extent of its deficit with the help of a derivatives deal (Goldman Sachs arranged a secret loan of 2.8
billion euros for Greece, disguised
as an off-the-books “cross-currency swap”.—a
complicated transaction in which Greece's foreign-currency debt was converted
into a domestic-currency obligation using a fictitious market exchange rate.) that legally
circumvented the EU Maastricht deficit rules. At some point the so-called cross currency
swaps will mature, and swell the country's already bloated deficit https://www.thenation.com/article/archive/goldmans-greek-gambit/)
2.
What are the
pros and cons associated with establishing a currency swap?
3.
Explain what
is an interest rate swap using an example.
4. Company AAA will borrow $1,000,000 for ten years at a floating rate. Company BBB will borrow for ten years at a fixed rate for $1,000,000. Refer to the following for details.
|
|
Fixed-Rate Borrowing Cost |
Floating-Rate Borrowing Cost |
|
|
|
Company AAA |
10% |
LIBOR |
|
|
|
Company BBB |
12% |
LIBOR + 1.5% |
|
|
|
Note: ·
Company AAA anticipates
the interest rates to fall in the future and prefers a floating rate
loan. However, company AAA can get a
better deal in a fixed rate loan. ·
On the contrary, company
BBB anticipates the interest rates to rise and therefore prefers a fixed
rate loan. Company BBB’s comparative advantage is in getting a floating
rate loan. ·
So both companies could be
better off with a interest rate swap contract. Assume that a swap bank help the
two parties. 1 According to the swap contract, Firm BBB will pay the swap
bank on $1,000,000 at a fixed rate of 10.30% 2 The swap bank will pay firm
BBB on $1,000,000 at the floating
rate of (LIBOR - 0.15%). 3 Firm AAA needs to pay the swap bank
on $1,000,000 at the floating rate of (LIBOR - 0.15%); 4 The swap bank will pay firm AAA on
$10,000,000 at a fixed rate of 9.90%. Please answer the following
questions. · Show the value of this swap to firm
AAA? (answer: Firm AAA can save $500
each year) · Show the value of this swap to firm
BBB? ( answer:
Firm BBB will save $500 per year) · Show the value of the swap to the swap bank. (answer: The swap bank can earn $4,000 each year) |
|
||||
Hint: Just write down all relevant transactions for each player,
and sum them up. For example, AAA pays 10% and LIBOR-0.15%, and receive 9.9% è net result: 10% - 9.9% + LIBOR-0.15% = LIBOR
-0.05%, a saving of 0.05%, since if AAA gets the debt from the bank, AAA’s
interest rate would be LIBOR. Similarly, for BBB, pay LIBOR + 1.5% - (LIBOR -0.15%) + 10.3% = 11.95%, a
saving of 0.5%, since BBB could get 12% interest rate if BBB gets the loan
from the bank directly; To the SWAP Bank, its net result = Receive 10.3% from
BBB, and pays 9.9% to AAA, and receive LIBOR-0.15% from AAA and pays
LIBOR-0.15% to BBB, so net result = 10.3% - 9.9% +(LIBOR -0.15%) –
(LIBOR=0.15%) = 0.4%, the profit of the SWAP bank.)
Final Exam and
Term Project due
Term Project Review on 4/11/2023 and 4/16/2024
Class
Video Word Session (in class
4/16/2024) Part I
Class
Video Excel Session (in class
4/11/2024)
Final Exam (during final week, in class, non-cumulative)
- 4/22-25, from 1pm to 5 pm, in
office 118A
- You may also arrange to meet
and take the final exam at a different time by appointment
Happy Summer!
