Question

Which of the following is true? An undervalued fixed rate currency encourages inflation in that country An overvalued currency is a sign of a trade surplus for that country An undervalued currency is a sign of an excess supply of that currency An overvalued currency increases a country’s exports

A US corporation has a CNY1,000,000 account payable due in 6 months. To hedge its currency risk your company enters into an NDF contract. The current spot rate is CNY7.15/$, the NDF contract rate is CNY7.00/$, and the spot rate 6 months from today is CNY7.25/$

Your company pays $1,929.11

Your company pays $4,926.11

Your company receives $1,929.11

Your company receives $4,926.11

Which of the following transactions is/are in the US BOP account?

I.)    A Chinese company buys US Treasury securities from a broker/dealer in Sydney, Australia.

II.)  An Italian family flies United Airlines to New York.

III.)  A US investment bank buys a German stock from a US insurance company.

IV.) A Spanish mutual fund sells a Chinese company’s stock to a NY investment bank.

V.)  A US company sells a factory in Malaysia to a Chinese bank.

II and V

I and II

II, IV, and V

III and V

Answer 1

1. Of the following,

An undervalued fixed rate currency encourages inflation in that country - An undervalued fixed exchange rate encourages exports and discourages imports. This leads to an excess of foreign exchange reserves in the country which must be continually bought out by the central bank, hence encouraging inflation. True.

An overvalued currency is a sign of a trade surplus for that country - An overvalued currency discourages exports and encourages imports. This causes an increase in trade deficit. False

An undervalued currency is a sign of an excess supply of that currency - As in point A, an undervalued currency creates an excess supply of the foreign currecy, not the domestic currency itself. False.

An overvalued currency increases a country’s exports - An overvalued currency increases a country's imports, not exports. False.

2. Amount Payable in 6 months = CNY1,000,000

NDF Contract Rate = CNY7.00/$

Amount Payed by US Firm to enter into NDF Contract = USD(1,000,000/7.00) = USD142,857.14

Amount Payable at Future spot rate = USD(1,000,000/7.25) = USD137931.03

Gain made by entering into NDF contract = USD142,857.14 - USD137931.03 = USD4926.11

Hence, Your company receives $4,926.11

3. Of the following,

I.)    A Chinese company buys US Treasury securities from a broker/dealer in Sydney, Australia. - Since the transaction is taking place from an intermediary and not directly from the US, the item will not be included.

II.)  An Italian family flies United Airlines to New York. - The cost of the ticket and all expenditure incurred by the family will be included under the US BOP current account.

III.)  A US investment bank buys a German stock from a US insurance company. - Since the purchase is taking place from another US company, the item will not be included in the BOP.

IV.) A Spanish mutual fund sells a Chinese company’s stock to a NY investment bank. - Since a US investment bank is purchasing a foreign stock, the item will be included under the capital account of US BOP.

V.)  A US company sells a factory in Malaysia to a Chinese bank. - Since the factory is a productive asset for the US firm, its sale in foreign land to a Chinese Bank will be included under the current account of the US BOP.

Hence, II, IV, and V should be included.