Economics
Economics on this exam splits into three blocks: microeconomics (elasticity, costs, market structure), macroeconomics (output, inflation, unemployment, policy), and currency markets (cross rates, forward pricing, parity conditions). Items usually ask you to apply a rule to a small scenario rather than recite theory.
Microeconomics
- Price elasticity of demand: if |E| > 1 demand is elastic and a price rise reduces total revenue; if |E| < 1 a price rise increases revenue.
- Perfect competition reaches long-run equilibrium where price equals marginal cost and economic profit is zero; a monopolist sets marginal revenue equal to marginal cost and prices above marginal revenue.
Macroeconomics
- Expenditure approach: GDP = C + I + G + (X - M). Real GDP removes price effects using the GDP deflator.
- Demand-pull inflation follows excess aggregate demand; cost-push follows input or wage shocks, and both push the short-run aggregate supply curve.
- A central bank raising its policy rate typically dampens inflation and supports the currency in the short run.
Currency markets
- Build cross rates by eliminating the intermediate currency, and check the units before multiplying or dividing.
- Forward rate approximately equals spot x (1 + interest rate of the price currency) / (1 + interest rate of the base currency). The higher-interest-rate currency trades at a forward discount.
Worked example
Spot is 1.20 USD per EUR, the one-year USD rate is 4% and the one-year EUR rate is 2%. Forward = 1.20 x 1.04 / 1.02 = 1.2235 USD per EUR. The euro is at a forward premium of about 1.96% and the dollar at a forward discount of roughly the same amount, which is what interest rate parity requires. If a dealer quoted 1.2600, you would borrow dollars, buy euros spot, invest in euros, and sell euros forward to lock in the difference.
Traps that cost marks
- Quoting forward points without stating whether they are added to or subtracted from spot.
- Mixing nominal and real GDP when computing the deflator.
- Assuming purchasing power parity holds in the short run; it is a long-run relationship.
- Reversing the base and price currency in the parity formula, which inverts the answer.