FIN415 • Midterm 1 Study Guide

Modules 1–7 Key terms • Theories • Formulas Examples included
How to study (fast & effective): For each module: (1) read the Big Ideas (2) memorize the Key Terms (3) copy the Formulas once on paper (4) walk through the Example (5) review the Common Traps (these are where T/F questions come from).
T/F “trap words” checklist watch these
  • always, never, only, guarantees, immediately, exactly the same
  • “in the short run” vs “in the long run” (FX & trade balance)
  • Confusing bid vs ask; confusing base vs quote
What the midterm is testing think like examiner
  • Can you identify the logic (cause → effect) in each topic?
  • Can you use identities correctly? (BoP, S−I, trilemma)
  • Can you spot “sounds right” but wrong statements (classic T/F)?

Modules 1–7

Click each module to open. This page is a study guide only.
Module 1 Trade Architecture + Intl Orgs + BRICS
comparative advantage WTO / MFN (most favoriate nations)

Big Ideas (what you must be able to explain)

  • Comparative advantage is about opportunity cost, not “who is better at everything.”
  • Trade is usually positive-sum overall, but it creates winners and losers inside countries.
  • Institutions (WTO rules, enforcement, predictability) reduce “trade chaos.”
  • Reserve currency discussions (e.g., BRICS) depend on convertibility, deep markets, and trust.

Key Terms (one-sentence definitions)

Comparative advantage
Specialize where opportunity cost is lowest.
Trap: “absolute advantage” ≠ comparative advantage.
Opportunity cost
What you give up to produce one more unit of something else.
Tariff
Tax on imports → raises domestic price → transfers + deadweight loss.
Quota
Quantity limit on imports → creates quota rents (who gets them depends on license rules).
WTO / MFN (most favoriate nations)
MFN (most favoriate nations) = nondiscrimination across WTO members (with exceptions like FTAs/customs unions).
Trade creation vs diversion
Creation: shift toward lower-cost sources. Diversion: shift toward higher-cost inside a bloc.
Convertibility
Ability to exchange currency freely without heavy capital controls.
Network effects
The more users adopt a system (currency/hub), the more valuable it becomes.

Example (comparative advantage in 60 seconds)

Mini-example: opportunity cost T/F favorite
Country A (1 hour): 4 shirts OR 2 phones OC(1 phone) = 2 shirts Country B (1 hour): 1 shirt OR 1 phone OC(1 phone) = 1 shirt
  • B has lower OC for phones (1 shirt < 2 shirts) ⇒ B has comparative advantage in phones.
  • A has comparative advantage in shirts (because B’s OC for shirts is higher).
Trap: Even if A is “more productive” in both goods, trade can still make sense because OC can differ.

Common Confusions (where T/F statements come from)

  • “MFN (most favoriate nations) means no exceptions ever” → false.
  • “Quota always gives revenue to government like a tariff” → false (depends who gets quota licenses).
  • “Trade creation = buying from higher-cost producer inside bloc” → false (that’s diversion).
Module 2 Tariffs → Uncertainty → FX/Capital Response
welfare retaliation

Big Ideas

  • Tariffs change relative prices → changes in quantities → welfare effects (CS, PS, revenue, DWL).
  • Retaliation and uncertainty can increase damage beyond the tariff itself.
  • FX and capital flows can react quickly to policy news.

Key Terms

Consumer surplus (CS)
Usually falls with tariffs (higher prices).
Producer surplus (PS)
Often rises for protected domestic producers (not always).
Government revenue
Tariff × imported quantity (but imports may fall).
Retaliation
Partner responds with its own trade barriers.
Pass-through
How much FX or tariff cost shows up in final import price.
Trap: pass-through is rarely 100% instantly.

Example (welfare logic: who wins/loses)

Tariff effects in words know the direction
  • Domestic price of the import: up
  • Imports: down (usually)
  • Consumers: worse off
  • Protected domestic producers: better off
  • Government: gets revenue
  • Economy overall: DWL exists → not free money
T/F trap: “Tariffs always improve national welfare because jobs.” → almost always false in standard models.

Common Confusions

  • “Tariffs help the country” ignores consumer losses + DWL.
  • “Exchange rates offset tariffs perfectly” → generally false.
  • “Policy affects FX only through trade flows” → false (capital flows matter a lot).
Module 3 Balance of Payments (BoP) + Identities
CA + FA = 0 CA = S − I

Big Ideas

  • BoP is double-entry accounting. In total, it must balance (with errors/omissions).
  • Key identity: CA = S − I. This is a favorite for T/F.
  • A CA deficit corresponds to net capital inflow (financial account surplus).
  • Trade balance response to FX can be delayed (J-curve).

Formulas you must know

BoP identity (simplified): CA + FA + KA + Errors/Omissions = 0 Saving–investment identity: CA = S − I

Key Terms

Current Account (CA)
Goods/services trade balance + net income + net transfers.
Financial Account (FA)
Cross-border capital flows (assets & liabilities).

Example (CA deficit ↔ capital inflow)

Mini-example: identity logic exam style
  • If the U.S. runs a current account deficit, it is importing more than exporting (net).
  • To finance that net purchase, foreigners must acquire U.S. assets (or reduce U.S. holdings abroad) → financial account surplus.
T/F trap: “A CA deficit means a FA deficit.” → false (they generally move opposite).
Module 4 Monetary Systems + Trilemma
gold trilemma

Big Ideas

  • Monetary regimes are tradeoffs: stability vs flexibility.
  • Trilemma: fixed FX, free capital, independent monetary policy → pick only two.
  • Capital controls can “buy room” for policy autonomy under a peg.

Core framework (must memorize)

TRILEMMA (Impossible Trinity) Pick TWO: 1) Fixed exchange rate 2) Free capital mobility 3) Independent monetary policy

Key Terms

Gold standard
Currency convertible to gold; limits monetary policy discretion.
Bretton Woods
Fixed-but-adjustable pegs with USD central role historically.
Floating FX
FX determined by market; monetary policy targets inflation/employment.
Capital controls
Restrictions on cross-border capital movement.

Example (trilemma in plain English)

If you want a hard peg… what must you give up?
  • If you also allow free capital, you generally give up independent monetary policy.
  • If you insist on setting your own interest rate and keeping a peg, you likely need capital controls.
T/F trap: “A country can have fixed FX + free capital + independent monetary policy if it tries hard enough.” → false.
Module 5 International Financial Hubs + Follow-the-Sun
liquidity network effects

Big Ideas

  • Hubs form where there is liquidity, institutions, talent, infrastructure, and networks.
  • Follow-the-sun: global trading rotates by time zone (Asia → Europe → US).
  • Once liquidity concentrates, network effects make it hard to dislodge the hub.

Key Terms

Liquidity
Ability to trade quickly at low cost with little price impact.
Market depth
Large volume near current price; usually narrower spreads.
Clearing
Process of confirming trades and managing obligations.
Settlement
Final transfer of cash and ownership (not the same as trading).
Rule of law
Predictable enforcement of contracts/property rights.

Example (why hubs persist)

Why liquidity attracts liquidity network effect
  • More traders → tighter spreads → lower costs → more traders.
  • Supporting services cluster: lawyers, compliance, clearing, research, market data.
T/F trap: “Low taxes alone create a top hub.” → false (institutions + depth matter).
Module 6 FX Quotes + Cross Rates + Triangular Arbitrage
bid/ask cross rates

Big Ideas

  • Always identify base vs quote currency.
  • Cross rates come from a shared currency (often USD).
  • Arbitrage requires using the correct bid vs ask at each step; spreads kill “paper” profits.

Core rules (memorize)

EUR/USD = 1.10 → 1 EUR costs 1.10 USD Base currency = first (EUR) Quote/terms currency = second (USD) Dealer buys base at BID, sells base at ASK

Example (cross rate)

Cross rate example (no spreads) quick math
GBP/USD = 1.25 (1 GBP = 1.25 USD) USD/JPY = 150 (1 USD = 150 JPY) GBP/JPY = (GBP/USD) × (USD/JPY) = 1.25 × 150 = 187.5
Trap: With bid-ask spreads, you must choose the correct side for each conversion.

Common Confusions

  • Bid = dealer buys; Ask = dealer sells (students flip this constantly).
  • Reciprocal: if A/B = x then B/A = 1/x.
Module 7 What Determines Currency Value? (USD)
capital flows risk premia

Big Ideas

  • FX is asset pricing: expected return + risk premium.
  • Trade flows matter, but capital flows often dominate in the short run.
  • Reserve status comes from deep markets, institutions, and network effects.
  • Carry trades earn interest differentials but have crash risk.

Key Terms

Safe-haven currency
Tends to appreciate during global stress (“risk-off”).
Risk premium
Extra return demanded for holding risky currencies/assets.
Carry trade
Borrow low-rate currency, invest in high-rate currency; vulnerable to reversals.
Reserve currency
Used for reserves/invoicing/finance; “sticky” due to network effects.

Example (why “higher rates” is not always simple)

Interest rates & currency value T/F trap
  • Higher rates can attract inflows → currency may appreciate…
  • But if higher rates reflect inflation risk, crisis risk, or weak growth, the currency can still weaken.
T/F trap: “Higher interest rates always cause a currency to depreciate/appreciate.” → usually false because “always.”
Final checklist before you walk into the exam: Can you (1) define CA/FA and use CA = S − I, (2) explain the trilemma, (3) do a cross-rate quickly, (4) state tariff winners/losers, (5) explain why hubs/reserve currencies persist (network effects)?