Global Capital Markets Flashcards

The 'global financial cycle' hypothesis, associated with economist Hélène Rey, suggests that:

Answer: A single global factor driven largely by U.S. monetary policy drives cross-border capital flows and asset prices worldwide

Rey's research found that a common global factor—heavily influenced by the Fed's stance and the VIX—drives synchronized booms and busts in cross-border capital flows and risky asset prices.

A 'currency board' arrangement, as used historically in Hong Kong and Argentina, requires the monetary authority to:

Answer: Hold foreign exchange reserves at least equal to the monetary base to defend a fixed peg

Under a currency board, every unit of domestic currency in circulation must be fully backed by foreign reserves at the fixed rate, eliminating discretionary monetary policy.

Which scenario would most likely trigger a 'sudden stop' in capital flows to an emerging market economy?

Answer: A sharp tightening of global financial conditions combined with rising domestic political uncertainty

Sudden stops are typically triggered by a combination of external shocks (global risk aversion, Fed tightening) and domestic vulnerabilities (political instability, current account deficits) that cause foreign investors to abruptly withdraw capital.

In the context of global equity risk premiums, the 'Dimson-Marsh-Staunton' database is most useful for:

Answer: Providing long-run historical equity risk premium data across multiple countries to assess long-term expected returns

The DMS database compiles over 100 years of equity, bond, and bill returns for more than 20 countries, enabling robust long-run estimates of equity risk premiums globally.

A U.S.-based portfolio manager hedges a euro-denominated bond position back to USD using a currency forward. If the forward rate implies euro appreciation relative to today's spot rate, the hedge will:

Answer: Create a negative carry cost because the manager sells euros at a premium, reflecting higher eurozone rates

When the forward rate shows euro at a premium to spot, it typically reflects higher EUR interest rates; the manager selling euros forward at the premium incurs a negative carry relative to holding unhedged.

The 'international Fisher effect' predicts that differences in nominal interest rates between countries should equal:

Answer: Expected differences in inflation rates, resulting in no real interest rate differential long-term

The international Fisher effect extends domestic Fisher theory globally: nominal rate differentials between countries reflect expected inflation differentials, implying equal real rates in the long run.

When a central bank intervenes to weaken its own currency by purchasing foreign exchange reserves, the most direct domestic monetary consequence—absent sterilization—is:

Answer: An expansion of the domestic monetary base, creating inflationary pressure

Buying foreign currency injects domestic currency into the banking system, expanding the monetary base; without sterilization (selling domestic bonds to drain the liquidity), this is inflationary.