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Reason for holding foreign currency
1. trade and investment 2. interest rate arbitrage 3.speculation
interest rate arbitrage
borrow where rates are low, loan where rates are high
predicting exchange rate movements
buying and selling in the present
exchange rate risk
expected future payments in a foreign currency will differ from the current amount if the exchange rate changes
forward contracts
specify a future transaction date and will take the exchange rate of when the contract was set
law of one price (individual commodity)
identical goods sold in different countries must sell for the same price when price is expressed in terms of the same currency. This occurs in competitive markets free of transportation and barriers of trade.
purchasing power parity
an exchange rate is at the level where a given amount of money can by the same quantity of goods abroad as it will buy at home
business cycle
natural but irregular rhythms of expansion and recession that every country undergoes
real exchange rate
the market (or nominal) rate adjusted for price differences
more units must be exchanged for 1 unit of foreign currency
domestic currency is more valuable and fewer units exchanged for 1 unit of foreign currency
capital flight
a large and sudden movement of funds out of a country into another one
expenditure switching
changing trade balance between X and M
expenditure reducing
reducing M
statistical discrepancy
the amount by which current+capital+financial accounts don't = 0
balance of payments
current, capital and financial account=0
sudden stop
a large outflow of financial capital and stopping of flow of financing
Gross Domestic Product
The market value of all final goods and services produced within a country during a given time period
Gross National Product
The market value of all final goods and services produced anywhere by a country's resources in a given time period
private savings
the part of disposable income that is saved rather than consumed
government savings
tax revenue minus government expenditures
international debt
money owed to nonresidents that must be paid in foreign currency
debt service
principal and interest repayment
foreign loans will be used to increase skills, productivity and capacity will be easily repaid

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