I1, what are foreign exchange market and what are the unique characters of foreign exchange

market ?
- Foreign exchange market is an organizational framework within which individual ,firms
and bank buy and sell foreign currency
- Foreign exchange market where currency is traded

# The unique characters of foreign exchange market is

- The transaction are very big , the largest financial market in the world and it also the most liquid
and transparent market

2, what are the major purpose of foreign exchange market , discuss ?

A, TRANSFER FUNCTION – the basic function of the foreign exchange market is to facilitate
conversion of one currency into another. i.e to accomplish transfer of purchasing power
between two country. This transfer of purchasing power is affected through a variety of a credit
Instrument such as telegraphic transfer, bank draft and foreign bills.
B,CREDIT FUNCTION – is to provide credit both national and international ,to provide foreign
trade . obviously when foreign bills of exchange are used in international payment ,accredit for
about 3 month till their maturity is required .
C, HEDGING FUNCTION – is to hedge foreign exchange risks . hedging means the avoidance of
foreign exchange risk.
In foreign exchange market when exchange rate . these is price one currency in terms of
another currency , change there may be again or loss to the party concerned . under this
condition a person or firms undertake a great exchange, risk if there are huge amount of net
claims or net liabilities which are to be met in foreign money .
3, how do distinguish between spot foreign exchange transaction and forward exchange
transaction ? explain
- A SPOT FOREIGN EXCHANGE TRANSACTION –refers to the purchase or sale of foreign
exchange for immediate delivery I,e for delivery within two business days .
- Represent the contracted price for the purchase of or sale of a commodity , security or
currency for immediate delivery and payment on spot rate which is normally one or two
business day after the trade date .
B, FORWARD FOREIGN EXCHANGE TRANSACTION – is a contract to purchase or sale a
set of amount of a foreign currency at specified price for settlement of a predetermined
future date or within range of dates in the future .
4, HOW DOES THE DEMAND FOR FOREIGN EXCHANGE ARISE AND HOW DOES THE
SUPPLY OF A FOREIGN EXCHANGE ARISE ? EXPLAIN DEMAND FOR FOREIGN CURRENCY
ARISE BECAUSE OF THE FOLLOWING REASONS
# One needs foreign currency
A, for import goods and service , it requires foreign exchange because pay for import are made
in foreign exchange only .
B, FOR INVESTEMENT – investment in the rest of the world is an important business activity .
we need foreign currency in which investment is to be made .
C, FOR DIRECT PURCHASE ABROAD – foreign exchange is needed to make direct purchase of
good and service from abroad .
# SUPPLY OF FOREIGN CURRENCY ARISE BECOUSE OF
A, the supply of foreign currency arise because of
- Export of good and service is an important source of supply of foreign exchange
- For grant and donation from the rest of the world a significant amount of foreign
exchange flows from rich to poor countries by way of grant and donation .
5, write short note on each off the following concept / phrase ? give examples where
necessary
A, FOREIGN EXCHANGE – is an instutions or system for dealing in the currency of other
countries .
-is the conversion of one currency into another
-is trading of one currency for another
For example , one can swap the Ethiopian birr for US dollar .
B, NOMINAL EXCHANGE RATE –is relative price of one currency of two countries , for example ,
if one pound is exchanged for two US dollar then a british can exchange one pound for two
dollar in the world market .
C, REAL EXCHANGE RATE – relative price of good of two countries
-it is the rate at which one country can trade its own good for those of another .
D, REAL EFFECTIVE EXCHENGE RATE- is the weighted avariage of a country currency in relation
to an index or basket of other major currency . the weight are determined by comparing the
relative trade balance of a country currency against each country within the index .
E, FREELY FLOATING OR FLEXIBLE EXCHANGE RATE- is a regime where the currency , price of a
nation is set by the forest market based on supply and demand relative to other currency .
- Is determined by supply and demand on the open market
F, FIXED EXHANGE RATE –is a regime to applied by government or central bank that ties the
country exchange rate to another country currency
- Provide greater certainty for export and import
 G, A MANEGED FLOATING EXHANGE RATE –it is the exchange rate when the central bank
may choose to intervene in the foreign exchange market to affect the value currency to
meet specific macro economic objective , for example central bank might attempt to bring
about a deprecation to
- Improve the balance of trade in good and service
- Improve current account position
H, ARBITRAGE – is the purchase and sale of a currency in order to profit from a difference in
the currency
- Is purchase currency in monitory center where it cheaper for immediate resale in monetary
center where it is more expensive in order to make profit
I, HEDGING- the avoidance of foreign exchange risk or the covering of an open position a
hedger seek to cover a foreign exchange risk .
J, SPECULATION- is the percentage of foreign exchange risk or open position , in the hope of
making profit . speculator accept or even seek out foreign exchange risk ( risk lover ) .
6, HOW DO YOU DISTINGUISH BETWEEN DEPRECIATION AND DEVALUATION OF CURRENCY ?
APPRECIATION AND REVALUATION OF A CURRENCY ?
A,APPRECIATION/REVALUATION – both convey the same message ; increase in the value of the
currency however appreciation of currency is increase of the value of the currency because of
market force but revaluation is increase in value of currency as result of deliberate policy action
taken by monitory authority .
B, DEPRECIATION/DEVALUATION – both convey the same message ; decrease in the value of
the currency however depreciation of currency is decrease in value of currency because of
market force but devaluation is decrease in value of currency as result of deliberate policy
action taken by monitory authority .
7 I, WHAT ARE THE THEORITICAL ARGUMENT OF FOR CURRENCY DEVUALITION ?
- Devualition is increase the amount of domestic currency needed to buy one unit of
another foreign currency
- Country depreciate its currency may because of the economy
WHAT IS YOUR VIEW CURRENCY DEVAULITION IN CONTEST PRIMARY COMMODITY PRODUCING
COUNTRY
- In primary commodity producing developing country devaluation of the currency is
important for the following reason

A, Devaluation will generally lead to a redistribution of _income, and this distributive

effect, while present for any devaluation, is likely to be especially important in
developing countries with heavy reliance on primary products for export. Unless
checked by special export taxes, a devaluation will lead to a sharp increase in rewards to
those in the export industry, who are often landowners. Whether large or small,
landowners are likely to have different saving and consumption patterns from urban
dwellers, generally saving more out of marginal changes in income at least in the short
run. Thus, a redistribution of real income from workers to businessmen and from urban
to rural dwellers is likely, in the first instance, to lead to a drop in total expenditure out
of a given aggregate income, and this drop will be deflationary. But of course the
redistributional effect could also go the other way, If as a result of devaluation the real
income of those with a low marginal propensity to save is increased at the expense of
others. The redistributional effect will also affect the level of imports out of a given total
income, since consumption pattern of those who gain may differ from that of losers. But
this effect is likely to be less marked than the total expenditure effect, partly because
much of the import bill of developing countries represents inputs into domestically
produced goods and services, so they are somewhat more widely diffused throughout
the economy than would be the case for direct imports of manufactured consumer
Goods, devaluation will lead to a rise in the domestic costs of servicing external debt
denominated in foreign currency. Where the liabilities are those of businessmen who do
not benefit much from the devaluation, it may lead to bankruptcy and an attendant
decline in business activity, even when businesses are otherwise sound. This factor
allegedly figured in the decline in investment following the Argentine devaluation of I
962. Even where the debt is held officially, the problem of raising the local-currency
counterpart of external servicing charges often poses a serious problem, and sometimes
represents a serious inhibition to devaluation. Indeed (to digress for a moment), these
"accounting" relationships, usually ignored by economists.

The money market is an organized exchange market where participants can lend and
borrow short-term, high-quality debt securities with average maturities of one year or
less. It enables governments, banks, and other large institutions to sell short-term
securities to fund their short-term cash flow needs. Money markets also allow individual
investors to invest small amounts of money in a low-risk setting
1. A Medium of Exchange:
The only alternative to using money is to go back to the barter system.
However, as a system of exchange the barter system would be highly
impracticable today.

For example, if the baker who supplied the green-grocer with bread
had to take payment in onions and carrots, he may either not like
these foodstuff or he may have sufficient stocks of them.

ADVERTISEMENTS:

Under the barter system, it is very difficult to measure the value

of goods. For example, a horse may be valued as worth five cows
or 100 quintals of wheat, or a Maruti car may be equivalent to 10
two- wheelers. Thus one of the disadvantages of the barter
system is that any commodity or service has a series of exchange
values

(8II) WHAT IS FUNCTION MONEY ? EXPLAIN

- Money is often defined in terms of the three functions or services that it provides.
Money serves as a medium of exchange, as a store of value, and as a unit of account.
Medium of exchange. Money's most important function is as a medium of exchange to
facilitate transactions. Without money, all transactions would have to be conducted by
barter, which involves direct exchange of one good or service for another. The difficulty
with a barter system is that in order to obtain a particular good or service from a
supplier, one has to possess a good or service of equal value, which the supplier also
desires. In other words, in a barter system, exchange can take place only if there is a
double coincidence of wants between two transacting parties. The likelihood of a
double coincidence of wants, however, is small and makes the exchange of goods and
services rather difficult. Money effectively eliminates the double coincidence of wants
problem by serving as a medium of exchange that is accepted in all transactions, by all
parties, regardless of whether they desire each others' goods and services.
Store of value. In order to be a medium of exchange, money must hold its value over
time; that is, it must be a store of value. If money could not be stored for some period of
time and still remain valuable in exchange, it would not solve the double coincidence of
 wants problem and therefore would not be adopted as a medium of exchange. As a
store of value, money is not unique; many other stores of value exist, such as land,
works of art, and even baseball cards and stamps. Money may not even be the best
store of value because it depreciates with inflation. However, money is more liquid than
most other stores of value because as a medium of exchange, it is readily accepted
everywhere. Furthermore, money is an easily transported store of value that is available
in a number of convenient denominations.
Unit of account. Money also functions as a unit of account, providing a common
measure of the value of goods and services being exchanged. Knowing the value or price
of a good, in terms of money, enables both the supplier and the purchaser of the good
to make decisions about how much of the good to supply and how much of the good to
purchase

8iii, Use of money overcomes the drawbacks of barter system of exchange in the
following manner:
- With the introduction of money, double coincidence of wants is no longer needed.
- Money facilitates storage of value which is difficult in barter system.
- Money facilitates satisfaction of wants even in smaller units which is not possible in
barter system.
8 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

A , Monetary policy is the process of drafting, announcing, and implementing the

plan of actions taken by the central bank, currency board, or other competent
monetary authority of a country that controls the quantity of money in
an economy and the channels by which new money is supplied.

- Monetary policy consists of the management of money supply and interest

rates, aimed at meeting macroeconomic objectives such as
controlling inflation, consumption, growth, and liquidity.
--- This is achieved by actions such as modifying the interest rate, buying
or selling government bonds, regulating foreign exchange (forex) rates,
and changing the amount of money banks are required to maintain as
reserves.

- THERE ARE MANY TOOLS MONETARY POLICY FOR EXAMPLE,

B, central banks have three tools of monetary policy in common. ---

-- First, they all use open market operations. They buy and sell government bonds and other
securities from member banks. This action changes the reserve amount the banks have on
hand. A higher reserve means banks can lend less. That's a contractionary policy. In the United
States, the Fed sells Treasurys to member banks.
- The second tool is the reserve requirement, in which the central banks tell their
members how much money they must keep on reserve each night. Not everyone needs
all their money each day, so it is safe for the banks to lend most of it out. That way, they
have enough cash on hand to meet most demands for redemption. Previously, this
reserve requirement has been 10%. However, effective March 26, 2020, the Fed has
reduced the reserve requirement to zero.8
When a central bank wants to restrict liquidity, it raises the reserve requirement. That gives
banks less money to lend. When it wants to expand liquidity, it lowers the requirement. That
gives members banks more money to lend. Central banks rarely change the reserve
requirement because it requires a lot of paperwork for the members.
- The third tool is the discount rate. That's how much a central bank charges members to
borrow funds from its discount window. It raises the discount rate to discourage banks
from borrowing. That action reduces liquidity and slows the economy. By lowering the
discount rate, it encourages borrowing. That increases liquidity and boosts growth.
In the United States, the Federal Open Market Committee sets the discount rate a half-point
higher than the fed funds rate. The Fed prefers banks to borrow from each other.
Most central banks have many more tools. They work together to manage bank reserves.
The Fed has two other major tools it can use. It is most well-known is the Fed funds rate. This
rate is the interest rate that banks charge each other to store their excess cash overnight. The
target for this rate is set at the FOMC meetings. The fed funds rate impacts all other interest
rates, including bank loan rates and mortgage rates.