Question

Please post your responses below by due date as instructed. Please attempt at least 5 of the following questions as optional assignments. However, a maximum of extra 10 points (equivalent of about 2 points toward course grade) will be awarded, if attempted and substantiated. 1) "A balance of trade deficit must always be offset by net capital inflows from abroad." Agree or disagree with this statement and explain. 2) Suppose a Japanese firm buys a 1 year treasury bill with a face value of $10,000 today for $9400. If the value of the dollar declined from 90 to 80 yen during the year, what rate of return does the Japanese firm earn on its investment? 3) Draw a supply-demand diagram of the foreign exchange market for the dollar (valued in euros/$) Show the effects of the following events on the exchange rate. Explain your reasoning! a) The release of data showing stronger than expected RGDP growth in Germany. b) An increase in the federal funds rate by the Federal Reserve c) An announcement that U.S. trade deficits for the last quarter were much larger than previously expected d) A larger than expected increase in hourly wage rates in the US. 4) If the Fed wished to defend the exchange rate of the $ (i.e. prevent the $ exchange rate from falling) what policy action could it take? Explain. 5a) What is the "purchasing power parity" theory of exchange rates? If the price of a representative bundle of tradable goods is currently $5000 in the U.S. and 550000 yen in Japan, is the $ undervalued or overvalued when the exchange rate is 90 yen per $? 5b) Why don't actual exchange rates move to purchasing power parity levels in the short run? 6) The treasurer of a U.S. firm noted that although short run deposits in Swiss bank accounts had earned the firm only a 3% annualized return when measured in Swiss francs, in dollars the firm had realized a 12% rate of return. Explain as precisely as possible how this was possible. 7) In recent years the exchange rate of the $ has been noticeably high against the yen. If for some reason investors around the world now decide that this increase is a temporary phenomena and that the $ will fall relative to the yen in coming months, what would be the effect on prices of U.S. Treasury Securities? Explain. 8) Do US producers of tradable goods prefer a strong dollar or a weak dollar in currency markets? Explain.

Answer 1

1) Capital inflows mean cash is coming in, through venture, and balance of trade deficit (exchange deficiencies) mean cash is turning out. Since the wellsprings of money must equivalent the employment of money, the cash turning out (exchange shortfall) will mean there is cash coming in some other way (speculation). There is a significantly more long clarification of why the present record deficiency is equivalent to the monetary record overflow.

Add up to exchange the long run really is adjusted because of the drifting conversion scale. Add up to exchange incorporates exchange money related resources (capital streams) and exchange merchandise and enterprises (current record shortfall/overflow).

A nation running an expansive current record deficiency will have cash coming in through a capital inflow (a.k.a budgetary record). Essentially, cash comes in a single manner and goes out another way.

8) The Strong dollar refers to a situation where dollars can buy more number of other currencies and Weak dollar refers just the opposite situation.

The US producers of tradable goods may prefer a weak/strong dollar situation depending on the availability of proper. In case of substitutes availability they will prefer weak dollar situation since they can sell the goods at a cheaper price due to lower exchange rate prevailing in the market and grab a more market but there is another scenario also the US producer of tradable goods might also prefer a strong dollar situation if there is no proper substitute for their good since it will provide higher return since the prices of their good will be high.

7)If they perceive that the $ will fall against yen then they will sell the treasury bills in the current period or the demand for US treasury bill will fall and hence the price for the bills will fall.

6) This case is due to the difference in the exchange rate. The current exchange rate would be lower which will facilitate the return. for e.g. previously might be exchange rate $1= 5francs now someone has a short run deposit of $200(1000francs) with an interest rate of 3%. So, at the end of the period one obtain 1030 francs but now the exchange rate is $1=4.6 francs which will provide approximately $224 i.e. a return of 12% so lowering the exchange rate has facilitated the return.

4) There are various policies that Central Bank can take to defend the exchange rate of $ which are as follows:

i)Buying their own currency by selling foreign assets: US sell the bills of different countries and get their currency back then they can defend the exchange rate since it is going to create a shortage of dollars.

ii) Higher Interest rates: Higher interest rate will provide better return on US saving accounts which will initiate a flow of capital to take the advantage and increase the demand for $ and hence appreciation of Exchange rate or prevent the fall in the exchange rate.

iii) Lowering the inflation: On the off chance that inflation is lower than contenders, at that point the $ will turn out to be more alluring and demand will rise. Lower inflation tends to build the estimation of the cash in the long haul. To diminish inflation, the administration/Central bank can seek after more tightly financial and money related arrangement and furthermore supply-side approaches.