Know the pros and cons of weak and strong currency o WEAK HOME CURRENCY Stimulate foreign demand for US goods Reduce unemploymeny Prevent US consumers from importing foreign goods Higher US inflation o STRONG HOME CURRENCY Pros Cons Pros Stimulate US Imports Encourage consumers to buy from foreign countries Cons Lower inflation Higher Unemployment Know how the central bank can intervene to stimulate the economy or reduce inflation o Stimulate the US Economy o Reduce Inflation Know the three types of arbitrage and how to calculate the profits o International Arbitrage capitalizing on a discrepancy in quoted prices by making a riskless profit o Arbitrage will cause prices to realign o LOCATIONAL ARBITRAGE the process of buying a currency at the location where it is priced cheap and immediately selling it at another location where it is priced higher Gains are based on the amount of money used and the Realignment drives prices to adjust in different locations size of the discrepancy to eliminate discrepancies o TRIANGULAR ARBITRAGE currency transactions in the spot market to capitalize on discrepancies in the cross exchange rates between two currencies Accounting for the Bid Ask Spread bid ask spread can reduce or even eliminate the gains from triangular arbitrage Transaction costs Realignment forces exchange rates back into equilibrium o COVERED INTEREST ARBITRAGE the process of capitalizing on the interest rate differential between two countries while covering your exchange rate risk wit a forward contract Consists of two parts the process of capitalizing on the Interest arbitrage difference between interest rates between two countries Covered risk hedging the position against interest rate due to covered interest arbitrage causes Realignment market realignment Timing of realignment before realignment is completed may require several transactions Know what interest rate parity is and how to calculate the forward premium from the IRP relationship o INTEREST RATE PARITY In equilibrium the forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between two currencies o Forward Premium p 1 1 ih 1 if p F S S ih if o Transaction costs o Political risk o Differential tax laws Know the three considerations when assessing interest rate parity
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