Question 1 (9 points)
Show how and in what accounts of the US BOP the following transactions will be recorded by filling out the table for each transaction. CA = Current account; CFA= Capital and financial account; BOP = Balance of Payments. I filled out the first table as an example.
1.1. In the 2000’s, Pepsico (a US-owned firm) sold $3billion worth of Pepsi syrup to Russia in exchange for $3billion worth of Stolichnaya vodka.
CA credit
+3 billion (EXPORTS) CA debit
-3 billion (IMPORTS) CFA credit
0 CFA debit
0
CA NET 0 CFA NET 0
BOP NET 0
1.2. A US book publisher sells $20,000 of books to China and is paid with a check.
CA credit CA debit CFA credit CFA debit
CA NET CFA NET
BOP NET
1.3. A US firm imports SF50,000 worth of goods from Switzerland. It pays with a check and the exchange rate is $1 = SF2.
CA credit CA debit CFA credit CFA debit
CA NET CFA NET
BOP NET
1.4. GM buys an automobile factory in Mexico worth $10 million.
CA credit CA debit CFA credit CFA debit
CA NET CFA NET
BOP NET
1.5. George, an American tourist, is in Paris for his vacation. He spends $110 on French wine one evening and pays with his American Express credit card.
CA credit CA debit CFA credit CFA debit
CA NET CFA NET
BOP NET
6. George was in the Paris bar to meet up with his Danish cousin, Georg. They both work as wine merchants and consider themselves connoisseurs. George convinces Georg to try an Arkansas chardonnay and Georg convinces George to try some Danish wine, Jutland rose. Each cousin returns home and ships a case of wine (worth $36) to the other one (they simply exchange the cases, no international payment is involved).
CA credit CA debit CFA credit CFA debit
CA NET CFA NET
BOP NET
7. George, very impressed by the quality of the French wines tasted in Paris, decides to invest $10,000 of his savings to buy French stock in a French winery.
CA credit CA debit CFA credit CFA debit
CA NET CFA NET
BOP NET
8. The US is sending $1 mil. worth of wheat to Somalia as international non-military aid.
CA credit CA debit CFA credit CFA debit
CA NET CFA NET
BOP NET
9. A French student comes to study at Iona College for a year and pays with a check $30,000 in tuition.
CA credit CA debit CFA credit CFA debit
CA NET CFA NET
BOP NET
10. An American company from NY buys $8,000 worth of fresh produce from an American farmer in California.
CA credit CA debit CFA credit CFA debit
CA NET CFA NET
BOP NET
Question 2 (2 points)
Use the interest parity to explain the fallacy in the following comment:
“In 1993, short-term Mexican bonds paid an interest rate of over 17%, Argentine bonds over 23%, Indonesian certificates of deposit over 15%, and Philippines Treasury bills over 12%. US interest rates on dollar-denominated assets during the same period ranged from 3% to 6%, depending on the type of asset. This is proof that portfolio owners do not pursue high rates of return. Otherwise, no one would have held any dollar asset in 1993.”
Question 3 (6 points)
Current market conditions are as follows: spot rate (e) between dollar and pound is $1.33 = £1. The rate of return on 1-year domestic bonds (i$) is 1% and the rate of return on 1-year British bonds (i£) is 2%.
3.1. What is the expected spot rate (ee) 1 year from now that eliminates any arbitrage opportunities given the current market conditions? (Round your answer to 2 decimals).
3.2. If the spot rate 1-year from now turns out to be $1.29/£1, what is the loss/gain of an American investor who bought $100 worth of British bonds? The investor did not cover her FX risk exposure.
3.3. If the spot rate 1-year from now turns out to be $1.35/£1, what is the loss/gain of an American investor who bought $100 worth of British bonds? The investor did not cover her FX risk exposure.
3.4. In order to completely eliminate the exposure to the FX risk, what would you advise the investor do?
Question 4 (2 points)
Assume that a basket of commodities costs $100 in the USA. The same basket of commodities costs €97 in Germany. What is the PPP exchange rate between the US dollar and Euro? If the official exchange rate is $1 = €0.88, is the US dollar appreciated or depreciated against the Euro? Briefly explain.
Question 5 (3 points)
Assume the law of one price holds. The exchange rate is $1.5 = £1.
5.1. If a sweater sells for $45 in New York, what is its price (in £) in London?
5.2. What kind of possible arbitrage might occur if the sweater sells for £28 in London?
5.3. What kind of possible arbitrage might occur if the sweater sells for £35 in London?
Question 6 (4 points)
6.1. Suppose ABC Inc., a U.S. auto manufacturer, obtains all of its auto components in the United States and that its costs are denominated in dollars. Assume the dollar’s exchange value appreciates by 50% against the Mexican peso. What impact does the dollar appreciation have on the firm’s international competitiveness? Assume now that the dollar’s exchange value depreciates by 10% against the Mexican peso. What impact does the dollar depreciation have on the firm’s international competitiveness?
6.2. Suppose XYZ Inc., a U.S. auto manufacturer, obtains some of its auto components in Mexico and that the costs of these components are denominated in pesos; the costs of the remaining components are denominated in dollars. Assume the dollar’s exchange value appreciates by 50 percent against the peso. What impact will the dollar appreciation have on the firm’s international competitiveness? Assume now that the dollar’s exchange value depreciates by 10% against the Mexican peso. What impact does the dollar depreciation have on the firm’s international competitiveness?
Question 7 (6 points)
Assume the United States exports 1,000 computers costing $3,000 each and imports 150 UK autos at a price of £10,000 each. Assume that the dollar/ pound exchange rate is $2 per pound.
7.1. Calculate in dollar terms, the U.S. export receipts, import payments, and trade balance prior to a depreciation of the dollar’s exchange value.
7.2. Suppose the dollar’s exchange value depreciates by 10 percent. Assuming that the price elasticity of demand for U.S. exports equals 3.0 and the price elasticity of demand for U.S. imports equals 2.0, does the dollar depreciation improve or worsen the U.S. trade balance? Why?
7.3. Now assume that the price elasticity of demand for U.S. exports equals 0.3 and the price elasticity of demand for U.S. imports equals 0.2. does the dollar depreciation improve or worsen the U.S. trade balance? Why?