Page 18 - FINAL CFA II SLIDES JUNE 2019 DAY 4

LOS 11.l: Describe objectives of central bank or READING 11: CURRENCY EXCHANGE RATES: UNDERSTANDING EQUILIBRIUM VALUE
government intervention and capital controls and describe
the effectiveness of intervention and capital controls.
MODULE 11.3: EXCHANGE RATE DETERMINANTS, CARRY TRADE, AND
CENTRAL BANK INFLUENCE

Objectives
The objectives of capital controls or central bank intervention in FX markets are to:
• Ensure that the domestic currency does not appreciate excessively.
• Allow the pursuit of independent monetary policies without being hindered by their impact on currency values.
• Reduce the aggregate volume of inflow of foreign capital.

Effectiveness
For developed market countries, the volume of trading in a country’s currency is usually very large relative to the foreign
exchange reserves of its central bank (hence their central banks are relatively ineffective at intervening in the forex markets).
Central banks of emerging market countries may be able to accumulate sufficient foreign exchange reserves (relative to trading
volume) to affect the supply and demand of their currencies in the foreign exchange markets.

LOS 11.m: Describe warning signs of a currency crisis.

• Terms of trade (i.e., ratio of exports to imports) deteriorate.
• Fixed or partially-fixed exchange rates (versus floating exchange rates).
• Official foreign exchange reserves dramatically decline.
• Currency value that has risen above its historical mean.
• Inflation increases.
• Liberalized capital markets, that allow for the free flow of capital.
• Money supply relative to bank reserves increases.
• Banking crises (may also be coincident).