Learning objectives
By the end you can:
- Convert between the two live quote conventions (the market's base/quote pair and the CFA's price-currency/base-currency form), read any quoted rate correctly under either, and compute the asymmetry between one currency's appreciation and the other's depreciation exactly rather than approximately.
- Build a cross rate from two-way quotes with the bid and offer on the correct side, and test a third dealer's quote for triangular arbitrage, reporting a profit or a loss after the spread rather than before it.
- Derive and solve all five parity conditions (covered interest parity, uncovered interest parity, absolute and relative purchasing power parity, the Fisher effect and the international Fisher effect) from a single set of spot, interest and inflation inputs, and reconcile the forward premium against the purchasing-power drift through the real-rate wedge.
- Price a forward two ways, from covered interest parity and from quoted forward points, read the gap as an implied funding basis rather than an arbitrage, and state what forward-rate unbiasedness claims, how the regression tests it, and why the forward-premium puzzle and the carry trade are one fact rather than two.
- Classify any cross-border transaction into the current, capital or financial account under the sixth edition of the balance-of-payments manual, apply the sign convention, and make the identity close with a stated errors-and-omissions residual.
- Solve the Mundell-Fleming system for monetary and fiscal shocks under fixed and floating rates at high and low capital mobility, and state the exchange-rate prediction and the crowding-out mechanism in each cell.
- Trace a Dornbusch overshoot from a money-supply shock through the impact jump, the walk-back and the long-run level, and say precisely which assumption produces the overshoot.
- Decompose an interest differential into expected depreciation and a currency risk premium, explain how a rising stock of government debt moves the premium and therefore the spot rate under floating, and cost a sterilised intervention, which reaches the exchange rate through that same imperfect-substitutes channel.
- Test the Marshall-Lerner condition on stated elasticities, tabulate the J-curve path, and compute the consumer loss, producer gain, revenue or rent and both deadweight triangles for a tariff, a quota, a voluntary export restraint and an export subsidy.
- Rank a trade agreement on the free-trade-area to economic-union ladder, separate trade creation from trade diversion with the resource-cost arithmetic, and score an emerging market against a currency-crisis checklist from primary data, saying what would have to change for the verdict to flip.
Prerequisites & connections
Builds on. M7.06 gave you the FX market's plumbing: what an exchange rate is, the five forces that move one, covered interest parity with the arbitrage that enforces it, the carry trade, the impossible trinity, and the dollar system with its eurodollar and swap-line machinery. This node assembles those pieces into a single solvable system and extends them; it does not re-derive the trilemma or re-explain the eurodollar. M7.03 supplies the real-versus-nominal distinction and the Fisher decomposition that the international Fisher effect exports across a border. DV1.01 owns forward and futures pricing mechanics, including the cost-of-carry logic that makes the covered forward a no-arbitrage price rather than a forecast, and this node uses that result as given. MS1.04 owns the FX swap, the non-deliverable forward and the cross-currency basis as funding instruments, which is why the basis appears here only as a number to interpret. EC1.01 owns consumer and producer surplus, the choke price, deadweight loss and the elasticity machinery; the trade-policy arithmetic below is that toolkit applied at a border and adds no new welfare theory.
Deliberate non-overlaps. We do not re-teach the quote conventions from scratch, the CIP arbitrage narrative, the carry trade's risk profile, the impossible trinity, comparative advantage and the distributional debate around it, or the global financial cycle and sudden-stop mechanism; all of those are M7.06's, and it gains the two-notation box as a section fix. Nor do we re-teach forward pricing mechanics (DV1.01), the cross-currency basis as a funding instrument (MS1.04), or the derivation of surplus and deadweight loss (EC1.01). Where those own a concept, this node cites and moves on. The balance-of-payments treatment here is the exception that is not an exception: M7.06 gives the two-halves identity and the quality-of-financing lens, and gains the manual-edition box as a section fix, while the three-account separation and the classification drill live here.