You are given the following information about a country’s international transactions during a year:
a.Calculate the values of the country’s goods and services balance,current account balance,and official settlements balance?
a.Merchandise trade balance: $330 - 198 = $132
Goods and services balance: $330 - 198 + 196 - 204 = $124
Current account balance: $330 - 198 + 196 - 204 + 3 - 8 = $119
Official settlements balance: $330 - 198 + 196 - 204 + 3 - 8 + 102 - 202 + 4 = $23
b.What are the value of the change in official reserve assets(net)?Is the country increasing or decreasing its net holdings of official reserve assets?
b.Change in official reserve assets (net) = - official settlements balance = -$23
The country is increasing its net holdings of official reserve assets.
What are the major types of transactions or activities that result in supply of foreign currency in the spct foreign exchange market?
Exports of merchandise and services result in supply of foreign currency in the foreign
exchange market. Domestic sellers often want to be paid using domestic currency, while
the foreign buyers want to pay in their currency. In the process of paying for these exports,
foreign currency is exchanged for domestic currency, creating supply of foreign currency.
International capital inflows result in a supply of foreign currency in the foreign exchange
market. In making investments in domestic financial assets, foreign investors often start
with foreign currency and must exchange it for domestic currency before they can buy the
domestic assets. The exchange creates a supply of foreign currency. Sales of foreign
financial assets that the country's residents had previously acquired, and borrowing from
foreigners by this country's residents are other forms of capital inflow that can create
supply of foreign currency.
You have access to the following three spot exchange rates:
$0.01/YEN
$0.20/KRONE
25YEN/KRONE
You strat with dollars and want to end up with dollars
a.hoe would you engage in arbitrage to profit from these three rates?what is the profit for each
dollar used initially?
a.The cross rate between the yen and the krone is too high (the yen value of the krone is too
high) relative to the dollar-foreign currency exchange rates. Thus, in a profitable
triangular arbitrage, you want to sell kroner at the high cross rate. The arbitrage will be:
Use dollars to buy kroner at $0.20/krone, use these kroner to buy yen at 25 yen/krone, and
use the yen to buy dollars at $0.01/yen. For each dollar that you sell initially, you can
obtain 5 kroner, these 5 kroner can obtain 125 yen, and the 125 yen can obtain $1.25. The
arbitrage profit for each dollar is therefore 25 cents.
b.As a result of this arbitrage,what is the pressure on the cross-rate between yen and krone?what must the value of the cross-rate be to eliminate the opportunity for triangular arbitrage?
b.Selling kroner to buy yen puts downward pressure on the cross rate (the yen price of
krone). The value of the cross rate must fall to 20 (=0.20/0.01) yen/krone to eliminate the
opportunity for triangular arbitrage, assuming that the dollar exchange rates are
unchanged.
Explain the nature of the exchange rate risk for each of the following,from the perspective of
the U.S frim or person.in your answer,include whether each is a long or short position in foreign currency.
a.a small U.S firm sold experimental computer computer compoments to a Japanese firm,and it will receive payment of 1 million yen in 60 days.
a.The U.S. firm has an asset position in yen—it has a long position in yen. To hedge its
exposure to exchange rate risk, the firm should enter into a forward exchange contract
now in which the firm commits to sell yen and receive dollars at the current forward rate.
The contract amounts are to sell 1 million yen and receive $9,000, both in 60 days.
The current spot exchange rate is $1.20/euro.the current 90-day forward exchange rate is$1.18/euro.you expect the spot rate to be $1.22/euro in 90 days.how would you speculate using a forward contract?if many people speculate in this way,what pressure is placed on the walue of the current forward exchange rate?
Relative to your expected spot value of the euro in 90 days ($1.22/euro), the current
forward rate of the euro ($1.18/euro) is low—the forward value of the euro is relatively
low. Using the principle of \"buy low, sell high,\" you can speculate by entering into a
forward contract now to buy euros at $1.18/euro. If you are correct in your expectation,
then in 90 days you will be able to immediately resell those euros for $1.22/euro,
pocketing a profit of $0.04 for each euro that you bought forward. If many people
speculate in this way, then massive purchases now of euros forward (increasing the
demand for euros forward) will tend to drive up the forward value of the euro, toward a
current forward rate of $1.22/euro.
The following rates are available in the markets:
Current spot exchange rate: $0.500/SFr
Current 30-day forward exchange rate: $0.505/SFr
Annualized interest rate on 30-day dollar-denominated bonds:12%(1.0% for 30 days)
Annualized interest rate on 30-day Swiss franc-denominated bonds:6%(0.5% for 30 days)
a.Is the swiss franc at a forward premium or discount?
a.The Swiss franc is at a forward premium. Its current forward value ($0.505/SFr) is greater
than its current spot value ($0.500/SFr).
b.should a U.S-based investor make a covered investment in swiss franc-denominated 30-day bonds,rather than investing 30-day dollar-denominated bonds?Explain.
b.The covered interest differential \"in favor of Switzerland\" is ((1 + 0.005)⋅(0.505) / 0.500)
- (1 + 0.01) = 0.005. (Note that the interest rate used must match the time period of the
investment.) There is a covered interest differential of 0.5% for 30 days (6 percent at an
annual rate). The U.S. investor can make a higher return, covered against exchange rate
risk, by investing in SFr-denominated bonds, so presumably the investor should make this
covered investment. Although the interest rate on SFr-denominated bonds is lower than
the interest rate on dollar-denominated bonds, the forward premium on the franc is larger
than this difference, so that the covered investment is a good idea.
c.Because of covered interest arbitrage,what pressures are placed on the various rates?if the only rate that actually changes is forward exchange rate,to what value will it bu driven?
c.The lack of demand for dollar-denominated bonds (or the supply of these bonds as
investors sell them in order to shift into SFr-denominated bonds) puts downward pressure
on the prices of U.S. bonds—upward pressure on U.S. interest rates. The extra demand
for the franc in the spot exchange market (as investors buy SFr in order to buy
SFr-denominated bonds) puts upward pressure on the spot exchange rate. The extra
demand for SFr-denominated bonds puts upward pressure on the prices of Swiss
bonds—downward pressure on Swiss interest rates. The extra supply of francs in the
forward market (as U.S. investors cover their SFr investments back into dollars) puts
downward pressure on the forward exchange rate. If the only rate that changes is the
forward exchange rate, this rate must fall to about $0.5025/SFr. With this forward rate and
the other initial rates, the covered interest differential is close to zero.
Why is testing whether uncovered interest parity holds for actual rates more difficult than testing whether covered interest parity holds?
In testing covered interest parity, all of the interest rates and exchange rates that are
needed to calculate the covered interest differential are rates that can observed in the bond
and foreign exchange markets. Determining whether the covered interest differential is
about zero (covered interest parity) is then straightforward (although some more subtle
issues regarding timing of transactions may also need to be addressed). In order to test
uncovered interest parity, we need to know not only three rates—two interest rates and the
current spot exchange rate—that can be observed in the market, but also one rate—the
expected future spot exchange rate—that is not observed in any market. The tester then
needs a way to find out about investors' expectations. One way is to ask them, using a
survey, but they may not say exactly what they really think. Another way is to examine
the actual uncovered interest differential after we know what the future spot exchange rate
actually turns out to be, and see whether the statistical characteristics of the actual
uncovered differential are consistent with an expected uncovered differential of about
zero (uncovered interest parity)
the following rates currently exist:
spot exchange rate: $1.000/euro.
Annual interest rate on 180-day euro-denominated bonds:3%
Annual interest rate on 180-day U.S dollar-denominated bonds:4%
Ibvestors currently expect the spot exchange rate to be about$1.005/euro in180 days.
a.show that uncovered interest parity holds(approximately)at these rates
a.The euro is expected to appreciate at an annual rate of approximately ((1.005 -
1.000)/1.000)⋅(360/180)⋅100 = 1%. The expected uncovered interest differential is
approximately 3% + 1% - 4% = 0, so uncovered interest parity holds (approximately).
What is likely to be the effect on the spot eschange rate if the interest rate on 180-day dollar-denominated bonds declines to 3%? If the euro interest rate and the expected future spot rate are unchanged,and if uncovered interest parity is reestablished,what will the new current spot exchange rate be?has the dollar appreciated or depreciated?
b.If the interest rate on 180-day dollar-denominated bonds declines to 3%, then the spot
exchange rate is likely to increase—the euro will appreciate, the dollar depreciate. At the
initial current spot exchange rate, the initial expected future spot exchange rate, and the
initial euro interest rate, the expected uncovered interest differential shifts in favor of
investing in euro-denominated bonds (the expected uncovered differential is now positive,
3% + 1% - 3% = 1%, favoring uncovered investment in euro-denominated bonds. The
increased demand for euros in the spot exchange market tends to appreciate the euro. If
the euro interest rate and the expected future spot exchange rate remain unchanged, then
the current spot rate must change immediately to be $1.005/euro, to reestablish uncovered
interest parity. When the current spot rate jumps to this value, the euro's exchange rate
value is not expected to change in value subsequently during the next 180 days. The
dollar has depreciated immediately, and the uncovered differential then again is zero (3%
+ 0% - 3% = 0)
You observe the following current rates:
Spot exchange rate: $0.01/yen
Annual interest rate on 90-day U.S dollar-denominated bonds:4%
Annual interest rate on 90-day yen-denominated bonds:4%
a.if uncovered interest parity holds,what spot exchange rate do investors expect to exist in 90 days?
a.For uncovered interest parity to hold, investors must expect that the rate of change in the
spot exchange-rate value of the yen equals the interest rate differential, which is zero.
Investors must expect that the future spot value is the same as the current spot value,
$0.01/yen.
b.a close U.S presidential has just been decided.the candidate whom international investors view as the stronger and more probusiness person won.because of this,investors expect the exchange rate to be$0.0095/yen in 90 days.what will happen in the foreign exchange market?
b.If investors expect that the exchange rate will be $0.0095/yen, then they expect the yen to
depreciate from its initial spot value during the next 90 days. Given the other rates,
investors tend to shift their investments toward dollar-denominated investments. The
extra supply of yen (and demand for dollars) in the spot exchange market results in a
decrease in the current spot value of the yen (the dollar appreciates). The shift to
expecting that the yen will depreciate (the dollar appreciate) sometime during the next 90
days tends to cause the yen to depreciate (the dollar to appreciate) immediately in the
current spot market.
To aid in its efforts to get reelected,the current government of o country decides to increase the growth rate of the domestic money supply by two percentage points.the increased growth rate becomes”permanene”because once started it is difficult to reverse.
a.according to the monetary approach,how will this affect the long-run trend for the exchange rate value of the country’s currency?
a.Because the growth rate of the domestic money supply (M s ) is two percentage points
higher than it was previously, the monetary approach indicates that the exchange rate
value (e) of the foreign currency will be higher than it otherwise would be—that is, the
exchange rate value of the country's currency will be lower. Specifically, the foreign
currency will appreciate by two percentage points more per year, or depreciate by two
percentage points less. That is, the domestic currency will depreciate by two percentage
points more per year, or appreciate by two percentage points less.
b.explain why the nominal exchange rate trend is affected,referring to PPP
b.The faster growth of the country's money supply eventually leads to a faster rate of
inflation of the domestic price level (P). Specifically, the inflation rate will be two
percentage points higher than it otherwise would be. According to relative PPP, a faster
rate of increase in the domestic price level (P) leads to a higher rate of appreciation of the
foreign currency.
A country has a marginal propensity to save of 0.15 and a marginal propensity to import of 0.4 real domestic spending now decreases by$2 billion
a.according to the spending multiplier(for a small open economy),,by how much will domestic product and income change?
a.The spending multiplier in this small open economy is about 1.82 (= 1/(0.15 + 0.4)). If
real spending initially declines by $2 billion, then domestic product and income will
decline by about $3. billion (= 1.82$2 billion)
b.what is the change in the country’s imports?
b. If domestic product and income decline by $3. billion, then the country's imports will
decline by about $1.46 billion (= $3. billion0.4).
c.if this country is large,what effect will this have on foreign product and income?explain
c. The decrease in this country's imports reduces other countries' exports, so foreign product
and income decline.
d.will the change in foreign product and income tend to counteract or reinforce the change in the first country’s domestic product and income?explain
d. The decline in foreign product and income reduce foreign imports, so the first country's
exports decrease. This reinforces the change (decline) in the first country's domestic
product and income—an example of foreign-income repercussions.
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