College of Business and Economics

Department of Economics

Econ. 2082: International Economics II, assignment

ABDULHAFIZ KEDIR
ID NO: BER/8712/11
SECTION: ONE

Submitted to: Dr. Girma Estiphanos

Submitted on: January 15/2021
 Review Questions

1) What is a foreign exchange market and what are its unique characteristics?
Explain
The foreign exchange market is an over-the-counter (OTC) marketplace
that determines the exchange rate for global currencies.
The foreign exchange market—also called forex, FX, or currency market—was one
of the original, largest in volume financial markets formed to bring structure to
the burgeoning global economy. In terms of trading volume, Aside from providing
a venue for the buying, selling, exchanging, and speculation of currencies, the
forex market also enables currency conversion for international trade settlements
and investments.
Examples
EUR/USD
USD/JPY
GBP/USD
The unique characteristics of exchange market are;
 is highly transparent.
 24 hours trading opportunity 5 days a week.
 a highly liquid market.
 highly leveraged market.
 enjoys the ease of access advantage

2) What are the major purposes of a foreign exchange market? Discuss.

The main functions of the market are to;

  facilitate currency conversion, so that relations between countries
shall grow economically
 provide instruments to manage foreign exchange risk (such as
forward exchange), and
 allow investors to speculate in the market for profit. This tends to
broaden the economic activities of investors and become a good
market center.

The basic function of the foreign exchange market is; to transfer purchasing
power between countries, i’e to facilitate the conversion of one currency into
another.

3) How do you distinguish between spot foreign exchange transaction and

forward foreign exchange transaction? Explain
In currency markets, the spot rate, as in others, refers to the
immediate exchange rate. The forward rate, on the other hand, refers to the
future exchange rate agreed upon in forward contract.

Forward Rate vs. Spot Rate

 The spot exchange rate is the amount one currency will trade for
another today. In other words, it's the price a person would have to
pay in one currency to buy another currency today. You could also
think of it as today's rate that one currency can be traded with
another.

 A forward market is an over-the-counter marketplace that sets the

price of a financial instrument or asset for future delivery. Forward
markets are used for trading a range of instruments, but the term is
primarily used with reference to the foreign exchange market. It can
 also apply to markets for securities and interest rates as well as
commodities
.

4) How does the demand for a foreign exchange arise and how does the
supply of a foreign exchange arise? Explain

 Demand for forex rise for a number of reasons:

 Imports of Goods and Services
 Tourism:
 Unilateral Transfers sent abroad:
 Purchase of Assets in Foreign Countries:

When price of a foreign currency falls, imports from that foreign country
become cheaper. So, imports increase and hence, the demand for foreign
currency rises. For example, if price of 1 US dollar falls from Rs 50 to Rs 45,
then imports from USA will increase as American goods will become
relatively cheaper. It will raise the demand for US dollars.
When price of a foreign currency falls, its demand rises as more people
want to make gains from speculative activities.
 The supply of foreign currency rises in the following situations:
 Exports of Goods and Services:
 Foreign Investment:
When price of a foreign currency rises, domestic goods become relatively
cheaper. It induces the foreign country to increase their imports from the
domestic country. As a result, supply of foreign currency rises. For example,
if price of 1 US dollar rises from Rs 45 to Rs 50, then exports to USA will
increase as Indian goods will become relatively cheaper. It will raise the
supply of US dollars.
 5) Write short notes on each of the following concepts/phrases. Give
examples, where necessary
examples where necessary.
A. Foreign exchange rate: Foreign exchange (Forex or FX) is the conversion of
one currency into another at a specific rate known as the foreign exchange rate.
The conversion rates for almost all currencies are constantly floating as they are
driven by the market forces of supply and demand.
B. Nominal exchange rate: The nominal exchange rate E is defined as the
number of units of the domestic currency that can purchase a unit of a given
foreign currency. A decrease in this variable is termed nominal appreciation of the
currency. ... An increase in this variable is termed nominal depreciation of the
currency.
C. Real exchange rate: represents the nominal exchange rate adjusted by the
relative price of domestic and foreign goods and services, thus reflecting the
competitiveness of a country with respect to the rest of the world
D. The real effective exchange rate: is the weighted average of a country's
currency in relation to an index or basket of other major currencies. The weights
are determined by comparing the relative trade balance of a country's currency
against each country within the index.
E. Freely floating exchange rate: is a flexible exchange rate system solely
determined by market forces of demand and supply of foreign and domestic
currency, and where government intervention is totally inexistent.

F. fixed exchange rate: is a regime applied by a government or central bank

that ties the country's official currency exchange rate to another country's
currency or the price of gold. The purpose of a fixed exchange rate system is to
keep a currency's value within a narrow ban.
G. Managed floating or dirty floating exchange rate: A dirty float is a floating
exchange rate where a country's central bank occasionally intervenes to change
the direction or the pace of change of a country's currency value. In most
instances, the central bank in a dirty float system acts as a buffer against an
external economic shock before its effects become disruptive to the domestic
economy. A dirty float is also known as a "managed float."
H. Arbitrage: describes the act of buying a security in one market and
simultaneously selling it in another market at a higher price, thereby enabling
investors to profit from the temporary difference in cost per share
I. Hedging: is an investment that is made with the intention of reducing the risk
of adverse price movements in an asset. Normally, a hedge consists of taking an
offsetting or opposite position in a related security.
J. speculation: In the world of finance, speculation, or speculative trading, refers
to the act of conducting a financial transaction that has substantial risk of losing
value but also holds the expectation of a significant gain or other major value.
With speculation, the risk of loss is more than offset by the possibility of a
substantial gain or other recompense.

6) How do you distinguish between depreciation and devaluation of a

currency? Appreciation and revaluation of a currency?

 Depreciation Vs Devaluation
Depreciation: a market decided fall in the value of a currency in floating
exchange rate system. Currency depreciation can occur due to factors
such as economic fundamentals, interest rate differentials, political
instability, or risk aversion among investors. While,
Devaluation: a government decided deliberate downward adjustment of the
value of a country's money relative to another currency, group of
currencies, or currency standard. Countries that have a fixed exchange
rate or semi-fixed exchange rate use this monetary policy tool.
 Appreciation Vs Revaluation
Appreciation: a market decided increase in the value of one currency in
relation to another currency. Currencies appreciate against each other for a
variety of reasons, including government policy, interest rates, trade
balances, and business cycles. It is under floating exchange rate system.
While,
Revaluation : a government decided change in a price of a good or product,
or especially of a currency, in which case it is specifically an official rise of
the value of the currency when it is found right time to boost the value of
the currency.

7)
I, What are the theoretical arguments for currency devaluation? What is your
view on currency devaluation in the context of primary commodities – producing
developing countries? Explain

Countries devalue their currencies for a number of reasons:

 To enlarge size of exports
 To reduce trade deficit
 To reduce sovereign debt burden
Devaluation in developing countries that produce primary-commodities is not
suitable. I think it doesn’t solve their problems I think of it as a vicious circle
exasperating already existing problems. The reasons why devaluation isn’t
effective in developing countries are:
Imports more expensive (any imported good or raw material will increase in price)
AD increases causing demand pull inflation.
II, what are some of the inflationary impacts of currency devaluation? What do
you think the way forward? Explain.
A devaluation is likely to contribute to inflationary pressures because of higher
import prices and rising demand for exports. ... Cost-push inflation. Demand-
pull inflation, which happens due to the increased need of holing money in that
local currencies became weaker due to the devaluation and, even non importable
commodities show increase in price.
I personally stand for the boost in productivity than rushing around values of
currencies. This is because it is the more one can produce and becomes
independent of others, the more market forces favor its currency.

8)
I, What do you understand by money market? What is money in the context of
international finance? Discuss
• The money market: is one of the safest financial markets available for
currency transactions. It is often used by the big financial institutions, large
corporations, and national governments. The investments made in money
markets are usually for a very short period of time and therefore they are
commonly known as cash investments.
• The international money market is a market where international currency
transactions between numerous central banks of countries are carried on. The
transactions are mainly carried out using gold or in US dollar as a base. The basic
operations of the international money market include the money borrowed or
lent by the governments or the large financial institutions. The international
money market is governed by the transnational monetary transaction policies of
various nations’ currencies. The international money market’s major
responsibility is to handle the currency trading between the countries.
II, What are the major functions of money? Explain

III, How does the use of money overcome the problems with a barter system?
Explain
IV, What is monetary policy and what are the tools of monetary policy? At a
theoretical level, when does monetary policy become impotent or ineffective?
Explain

V, What does purchasing power parity (PPP) theory postulate? How does PPP
theory differ from the law of one price?

9)
I, What is balance of payments and what are its major purposes?

II, Write and explain the components of balance of payments. List and explain the
items under each component.

III, At a theoretical level, what can you say about balance of payments surplus
and deficit?

IV, What are some of the corrective mechanisms for balance of payments deficit?

10)
I, What do you understand by an International Monetary System (IMS)? Explain
II, What are the criteria for evaluating an IMS? Explain each
III, Discuss and explain the evolution of the IMS. Distinguish between the Bretton
Woods system and the Gold Standard system?
IV, What were the reasons for the collapse of the Bretton Woods system?
 11) Write short notes on each of the following. Give examples, where
necessary
I, The Mint Parity Theory
II, Stocks versus Bonds
III, Exchange Rate Pass Through
IV, The Dutch Disease

12)
I, What are the major factors (or forces) that have led to increasing
interdependence between or among nations? Please make your own evaluation
of these factors

II, What is your evaluation of economic globalization? Please provide explanations

13)
I, What is meant by international macroeconomic policy coordination (IMPC)?
Explain
II, What are the reasons for an IMPC and how does such coordination take place?
Discuss
III, What are the benefits (advantages) and the costs (disadvantages) of an IMPC
and what should be the way forward? Explain

14)
I, Distinguish between foreign direct investment (FDI) and foreign portfolio
investment (FPI).
II, What are the basic motives for FDI and FPI? Discuss

15) Write short notes on each of the following. Give examples, where
necessary
I, The International Debt Crisis
II, The Reasons for the International Debt Crisis
III, The Role and Viewpoints of the Actors in the International Debt Crisis and the
Possible Remedies to the Debt Crisis
IV, The Paris Club
V, Default and Moratorium