The Foreign Exchange Market - AP Macroeconomics
- State the formula to calculate the exchange rate.
- Exchange Rate = . Shows how many foreign units equal one domestic unit.
- What is a multilateral exchange rate?
- An average exchange rate of a currency against multiple others. Weighted index showing overall currency strength.
- Which factor decreases demand for a currency?
- Lower interest rates in the currency's country. Capital flows away, reducing currency demand.
- Identify the role of the foreign exchange market.
- Facilitates currency conversion for international trade. Enables global commerce by allowing currency exchanges.
- What is a foreign exchange reserve?
- Holdings of foreign currencies used to influence exchange rates. Used for intervention and crisis management.
- What is the foreign exchange rate?
- The price of one currency in terms of another. Expressed as a ratio showing conversion between currencies.
- What is purchasing power parity (PPP)?
- A theory stating exchange rates adjust to equalize prices of goods. Based on law of one price across countries.
- What is a currency crisis?
- A situation where a currency experiences a rapid devaluation. Severe depreciation threatens economic stability.
- What is a managed float exchange rate system?
- Exchange rates primarily market-determined but subject to government intervention. Combines market forces with occasional government action.
- What is the spot exchange rate?
- The current exchange rate for immediate transactions. Used for current trading and quick settlements.
- What is a fixed exchange rate system?
- Exchange rates pegged to another currency or a basket of currencies. Government maintains specific exchange rate targets.
- What is the balance of payments?
- A record of all economic transactions between residents of a country and the rest of the world. Includes current, capital, and financial account balances.
- What is the impact of interest rate differentials?
- Can lead to capital flows affecting currency value. Higher rates attract foreign investment and capital.
- How does an increase in imports affect currency value?
- Increases currency supply, leading to depreciation. Domestic buyers exchange currency for foreign goods.
- Identify the effect of political stability on currency.
- Increases investor confidence, potentially appreciating currency. Reduces risk perception, attracting foreign investment.
- Identify a consequence of a strong domestic currency.
- Exports become more expensive, potentially reducing demand. Higher prices reduce international competitiveness.
- How does speculation affect currency value?
- Speculation can lead to currency appreciation or depreciation. Expectations about future value drive current demand.
- What is the financial account?
- Part of the balance of payments recording investment flows. Records portfolio and direct investment flows.
- What is the role of the International Monetary Fund (IMF)?
- Provides financial assistance and advice to member countries. Promotes global monetary stability and cooperation.
- What is a currency peg?
- A fixed exchange rate policy to stabilize a currency's value. Government intervention maintains artificial exchange rate.
- How does a government use devaluation?
- To make exports cheaper and boost economic growth. Official reduction in currency value stimulates exports.
- What does it mean when a currency appreciates?
- It increases in value relative to other currencies. Rising value means more purchasing power abroad.
- Identify the effect of a trade deficit on currency.
- Causes currency depreciation due to higher supply. Net imports create higher supply of the currency.
- How does inflation impact currency value?
- Higher inflation typically decreases currency value. Rising prices reduce purchasing power and attractiveness.
- How do central banks influence foreign exchange markets?
- Through interventions such as buying or selling currencies. Direct market participation affects supply and demand.
- What is a speculative attack?
- A massive selling of a currency anticipating devaluation. Creates downward pressure forcing potential devaluation.
- What is the J-curve effect?
- Post-devaluation, trade balance first worsens, then improves. Short-term costs precede long-term trade benefits.
- What is the forward exchange rate?
- The agreed-upon exchange rate for future transactions. Locks in rate to reduce uncertainty and risk.
- Which factor increases demand for a currency?
- Higher interest rates in the currency's country. Capital flows seek higher returns, increasing demand.
- Identify a consequence of a weak domestic currency.
- Exports become cheaper, potentially increasing demand. Lower prices increase international competitiveness.
- What is currency arbitrage?
- Exploiting price differences of a currency in different markets. Profit from temporary price discrepancies across markets.
- What does it mean when a currency depreciates?
- It decreases in value relative to other currencies. Falling value means less purchasing power abroad.
- What is the current account?
- Part of the balance of payments recording trade in goods and services. Records exports, imports, and income flows.
- What is a floating exchange rate system?
- Exchange rates determined by market forces without direct government control. Supply and demand determine rates freely.
- What is a bilateral exchange rate?
- Exchange rate between two specific currencies. Direct rate between any two currencies.
- How does an increase in exports affect currency value?
- Increases currency demand, leading to appreciation. Foreign buyers need domestic currency to purchase exports.
- Identify the effect of a trade surplus on currency.
- Causes currency appreciation due to higher demand. Net exports create higher demand for the currency.
- What is the capital account?
- Part of the balance of payments recording capital transactions. Records transfers and non-financial asset transactions.
- Identify an effect of currency depreciation on imports.
- Imports become more expensive, potentially reducing demand. Weaker currency increases import costs for consumers.
- What is capital flight?
- A large-scale exit of financial assets from a country. Rapid withdrawal creates currency pressure and instability.
- Identify an effect of currency appreciation on imports.
- Imports become cheaper, potentially increasing demand. Stronger currency reduces import costs for consumers.