Who wants to be a trillionaire?

The Economist Oct 26th, 2006 | HONG KONG | from the print edition

BY THE end of October, China's foreign-exchange reserves are likely to top $1 trillion, twice their level two years ago and more than one-fifth of global reserves. This handsome sum would be enough to buy all the gold sitting in central banks' vaults (indeed, twice over) or almost all of London's residential property.

China's massive hoard is the result of its large current-account surplus, significant inward foreign direct investment, and big inflows of speculative capital over the past couple of years. In theory, flows of foreign money into China should push up the yuan, but China has resisted this, forcing the central bank to buy up the surplus foreign currency. The growth in reserves has slowed in recent months, but it is still averaging a hefty $16 billion a month.

China's official reserves already far exceed what is required to ensure financial stability. As a rule of thumb, a country needs enough foreign exchange to cover three months' imports or to settle its short-term foreign debt. China's reserves are equivalent to 15 months of imports and are six times bigger than its short-term debt. The explosion in reserves is also a headache for the central bank. It creates excess liquidity, which risks fuelling higher inflation, asset-price bubbles and imprudent bank lending.

There are two simple ways to stop reserves rising. China could set free its exchange rate or it could relax restrictions on capital outflows and allow private citizens to hold foreign assets. Significant moves of either kind seem unlikely in the near future. So long as China runs a large external surplus (the natural result of its high saving rate) and refuses to set its currency free, its stash of foreign currency will probably continue to mount.

How that money is invested has big implications for the world economy, not just for China. Brad Setser, head of global research at Roubini Global Economics, estimates that about 70% of it is invested in dollars, mainly Treasury securities. This has propped up the dollar and reduced American bond yields—by up to 1.5 percentage points according to some estimates. A big shift out of dollars could therefore push up bond yields and hence mortgage rates, damaging America's already crumbling housing market.

China's central bank is thought to be switching from Treasury bonds to American mortgage backed securities and corporate bonds in an attempt to earn higher yields. Chinese officials have also discussed in private the need to diversify reserves out of dollars in order to reduce exposure to a big drop in the greenback. The bank may be putting a bigger slice of any increase in reserves into euros and emerging Asian currencies, but so far there is little sign of a shift out of its existing stock of dollars. One problem is that China's investments are so big that they move markets. Shifting money into euros would push down the dollar. China would then not only suffer a capital loss on its remaining dollar reserves, but it could also be forced to buy yet more reserves to hold its currency down against a weaker dollar

Fear of a capital loss, and dissatisfaction with unrewarding yields, have triggered a flurry of ideas on how to put the money to better use. One popular idea is to use some of China's reserves to buy oil and other commodities. The snag is that stockpiling oil would push up prices, yet absorb only a tiny proportion of the sums at China's disposal. Buying the equivalent of sixmonths' oil consumption, as has been suggested, would take only 8% of total reserves at current prices, but the extra oil bought would amount to three times the growth in global oil demand this year. Buying gold would have similar results: if China invested just 5% of its reserves in gold, it could buy the world's entire annual mine production.

Another proposal is to spend more money on infrastructure investment, which would yield a much higher return than American bonds. However, since China's investment already accounts for 40% of GDP, it is not clear that China needs more. Writing off banks' non-performing loans might seem more sensible. In 2004 and 2005 the People's Bank of China did indeed shift $60 billion to state banks. The remaining stock of bad loans is now around $250 billion, according to UBS.

By buying American bonds, China is subsidising rich American consumers while China's health care, education and social safety net are starved of funds. So why not use reserves to relieve rural poverty, improve health care, or inject money into the under-funded pension system?

Unfortunately, all of these proposals to spend money at home misunderstand the nature of foreign reserves. The problem is that conversion of the foreign currency into yuan would put upward pressure on the yuan and so force the central bank to buy yet more foreign currency to hold it down. Reserves would return to their original level.

The only real solution to the poor return on China's reserves is to stop accumulating them. That requires policy reforms to reduce China's massive saving, which drives its current-account surplus, and a more flexible exchange-rate system. But before that happens, China's reserves could well hit $2 trillion.

QUESTIONS:

1) Based on the article facts, why was China's massive hoarding of foreign exchange reserves the result of its large current-account surplus, significant inward foreign direct investment, and big inflows of speculative capital? Explain and motivate your answer

2) Based on the facts in the article, would you say that China is following a new-mercantilist policy? Explain and motivate your answer (Maximum length one page).

3) Based on the facts in the article, would you say that China is a currency manipulator? Make use of a demand and supply diagram to explain your answer

4) Note: this is a research-based question and all sources used should be properly referenced. What happened to China’s foreign exchange reserves since 2006? Is China still hoarding massive foreign exchange reserves? What are the implications of this in terms of new-mercantilist policy and currency manipulation?

In 2006, the Sigma Chi fraternity at Johns Hopkins University in Baltimore put on a weekend "Halloween in the Hood" party. One of the decorations was a skeleton hanging from a rope noose. On the invitation, which was posted on Facebook, Baltimore was referred to as an "HIV pit" and suggested that party-goers should wear rap style clothing and bling-bling. An image of an internationally prominent African-American appeared in the posting. The Black Student Union members protested to university administration, saying that Sigma Chi was being racially insensitive. A student protest emerged urging the banning of the fraternity. Individual African-American students were deeply disturbed by the noose imagery. The fraternity said it did not mean to offend anyone, and it was only a regular Halloween party. Hostility grew between student groups. The university administration suspended the fraternity, worried about its already tension-filled relations with the surrounding community and other manifestations of intolerance in the student body. Analyze the facts of this scenario critically using the following approach: a. explicitly use three (3) concepts in your analysis; b. identify and very briefly describe each concept you use and link it to specific evidence from the scenario; c. within your group of three concepts include at least one (1) concept from (Group Influences) and at least one (1) concept (Prejudice: Disliking Others) in your analysis.

In December 2006, Bob Prescott, the controller for the Blue Ridge Mill, was considering the addition of a new on-site longwood woodyard. The addition would have two primary benefits: to eliminate the need to purchase shortwood from an outside supplier and create the opportunity to sell shortwood on the open market as a new market for Worldwide Paper Company (WPC). The new woodyard would allow the Blue Ridge Mill not only to reduce its operating costs but also to increase its revenues. The proposed woodyard utilized new technology that allowed tree-length logs, called longwood, to be processed directly, whereas the current process required shortwood, which had to be purchased from the Shenandoah Mill. This nearby mill, owned by a competitor, had excess capacity that allowed it to produce more shortwood than it needed for its own pulp production. The excess was sold to several different mills, including the Blue Ridge Mill. Thus adding the new longwood equipment would mean that Prescott would no longer need to use the Shenandoah Mill as a shortwood supplier and that the Blue Ridge Mill would instead compete with the Shenandoah Mill by selling on the shortwood market. The question for Prescott was whether these expected benefits were enough to justify the $18 million capital outlay plus the incremental investment in working capital over the six-year life of the investment.

Construction would start within a few months, and the investment outlay would be spent over two calendar years: $16 million in 2007 and the remaining $2 million in 2008. When the new woodyard began operating in 2008, it would significantly reduce the operating costs of the mill. These operating savings would come mostly from the difference in the cost of producing shortwood on-site versus buying it on the open market and were estimated to be $2.0 million for 2008 and $3.5 million per year thereafter.

Prescott also planned on taking advantage of the excess production capacity afforded by the new facility by selling shortwood on the open market as soon as possible. For 2008, he expected to show revenues of approximately $4 million, as the facility came on-line and began to break into the new market. He expected shortwood sales to reach $10 million in 2009 and continue at the $10 million level through 2013. Prescott estimated that the cost of goods sold (before including depreciation expenses) would be 75% of revenues, and SG&A would be 5% of revenues.

In addition to the capital outlay of $18 million, the increased revenues would necessitate higher levels of inventories and accounts receivable. The total working capital would average 10% of annual revenues. Therefore the amount of working capital investment each year would equal 10% of incremental sales for the year. At the end of the life of the equipment, in 2013, all the net working capital on the books would be recoverable at cost, whereas only 10% or $1.8 million (before taxes) of the capital investment would be recoverable.

Taxes would be paid at a 40% rate, and depreciation was calculated on a straight-line basis over the six-year life, with zero salvage. WPC accountants had told Prescott that depreciation charges could not begin until 2008, when all the $18 million had been spent, and the machinery was in service.

You have been approached by Prescott with a request to evaluate the project. If the required rate of return is 9.65%, what are the payback period, profitability index, net present value, and internal rate of return for the investment project? Should WPC implement the investment project?

A national study shows that in 2006 the average price of gasoline was $2.51 per gallon. The population standard deviation was shown to be $0.61. A 2007 random study of 81 Maryland gas stations showed the average price of gasoline per gallon to be $2.73. Is there significant evidence to suggest that the average price of a gallon of gasoline is more in Maryland in 2007? Test at the 10% significance level.

In December 2006, Bob Prescott, the controller for the Blue Ridge Mill, was considering the addition of a new on-site longwood woodyard. The addition would have two primary benefits: to eliminate the need to purchase shortwood from an outside supplier and create the opportunity to sell shortwood on the open market as a new market for Worldwide Paper Company (WPC). The new woodyard would allow the Blue Ridge Mill not only to reduce its operating costs but also to increase its revenues. The proposed woodyard utilized new technology that allowed tree-length logs, called longwood, to be processed directly, whereas the current process required shortwood, which had to be purchased from the Shenandoah Mill. This nearby mill, owned by a competitor, had excess capacity that allowed it to produce more shortwood than it needed for its own pulp production. The excess was sold to several different mills, including the Blue Ridge Mill. Thus adding the new longwood equipment would mean that Prescott would no longer need to use the Shenandoah Mill as a shortwood supplier and that the Blue Ridge Mill would instead compete with the Shenandoah Mill by selling on the shortwood market. The question for Prescott was whether these expected benefits were enough to justify the $18 million capital outlay plus the incremental investment in working capital over the six-year life of the investment. Construction would start within a few months, and the investment outlay would be spent over two calendar years: $16 million in 2007 and the remaining $2 million in 2008. When the new woodyard began operating in 2008, it would significantly reduce the operating costs of the mill. These operating savings would come mostly from the difference in the cost of producing shortwood on-site versus buying it on the open market and were estimated to be $2.0 million for 2008 and $3.5 million per year thereafter. Prescott also planned on taking advantage of the excess production capacity afforded by the new facility by selling shortwood on the open market as soon as possible. For 2008, he expected to show revenues of approximately $4 million, as the facility came on-line and began to break into the new market. He expected shortwood sales to reach $10 million in 2009 and continue at the $10 million level through 2013. Prescott estimated that the cost of goods sold (before including depreciation expenses) would be 75% of revenues, and SG&A would be 5% of revenues. In addition to the capital outlay of $18 million, the increased revenues would necessitate higher levels of inventories and accounts receivable. The total working capital would average 10% of annual revenues. Therefore the amount of working capital investment each year would equal 10% of incremental sales for the year. At the end of the life of the equipment, in 2013, all the net working capital on the books would be recoverable at cost, whereas only 10% or $1.8 million (before taxes) of the capital investment would be recoverable. Taxes would be paid at a 40% rate, and depreciation was calculated on a straight-line basis over the six-year life, with zero salvage. WPC accountants had told Prescott that depreciation charges could not begin until 2008, when all the $18 million had been spent, and the machinery was in service. You have been approached by Prescott with a request to evaluate the project. If the required rate of return is 9.65%, what are the payback period, profitability index, net present value, and internal rate of return for the investment project? Should WPC implement the investment project?

As an audit supervisor in an international public accounting firm, you are in charge of the audit of several firms with 31 March year-ends. The financial statements of these firms are prepared in compliance with U.S GAAP, and are expected to be authorized for issue in early June 2017. Your audit juniors on the job have approached you for advice on the following case:

Auto Arrow (AA) does not maintain a proper accounting system. A main bulk of its existing source documents were destroyed in a fire. Based on available records and contacts with its customers and also with reference to its 2015/2016 financial statements, it managed to provide the following information for the 2016/2017 financial year:

A additional information

1. Sales returns during the year amounted to $6,000.
2. Cash received from its customers = $920,000 of which $50,000 related to an advance payment made by Customer L for goods to be delivered in the financial year 2017/2018.
3. $30,000 of Bad Debt Expense is recognized in the financial year 2016/2017 profit and loss.

The accountant is unsure of how to determine the gross sales revenue for the year. Assume all sales are on credit.

Required: Determine the gross sales revenue for the financial year 2016/2017.

Sheffield Corp. designs and manufactures mascot uniforms for high school, college, and professional sports teams. Since each team’s uniform is unique in color and design, Sheffield uses a job order costing system. On January 1, the T-accounts for some of Sheffield’s primary balance sheet accounts were as follows:

During the year, the following events occurred:

Record the transactions above in the appropriate T-accounts and calculate ending balances

You have developed a self-service kiosk capable of serving about 15 clients per hour. You have been told that the average rate of customers using this kiosk is about 10 customers per hour. You also know that the number of customers who approach the kiosk per hour follows the Poisson distribution.

1. Write out the pmf of the Poisson RV in this case and solve for 20 customers approaching the kiosk.

2. Use an R function to find a probability for the above.

3. Have R generate random numbers following the above distribution for 100,000 intervals. What is the maximum number of customers approaching the kiosk in your simulation?

Please show steps in the calculation.

1. There are three kinds of apple sold in a supermarket, namely Red Delicious, Fuji and Ambrosia. By experience, the chance of a customer purchases Fuji three times as much as each of the other two kinds. Suppose, there are 10 unrelated customers going to buy an apple and the supermarket management is interested in studying the sales of Fuji.

Answer the following: (Hint: Binomial distribution)

1. Show this is a Binomial experiment by stating the requirement in the context.

2. What is the chance that 7 customers will buy Fuji?

3. What is the chance that 3 customers will not buy Fuji?

4. What is the chance that at most 8 customers will buy Fuji?

5. For these 10 customers, how many does the management expect to buy Fuji on the average?