Macroeconomics 2 for ECO: International Finance summary - Tilburg university - Economics
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Macroeconomics 2 for ECO: International Finance
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Tilburg University (UVT)
Book
International Economics
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Summary for the course ''Macroeconomics 2''. This summary was written in order to study for the midterm as well as for the final. Everything you need to know is available in this summary.
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Macroeconomics 2 for ECO: International Finance
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MACROECONOMICS 2:
INTERNATIONAL
FINANCE
SUMMARY
@ECOsummaries
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1
,Macroeconomics 2
Chapter 13
Gross domestic product (GDP): value of the production of final goods and services in a certain period
within a country’s territorial borders
Gross national product (GNP): income that is earned in a certain period by the production factors of
the country
GNP = GDP + income factors from abroad
Net national product (NNP): GNP – depreciation
GNP = Y = national income
The current account (CA): Exports – Imports (trade balance)
National savings (S): S = I + CA
Private savings: S = Y – C – T
Public savings: S = T - G
Trading surplus: the country is lending to other countries and accumulates foreign wealth
Trading deficit: the country is borrowing from other countries and accumulates foreign debt
The balance of payments (BoP):
- Current account: transactions due to exports and imports
- exports + (credit)
- imports – (debit)
- wage, interest, dividend received from abroad + (credit)
- wage, interest, dividend paid to abroad – (debit)
- unilateral transfer without direct return +/- (both)
CA = credit – debit
more export → positive CA
- Financial account: transactions due to international purchase and sale of financial assets
- sale of asset to abroad + (credit)
- purchase of asset from abroad – (debit)
inflow of money (+), outflow of money (-)
FA = debit – credit
more asset sales than it buys → negative FA
- Capital account: transactions due to ‘intangible’ capital (debt remission, patents, copyrights)
debt remission of 2 billion → -2 billion on capital account
CA + FA + CPA = 0 → BoP = 0
Official settlements balance: CA + FA + CPA excluding official reserve transactions
= foreign assets
Reserves in hands of foreign CB: + (credit) on financial account
Reserves in hands of own CB: - (debit) on financial account
2
,Chapter 14
Exchange rate: the price of a country’s currency in terms of another country’s currency
Direct quotation: home currency / foreign currency (€/$)
→ if the exchange rate rises = depreciation of the home currency
→ you have to pay more home currency to obtain foreign currency
Indirect quotation: foreign currency / home currency ($/€)
If the currency of a country depreciates, the goods become cheaper for foreigners
→ you need less of that currency to buy the good
if the currency of a country appreciates, the goods become more expensive for foreigners
→ you need more of that currency to buy the good
Foreign exchange market: foreign currencies and assets are exchanged for domestic ones
1. Commercial banks: main actor
2. Nonbank financial institutes (e.g. pension funds)
3. Corporations
4. Central banks
Arbitrage: buying an asset cheaply on market and selling it at a higher price and at no risk on another
market
Spot exchange rate: a price at which to exchange currencies immediately
Forward exchange rate: specifies a price to exchange currencies in the future.
→ avoiding risk
e.g. ‘’worst’’ spot rate in 30 days could be 1.0 and ‘’best’’ spot rate in 30 days could be 2
at the forward rate, it is decided that the exchange rate will be 1.5 (hedge)
→ guaranteed positive profit and eliminates risk
Foreign exchange swap: is a spot sale of a currency combined with a forward repurchase of the
currency
Rate of return: e.g. interest rate of 5% has a 5% rate of return
Expected rate of return: e.g. you buy a share for 100 euro. After a year, it could be worth 95 or 115.
Both have a probability of 0.5. 🡪 0.5 * -0.05 + 0.5 * 0.15 = 0.5= the expected R.O.R.
Real rate of return: the expected rate of return adjusted for the change in prices.
→ if inflation is 5%, then the real rate of return is 0%
Interest rate on deposits: you obtain an interest rate form the bank. The higher the better
→ if you think that the euro will appreciate i.c.t. the dollar,
euro deposits become more attractive than dollar deposits
Expected rate on euro deposits: R€ + (Ee$/€ – E$/€) / E$/€
→ The investor will rather hold euro than dollar deposits if: R€ + (Ee$/€ – E$/€) / E$/€ > R$
R€ = interest rate on euro deposits (!R = r!)
(Ee$/€ – E$/€) / E$/€ = expected rate of appreciation of the euro
Interest parity condition: Foreign exchange market is in equilibrium → all currencies yield the same
expected rate of return.
3
, Arbitrage mechanism: if returns on the dollar were higher than on the euro, everybody wants to
hold dollar.
→ excess supply of euro deposits
→ dollar appreciates (E$/€ ↓) until the parity condition holds
Risk: important determinant on the decision to hold an asset
Liquidity: a Dutch firm may find it handy to hold dollar deposits if it has U.S. suppliers
Determinants of the exchange rate:
- higher interest rates on the dlaweposits for a currency → appreciation of that currency
- Ex. Exchange rate and the current exchange rate move in the same direction
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