Course Content
TOPICS IN DEMAND AND SUPPLY ANALYSIS
This chapter is covered under Reading 12 of Study Session 4. After reading this chapter, a student shall be able to: a. calculate and interpret price, income, and cross-price elasticities of demand and describe factors that affect each measure; b. compare substitution and income effects; c. distinguish between normal goods and inferior goods; d. describe the phenomenon of diminishing marginal returns; e. determine and describe break-even and shutdown points of production; f. describe how economies of scale and diseconomies of scale affect costs.
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Demand Concept
Supply Concepts
Market Equilibrium
THE FIRM AND MARKET STRUCTURES
This chapter is covered in reading 13 of study session 4 of the material provided by the Institute. After reading this chapter, a student shall be able to: a. describe characteristics of perfect competition, monopolistic competition, oligopoly, and pure monopoly; b. explain relationships between price, marginal revenue, marginal cost, economic profit, and the elasticity of demand under each market structure; c. describe a firm’s supply function under each market structure; d. describe and determine the optimal price and output for firms under each market structure; e. explain factors affecting long-run equilibrium under each market structure; f. describe pricing strategy under each market structure; g. describe the use and limitations of concentration measures in identifying market structure; h. identify the type of market structure within which a firm operates.
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LOS A to G: Types of Market Structure
LOS H: Identification of Market Structure
AGGREGATE OUTPUT, PRICES, AND ECONOMIC GROWTH
This chapter is covered in reading 14 of study session 4 of the material provided by the Institute. After reading this chapter, a student shall be able to: a. calculate and explain gross domestic product (GDP) using expenditure and income approaches; b. compare the sum-of-value-added and value-of-final-output methods of calculating GDP; c. compare nominal and real GDP and calculate and interpret the GDP deflator; d. compare GDP, national income, personal income, and personal disposable income; e. explain the fundamental relationship among saving, investment, the fiscal balance, and the trade balance; f. explain the IS and LM curves and how they combine to generate the aggregate demand curve; g. explain the aggregate supply curve in the short run and long run; h. explain causes of movements along and shifts in aggregate demand and supply curves; i. describe how fluctuations in aggregate demand and aggregate supply cause short-run changes in the economy and the business cycle; j. distinguish between the following types of macroeconomic equilibria: long-run full employment, short-run recessionary gap, short-run inflationary gap, and short-run stagflation; k. explain how a short-run macroeconomic equilibrium may occur at a level above or below full employment; l. analyze the effect of combined changes in aggregate supply and demand on the economy; m. describe sources, measurement, and sustainability of economic growth; n. describe the production function approach to analyzing the sources of economic growth; o. distinguish between input growth and growth of total factor productivity as components of economic growth.
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Introduction
LOS A: Aggregate Output and Income
LOS B to E: Gross Domestic Product
LOS F to L: Aggregate Demand, Aggregate Supply & Equilibrium
LOS M, N, and O: Economic Growth and Sustainability
UNDERSTANDING BUSINESS CYCLES
This chapter is covered in reading 15 of study session 4 of the material provided by the Institute. After reading this chapter, a student shall be able to: a. describe the business cycle and its phases; b. describe how resource use, housing sector activity, and external trade sector activity vary as an economy moves through the business cycle; c. describe theories of the business cycle; d. describe types of unemployment and compare measures of unemployment; e. explain inflation, hyperinflation, disinflation, and deflation; f. explain the construction of indexes used to measure inflation; g. compare inflation measures, including their uses and limitations; h. distinguish between cost-push and demand-pull inflation; i. interpret a set of economic indicators and describe their uses and limitations.
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LOS A and B: Overview of Business Cycle
LOS C: Theories of Business Cycle
LOS D: Unemployement
LOS E: Inflation
LOS I: Economic Indicators
MONETARY AND FISCAL POLICY
This chapter is covered in reading 16 of study session 5 of the material provided by the Institute. After reading this chapter, a student shall be able to: a. compare monetary and fiscal policy; b. describe functions and definitions of money; c. explain the money creation process; d. describe theories of the demand for and supply of money; e. describe the Fisher effect; f. describe roles and objectives of central banks; g. contrast the costs of expected and unexpected inflation; h. describe tools used to implement monetary policy; i. describe the monetary transmission mechanism; j. describe qualities of effective central banks; k. explain the relationships between monetary policy and economic growth, inflation, interest, and exchange rates; l. contrast the use of inflation, interest rate, and exchange rate targeting by central banks; m. determine whether a monetary policy is expansionary or contractionary; n. describe limitations of monetary policy; o. describe roles and objectives of fiscal policy; p. describe tools of fiscal policy, including their advantages and disadvantages; q. describe the arguments about whether the size of a national debt relative to GDP matters; r. explain the implementation of fiscal policy and difficulties of implementation; s. determine whether a fiscal policy is expansionary or contractionary; t. explain the interaction of monetary and fiscal policy.
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LOS A: Monetary Vs. Fiscal Policies
LOS B: Money
LOS C: Money Creation Process
LOS D: The Demand and Supply of Money
LOS E: Fisher Effect
LOS F: Role of Central Bank
LOS G: Cost of Inflation
LOS H: Policy Tools
LOS I, J, K, L, M, and N: Policies of The Central Bank
LOS O to S: Fiscal Policies
LOS T: Interaction of Fiscal and Monetary Policy
INTERNATIONAL TRADE AND CAPITAL FLOWS
This topic is covered under Reading 17 of the study session 5 provided by the institute. The candidate should be able to: a compare gross domestic product and gross national product; b describe benefits and costs of international trade; c distinguish between comparative advantage and absolute advantage; d compare the Ricardian and Heckscher–Ohlin models of trade and the source(s) of comparative advantage in each model; e compare types of trade and capital restrictions and their economic implications; f explain motivations for and advantages of trading blocs, common markets, and economic unions; g describe common objectives of capital restrictions imposed by governments; h describe the balance of payments accounts including their components; i explain how decisions by consumers, firms, and governments affect the balance of payments; j describe functions and objectives of the international organizations that facilitate trade, including the World Bank, the International Monetary Fund, and the World Trade Organization.
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Introduction
LOS A: Some Basic Terminologies for International Trade and GDP, GNP
LOS B: Cost and Benefits of International Trade
LOS C: Comparative and Absolute Advantage
LOS D: Ricardian and Heckscher–Ohlin models
LOS E, F, and G: Trade and Capital Flow
LOS H and I: Balance of Payment
LOS J: Trade Organizations
CURRENCY EXCHANGE RATES
This chapter is covered in Reading 18 of the study material provided by the institute. After reading this chapter, the student should be able to: a. define an exchange rate and distinguish between nominal and real exchange rates and spot and forward exchange rates; b. describe functions of and participants in the foreign exchange market; c. calculate and interpret the percentage change in a currency relative to another currency; d. calculate and interpret currency cross-rates; e. convert forward quotations expressed on a points basis or in percentage terms into an outright forward quotation; f. explain the arbitrage relationship between spot rates, forward rates, and interest rates; g. calculate and interpret a forward discount or premium; h. calculate and interpret the forward rate consistent with the spot rate and the interest rate in each currency; i. describe exchange rate regimes; j. explain the effects of exchange rates on countries’ international trade and capital flows.
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Introduction
LOS A: Real Exchange Rate Vs. Nominal Exchange Rate
LOS B: The Foriegn Exchange Market
LOS C: Appreciating or Depreciating Currency
LOS D: Currency Cross-Rates
LOS E to G: Forward Rate Quotations
LOS H: Exchange Rate Regimes
LOS J: Exchange Rate, International Trade, and Capital Flows
Economics
About Lesson

a.  The forward exchange rates are quoted in terms of points, also commonly known as pips (i.e. points in the percentage). The points are mostly quoted as 1:10000. The forward rates can be quoted as a number of pips from the spot rate or as a percentage of the spot rates.

b.  If the forward rate is more than the spot rate, the base currency is said to be trading at a forward premium.

c.  For example, suppose the A/B spot rate is 1.1500, and that the one-month forward premium is 50 pips. Therefore, the forward rate is:

Forward Rate = 1.1500 + (50/10000) = 1.1550

d.  If the forward rate is quoted in terms of percentage, say the spot rate is 1.2500 and it is quoted at a 0.5% premium, the forward will be:

 

Forward Rate = 1.2500 × 1.0050 = 1.25625

e.  On the other hand, if the forward rate is less than the spot rates, the base currency is said to be trading at a forward discount.

1.1.1.     Arbitrage Using Forwards

a.  We can explain the process of making arbitrage profits using an example.

b.  Suppose an investor has X amount of money to be invested.

c.  If the interest rates on his domestic currency are id, after the investment period he will receive the amount of investment plus the interest earned, that is:

X (1 + id)

d.  Alternatively, the investor can convert the local currency into a foreign currency at the spot rate Sf/d and invest the same in a foreign country, where the interest rate is if. By doing so he will have the following amount of foreign currency with him:

X × Sf/d (1 + if)

e.  The investor can get back the money by converting the same into domestic currency by dividing the same by the forward rate:

[X × Sf/d (1 + if)] / Ff/d

f.  Now, if the return from investing in the domestic currency was equal to the return earned through investing in the foreign currency, there would not be any arbitrage opportunities.

g.  So, there would not be any arbitrage opportunities if:

X (1 + id) =  [X × Sf/d (1 + if)] / Ff/d

Solving the above equation for the forward rates, we get:

Forward Rate Quotation CFA Level 1 Economics Study Notes

h.  Thus, for an arbitrage opportunity to exist,

Arbitrage Opportunity Forward Rate Quotation CFA Level 1 Economics Study Notes

i.  Example:

     i.  Suppose the spot exchange rates of two currencies (Sf/d) is 1.5000 and the interest rates in the domestic country (id) are 4% and that in the foreign country (if) is 5%.

    ii.  Then the no-arbitrage forward rates would be:

Ff/d = [1.5000 × (1 + 0.05)] / [1 + 0.04] = 1.5144

   iii.  Thus, we can say that the forward is trading at 144 pips.

   iv.  Now, if the forward rate was 1.6000 instead, this means that the price of the foreign currency is overstated in the forward market.

    v.  Therefore, the best the investor can do is go long on the domestic currency and short on the foreign currency. He can do this by borrowing 1.5000 of the foreign currency and convert the same into one unit of the domestic currency and sell the same in forward market at 1.6000.

   vi.  By investing in the domestic currency at the interest rate of 4% he receives 1.04 (i.e. 1.00*1.04) at the end of the period.

  vii.  Had, he invested in the foreign market and converted the same back into domestic currency, he would have received 0.9844, which is less than the amount he earned by investing in the domestic market.

j.  So the general rule for the forward pricing is:

     i.  If the base currency is the higher-yielding currency then the forwards for the same will trade at a discount.

    ii.  And, if the base currency is the lower-yielding currency, the forwards will be at a premium.

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