Question

You are planning to invest 3 million euros for one year, and you have two alternatives: a US asset with interest rate 1.9%, and a French asset with interest rate 0.9%. Note also that today’s euro nominal exchange rate per $ equals 0.920.

a) If you expect annual depreciation of the euro by 4%, what will be your choice?

b) Which expected nominal exchange rate will make you indifferent between the two alternatives?

B. The economic report for a Eurozone country for the year 2019 shows that its GDP (Y) is 215, its private consumption (C) equals 140 and its government expenditures (G) equal 65. Also, the country experiences a current account deficit (CA) that equals 20 (all numbers are in billion euros). Calculate the level of private investment (I) for the year 2019. Also, what will happen to CA if domestic private savings (S) increase by 30%?

Answer 1

Hi,

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Question:

Answer:

a). Answer:

My choice will be FRENCH ASSET

Euro nominal exchange rate per $ equals 0.920.

$1 = EUR0.920

Euro = $1.086

Planning to invest 3 million euros for one year

Interest rate (US)= 1.9%

interest rate (French asset) =  0.9%

3 million euros = 3000000*1.086 = $3260870

Final amount of investment(if invest in US asset) =

$3260870 + $3260870*1.9% = $3260870 + 61957 = $3322827

Final amount of investment(if invest in US asset) =$3322827

Final amount of investment(if invest in French asset) =

3000000 + 3000000* 0.9% = 3260870 + 270000 = EUR3027000

Final amount of investment in French asset (Value in USD) = 3027000 *  1.086 = $3285000

Now annual depreciation of the euro by 4%,

So, new exchange rate will be =

$1 = EUR0.9568 (0.9568 + 0.9568*4%)

1EUR = $1.0451

New Final amount of investment(if invest in French asset) in USD =  3027000 * 1.0451 = $3163671

New Final amount of investment(if invest in US asset) in USD

3 million euros = 3000000*1.0451 = $31353000

31353000 + 31353000*1.9% = 31353000 + 59571 = $31412571

My choice will be FRENCH ASSET.

b). Answer:

Expected nominal exchange rate will make me indifferent between the two alternatives when the value of both the investment will be equal in USD.

Total return of the investment in French asset=

3000000 + 3000000 * 0.9% = 3027000

Total return of the investment in US asset=

3000000 + 3000000 * 1.9% = 3000000 + 57000 = 3057000

Nominal exchange rate will make me indifferent between the two alternatives at:

1USD = EUR100.991

Calculation:

[3027000 *X% = 3057000

X = 100.991]

c). Answer:

GDP(Y) =  Euro215 billion

Private consumption (C) = Euro140 billion

Government expenditures (G) = Euro65 billion

Current account deficit (CA) that = Euro20 billion

GDP = C+ I + G + NX

215 = 140+ I + 65 + (-20)

I = 215-185 = Euro30 billion

GDP = C+ I + G + NX

215 = C+ 39+ 65 + (-20)

C = 215-84 = Euro131 billion

If domestic private savings (S) increase by 30% then C = Euro131 billion

Thank You