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Glossary

Chapter 10
Balance of international indebtedness a statement that summarizes a countrys stock of assets and liabilities against the rest of the world at a fixed point in time Balance of payments a record of the flow of economic transactions between the residents of one country and the rest of the world Capital and financial account the net result of both private-sector and official capital and financial transactions Credit transaction a balance of payments transaction that results in a receipt of a payment from foreigners Current account the net value of monetary flows associated with transactions in goods and services, investment income, employee compensation, and unilateral transfers Debit transaction a balance of payments transaction that leads to a payment to foreigners Double-entry accounting a system of accounting in which each credit entry is balanced by a debit entry, and vice versa, so that the recording of any transaction leads to two offsetting entries Goods and services balance the result of combining the balance of trade in services and the merchandise trade balance Merchandise trade balance the result of combining the dollar value of merchandise exports recorded as a plus (credit) and the dollar value of merchandise imports recorded as a minus (debit) Net creditor net creditor the status of a nation when that countrys claims on foreigners exceed foreign claims on that country at a particular time Net debtor the status of a nation when foreign claims on a country exceed that countrys claims on foreigners at a particular time Net foreign investment in national income accounting, is synonymous with the current account balance Official reserve assets holding key foreign currencies, special drawing rights, and reserve positions in the IMF by official monetary institutions

Official settlements transactions the movement of financial assets among official holders; these financial assets fall into two categories: official reserve assets and liabilities to foreign official agencies Statistical Discrepancy a correcting entry inserted into the balance-of-payments statement to make the sum of the credits and debits equal Trade Balance derived by computing the net exports (imports) in the merchandise accounts; also called merchandise trade balance Unilateral Transfers include transfers of goods and services (gifts in kind) or financial assets (money gifts) between the United States and the rest of the world

Chapter 11
Appreciation (as applied to currency markets) when, over time, it takes fewer units of a nations currency to purchase one unit of a foreign currency Bid rate the price that the bank is willing to pay for a unit of foreign currency Call option gives the holder the right to buy foreign currency at a specified price Covered interest arbitrage the process of moving funds into foreign currencies to take advantage of higher investment yields abroad, while avoiding exchange rate risk Cross exchange rate the resulting rate derived when the exchange rate between any two currencies can be derived from the rates of these two currencies in terms of a third currency Currency swap the conversion of one currency to another currency at one point in time, with an agreement to reconvert it to the original currency at a specified time in the future Depreciation (as applies to currency markets) when, over time, it takes more units of a nations currency to purchase one unit of a foreign currency Destabilizing speculation speculation that occurs when speculators expect a current trend in exchange rates to continue and their transactions accelerate the rise or fall of the target currencys value

Discount the valuation of a currency when it is worth less in the forward market than in the spot market Effective exchange rate a weighted average of the exchange rates between a domestic currency and that nations most important trading partners, with weights given by relative importance of the nations trade with each trade partner Exchange arbitrage the simultaneous purchase and sale of a currency in different foreign-exchange markets in order to profit from exchange-rate differentials in the two locations Exchange rate the price of one currency in terms of another Exchange-rate index a weighted average of the exchange rates between a domestic currency and that nations most important trading partners, with weights given by relative importance of the nations trade with each trade partner Foreign-currency options provide an options holder the right to buy or sell a fixed amount of foreign currency at a prearranged price, within a few days or several years Foreign-exchange market the organizational setting within which individuals, businesses, governments, and banks buy and sell foreign currencies and other debt instruments Forward market where foreign exchange can be traded for future delivery Forward rate the rate of exchange used in the settlement of forward transactions Forward transaction an outright purchase and sale of foreign currency at a fixed exchange rate but with payment or delivery of the foreign currency at a future date Futures market a market in which contracting parties agree to future exchanges of currencies and set applicable exchange rates in advance; distinguished from the forward market in that only a limited number of leading currencies are traded; trading takes place in standardized contract amounts and in a specific geographic location Hedging the process of avoiding or covering a foreign-exchange risk

Interbank market bank transactions with other banks Interest arbitrage the process of moving funds into foreign currencies to take advantage of higher investment yields abroad International Monetary Market (IMM) an extension of the commodity futures markets in which specific quantities of wheat, corn, and other commodities are bought and sold for future delivery at specific dates; the IMM provides trading facilities for the purchase and sale for future delivery of financial instruments (such as foreign currencies) and precious metals (such as gold) Maturity months the months of a given year when the futures contract matures Nominal exchange rates exchange-rate quotes published in newspapers that are not adjusted inflation rates in trading partners Nominal exchange-rate index the average value of a currency, not adjusted for changes in price levels of that country and its trading partners Offer rate the price at which the bank is willing to sell a unit of foreign currency Option an agreement between a holder (buyer) and a writer (seller) that gives the holder the right, but not the obligation, to buy or sell financial instruments at any time through a specified date Premium the valuation of a currency when it is worth more in the forward market than in the spot market Put option gives the holder the right to sell foreign currency at a specified price Real exchange rate the nominal exchange rate adjusted for changes in relative price levels Real exchange-rate index the average value of a currency based on real exchange rates

Speculation the attempt to profit by trading on expectations about prices in the future Spot market where foreign exchange can be traded for immediate delivery Spot transaction an outright purchase and sale of foreign currency for cash settlement not more than two business days after the date of the transaction Spread the difference between the bid and the ask prices Stabilizing speculation occurs when speculators expect a current trend in an exchange rates movement to change and their purchase or sale of the currency moderates movements of the exchange rate Strike price the price at which an option can be exercised Three-point arbitrage a more intricate form of arbitrage, involving three currencies and three financial centers; also called triangular arbitrage Trade-weighted dollar a weighted average of the exchange rates between a domestic currency and the currencies of the nations most important trading partners, with weights given by relative importance of the nations trade with each trade partner Two-point arbitrage the simultaneous purchase and sale of a currency in two foreign-exchange markets in order to profit from exchange-rate differentials in different locations Uncovered interest arbitrage when an investor does not obtain exchange-market cover to protect investment proceeds from foreign-currency fluctuations

Chapter 12
Asset-market approach a method of determining short-term exchange rates where investors consider two key factors when deciding between domestic and foreign investments; relative levels of interest rates and expected changes in the exchange rate itself over the term of the investment Forecasting exchange rates attempts to predict future rates of exchange

Fundamental analysis the opposite of technical analysis; involves consideration of economic variables that are likely to affect a currencys value Judgmental forecasts subjective or common-sense exchange rate forecasts based on economic, political, and other data for a country Law of one price part of the purchasing-power-parity approach to determining exchange rates; asserts that identical goods should cost the same in all nations, assuming that it is costless to ship goods between nations and there are no barriers to trade Market expectations examples include news about future market fundamentals and traders' opinions about future exchange rates Market fundamentals economic variables such as productivity, inflation rates, real interest rates, consumer preferences, and government trade policy Nominal (money) interest rate the rate of return on assets that can be earned in a particular country, not adjusted for the rate of inflation Overshooting an instance of an exchange rates short-term response to a change in market fundamentals is greater than its long-term response Purchasing-power-parity theory a method of determining the equilibrium exchange rate by means of the price levels and their variations in different nations Real interest rate the nominal interest rate minus the inflation rate Technical analysis method of exchange-rate forecasting that involves the use of historical exchange-rate data to estimate future values

Chapter 13
Adjustment mechanism a mechanism that works to return a balance of payments to equilibrium after the initial equilibrium has been disrupted; the process takes two different forms: automatic (economic processes) and discretionary (government policies) Automatic adjustment (of the balance-of-payments process) a mechanism that works to return a balance of payments to equilibrium automatically through the adjustments in economic variables Foreign repercussion effect the impact that changes in domestic expenditures and income levels have on foreign economies; a rise in domestic income stimulates imports, causing a foreign expansion that in turn raises demand for domestic exports Gold standard a monetary system in which each member nations money supply consisted of gold or paper money backed by gold, where each member nation defined the official price of gold in terms of its national currency and was prepared to buy and sell gold at that price; free import and export of gold was permitted by member nations Income adjustment mechanism in 1930s, John Maynard Keynes formulated this theory that focuses on automatic changes in income to bring about adjustment in a nations current account Price-adjustment mechanism see quantity of money theory Quantity theory of money states that increases in the money supply lead directly to an increase in overall prices, and a shrinking money supply causes overall prices to fall

Chapter 15
Adjustable pegged exchange rates a system of semifixed exchange rates where it is understood that the par value of the currency will be changed occasionally in response to changing economic conditions BrettonWoods system a new international monetary system created in 1944 by delegates from 44 member 535 nations of the United Nations that met at Bretton Woods, New Hampshire Capital controls government imposed barriers to foreign savers investing in domestic assets or to domestic savers investing in foreign assets; also known as exchange controls

Clean float when free-market forces of supply and demand are allowed to determine the exchange value of a currency Crawling peg a system in which a nation makes small, frequent changes in the par value of its currency to correct balance-of-payments disequilibriums Currency board a monetary authority that issues notes and coins convertible into a foreign anchor currency at a fixed exchange rate Currency crashes financial crises that often end in currency devaluations or accelerated depreciations Currency crisis a situation in which a weak currency experiences heavy selling pressure, also called a speculative attack Devaluation an official change in a currencys par value, which causes the currencys exchange value to depreciate Dirty float a condition under a managed floating system when free-market forces of supply and demand are not allowed to achieve their equilibrating role; countries may manage their exchange rates to improve the competitiveness of their producers Dollarization occurs when residents of a foreign country use the U.S. dollar alongside or instead of their domestic currency Exchange controls government-imposed barriers to foreign savers investing in domestic assets (for example, government securities, stock, or bank deposits) or to domestic savers investing in foreign assets Exchange rates the price of one currency in terms of another Exchange-stabilization fund a government entity that attempts to ensure that the market exchange rate does not move above or below the official exchange rate through purchases and sales of foreign currencies

Fixed exchange rates

a system used primarily by small developing nations whose currencies are anchored to a key currency, such as the U.S. dollar Floating exchange rates when a nation allows its currency to fluctuate according to the free-market forces of supply and demand Fundamental disequilibrium when the official exchange rate and the market exchange rate may move apart, reflecting changes in fundamental economic conditionsincome levels, tastes and preferences, and technological factors Impossible trinity a restriction whereby a country can maintain only two of the following three policies free capital flows, a fixed exchange rate, and an independent monetary policy Key currency a currency that is widely traded on world money markets, has demonstrated relatively stable values over time, and has been widely accepted as a means of international settlement Leaning against the wind intervening to reduce short-term fluctuations in exchange rates without attempting to adhere to any particular rate over the long term Managed floating system an exchange-rate system in which the rate is usually allowed to be determined by the freemarket forces of supply and demand, while sometimes entailing some degree of government (central bank) intervention Official exchange rate the exchange rate determined by comparing the par values of two currencies Par value a central value in terms of a key currency that governments participating in a fixed-exchange rate system set their currencies Revaluation an official change in a currencys par value, which causes the currencys exchange value to appreciate Seigniorage profit from issuing money Special drawing right (SDR) an artificial currency unit based on a basket of four currencies established by the IMF Speculative attack

see currency crisis Target exchange rates desired exchange rates for a currency set by the host country and supported by intervention

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