Suggested answers to questions and problems.docx

Suggested answers to questions and problems.docx

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Suggestedanswerstoquestionsandproblems

Suggestedanswerstoquestionsandproblems

（inthetextbook）

Chapter2

2.Disagree,atleastasageneralstatement.Onemeaningofacurrentaccountsurplusisthatthecountryisexportingmoregoodsandservicesthanitisimporting.Onemighteasilyjudgethatthisisnotgood—thecountryisproducinggoodsandservicesthatareexported,butthecountryisnotatthesametimegettingtheimportsofgoodsandservicesthatwouldallowitdomoreconsumptionanddomesticinvestment.Inthiswayacurrentaccountdeficitmightbeconsideredgood—theextraimportsallowthecountrytoconsumeandinvestdomesticallymorethanthevalueofitscurrentproduction.Anothermeaningofacurrentaccountsurplusisthatthecountryisengaginginforeignfinancialinvestment—itisbuildingupitsclaimsonforeigners,andthisaddstonationalwealth.Thissoundsgood,butasnotedaboveitcomesatthecostofforegoingcurrentdomesticpurchasesofgoodsandservices.Acurrentaccountdeficitisthecountryrunningdownitsclaimsonforeignersorincreasingitsindebtednesstoforeigners.Thissoundsbad,butitcomeswiththebenefitofhigherlevelsofcurrentdomesticexpenditure.Differentcountriesatdifferenttimesmayweighthebalanceofthesecostsandbenefitsdifferently,sothatwecannotsimplysaythatacurrentaccountsurplusisbetterthanacurrentaccountdeficit.

4.Disagree.Ifthecountryhasasurplus（apositivevalue）foritsofficialsettlementsbalance,thenthevalueforitsofficialreservesbalancemustbeanegativevalueofthesameamount（sothatthetwoaddtozero）.Anegativevalueforthisassetitemmeansthatfundsareflowingoutinorderforthecountrytoacquiremoreofthesekindsofassets.Thus,thecountryisincreasingitsholdingsofofficialreserveassets.

6.ItemeisatransactioninwhichforeignofficialholdingsofU.S.assetsincrease.Thisisapositive（credit）itemforofficialreserveassetsandanegative（debit）itemforprivatecapitalflowsastheU.S.bankacquirespoundbankdeposits.ThedebititemcontributestoaU.S.deficitintheofficialsettlementsbalance（whilethecredititemisrecorded"belowtheline,"permittingtheofficialsettlementsbalancetobeindeficit）.Allothertransactionsinvolvedebitandcredititemsbothofwhichareincludedintheofficialsettlementsbalance,sothattheydonotdirectlycontributetoadeficit（orsurplus）intheofficialsettlementsbalance.

8.a.Merchandisetradebalance:

$330-198=$132

Goodsandservicesbalance:

$330-198+196-204=$124

Currentaccountbalance:

$330-198+196-204+3-8=$119

Officialsettlementsbalance:

$330-198+196-204+3-8+102-202+4=$23

b.Changeinofficialreserveassets（net）=-officialsettlementsbalance=-$23.

Thecountryisincreasingitsnetholdingsofofficialreserveassets.

10.a.Internationalinvestmentposition（billions）:

$30+20+15-40-25=$0.

Thecountryisneitheraninternationalcreditornoradebtor.Itsholdingofinternationalassetsequalsitsliabilitiestoforeigners.

b.Acurrentaccountsurpluspermitsthecountrytoaddtoitsnetclaimsonforeigners.Forthisreasonthecountry'sinternationalinvestmentpositionwillbecomeapositivevalue.Theflowincreaseinnetforeignassetsresultsinthestockofnetforeignassetsbecomingpositive.

Chapter3

2.Exportsofmerchandiseandservicesresultinsupplyofforeigncurrencyintheforeignexchangemarket.Domesticsellersoftenwanttobepaidusingdomesticcurrency,whiletheforeignbuyerswanttopayintheircurrency.Intheprocessofpayingfortheseexports,foreigncurrencyisexchangedfordomesticcurrency,creatingsupplyofforeigncurrency.Internationalcapitalinflowsresultinasupplyofforeigncurrencyintheforeignexchangemarket.Inmakinginvestmentsindomesticfinancialassets,foreigninvestorsoftenstartwithforeigncurrencyandmustexchangeitfordomesticcurrencybeforetheycanbuythedomesticassets.Theexchangecreatesasupplyofforeigncurrency.Salesofforeignfinancialassetsthatthecountry'sresidentshadpreviouslyacquired,andborrowingfromforeignersbythiscountry'sresidentsareotherformsofcapitalinflowthatcancreatesupplyofforeigncurrency.

4.TheU.S.firmobtainsaquotationfromitsbankonthespotexchangerateforbuyingyenwithdollars.Iftherateisacceptable,thefirminstructsitsbankthatitwantstousedollarsfromitsdollarcheckingaccounttobuy1millionyenatthisspotexchangerate.ItalsoinstructsitsbanktosendtheyentothebankaccountoftheJapanesefirm.Tocarryoutthisinstruction,theU.S.bankinstructsitscorrespondentbankinJapantotake1millionyenfromitsaccountatthecorrespondentbankandtransfertheyentothebankaccountoftheJapanesefirm.（TheU.S.bankcouldalsouseyenatitsownbranchifithasabranchinJapan.）

6.Thetraderwouldseekoutthebestquotedspotrateforbuyingeuroswithdollars,eitherthroughdirectcontactwithtradersatotherbanksorbyusingtheservicesofaforeignexchangebroker.Thetraderwouldusethebestratetobuyeurospot.Sometimeinthenexthourorso（or,typicallyatleastbytheendoftheday）,thetraderwillentertheinterbankmarketagain,toobtainthebestquotedspotrateforsellingeurosfordollars.Thetraderwillusethebestspotratetosellherpreviouslyacquiredeuros.Ifthespotvalueoftheeurohasrisenduringthisshorttime,thetradermakesaprofit.

8.a.Thecrossratebetweentheyenandthekroneistoohigh（theyenvalueofthekroneistoohigh）relativetothedollar-foreigncurrencyexchangerates.Thus,inaprofitabletriangulararbitrage,youwanttosellkroneratthehighcrossrate.Thearbitragewillbe:

Usedollarstobuykronerat$0.20/krone,usethesekronertobuyyenat25yen/krone,andusetheyentobuydollarsat$0.01/yen.Foreachdollarthatyousellinitially,youcanobtain5kroner,these5kronercanobtain125yen,andthe125yencanobtain$1.25.Thearbitrageprofitforeachdollaristherefore25cents.

b.Sellingkronertobuyyenputsdownwardpressureonthecrossrate（theyenpriceofkrone）.Thevalueofthecrossratemustfallto20（=0.20/0.01）yen/kronetoeliminatetheopportunityfortriangulararbitrage,assumingthatthedollarexchangeratesareunchanged.

10.a.TheincreaseinsupplyofSwissfrancsputsdownwardpressureontheexchange-ratevalue（$/SFr）ofthefranc.ThemonetaryauthoritiesmustintervenetodefendthefixedexchangeratebybuyingSFrandsellingdollars.

b.Theincreaseinsupplyoffrancsputsdownwardpressureontheexchange-ratevalue（$/SFr）ofthefranc.ThemonetaryauthoritiesmustintervenetodefendthefixedexchangeratebybuyingSFrandsellingdollars.

c.Theincreaseinsupplyoffrancsputsdownwardpressureontheexchange-ratevalue（$/SFr）ofthefranc.ThemonetaryauthoritiesmustintervenetodefendthefixedexchangeratebybuyingSFrandsellingdollars.

d.Thedecreaseindemandforfrancsputsdownwardpressureontheexchange-ratevalue（$/SFr）ofthefranc.ThemonetaryauthoritiesmustintervenetodefendthefixedexchangeratebybuyingSFrandsellingdollars.

Chapter4

2.Youwillneeddataonfourmarketrates:

Thecurrentinterestrate（oryield）onbondsissuedbytheU.S.governmentthatmatureinoneyear,thecurrentinterestrate（oryield）onbondsissuedbytheBritishgovernmentthatmatureinoneyear,thecurrentspotexchangeratebetweenthedollarandpound,andthecurrentone-yearforwardexchangeratebetweenthedollarandpound.Dotheseratesresultinacoveredinterestdifferentialthatisveryclosetozero?

4.a.TheU.S.firmhasanassetpositioninyen—ithasalongpositioninyen.Tohedgeitsexposuretoexchangeraterisk,thefirmshouldenterintoaforwardexchangecontractnowinwhichthefirmcommitstosellyenandreceivedollarsatthecurrentforwardrate.Thecontractamountsaretosell1millionyenandreceive$9,000,bothin60days.

b.Thestudenthasanassetpositioninyen—alongpositioninyen.Tohedgetheexposuretoexchangeraterisk,thestudentshouldenterintoaforwardexchangecontractnowinwhichthestudentcommitstosellyenandreceivedollarsatthecurrentforwardrate.Thecontractamountsaretosell10millionyenandreceive$90,000,bothin60days.

c.TheU.S.firmhasanliabilitypositioninyen—ashortpositioninyen.Tohedgeitsexposuretoexchangeraterisk,thefirmshouldenterintoaforwardexchangecontractnowinwhichthefirmcommitstoselldollarsandreceiveyenatthecurrentforwardrate.Thecontractamountsaretosell$900,000andreceive100millionyen,bothin60days.

6.Relativetoyourexpectedspotvalueoftheeuroin90days（$1.22/euro）,thecurrentforwardrateoftheeuro（$1.18/euro）islow—theforwardvalueoftheeuroisrelativelylow.Usingtheprincipleof"buylow,sellhigh,"youcanspeculatebyenteringintoaforwardcontractnowtobuyeurosat$1.18/euro.Ifyouarecorrectinyourexpectation,thenin90daysyouwillbeabletoimmediatelyresellthoseeurosfor$1.22/euro,pocketingaprofitof$0.04foreacheurothatyouboughtforward.Ifmanypeoplespeculateinthisway,thenmassivepurchasesnowofeurosforward（increasingthedemandforeurosforward）willtendtodriveuptheforwardvalueoftheeuro,towardacurrentforwardrateof$1.22/euro.

8.a.TheSwissfrancisataforwardpremium.Itscurrentforwardvalue（$0.505/SFr）isgreaterthanitscurrentspotvalue（$0.500/SFr）.

b.Thecoveredinterestdifferential"infavorofSwitzerland"is（（1+0.005）（0.505）/0.500）-（1+0.01）=