Money, Banking, and International Finance ( PDFDrive )
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Money, Banking, and International Finance
17.Monetary policy has an immediate impact on operating targets like the federal funds rates and non-borrowed reserves. Over time, monetary policy influences the intermediate targets. Operating and intermediate targets differ by Fed control and time lags.
18.The Fed must accurately measure the targets and exert control over them. Furthermore, the target must respond to monetary policy predictably, and the target influences the Fed's goals.
19.The Fed's monetary policy coincides with the business cycle. Thus, monetary policy causes the economy to grow faster during a boom cycle, and slower during a recession. Monetary policy is supposed to do the opposite and smooth out the business cycles.
20.Economists suggest other targets, such as nominal GDP, yield curve, commodity prices, and U.S. dollar exchange rate.
Answers to Chapter 15 Questions
1.Purpose of the balance-of-trade accounts is to account for money flows between one country and the rest of the world. Economists classify money flows into categories that allow them to analyze patterns in the cash flows.
2.Current account includes exports and imports, services and insurance for transportation, and gifts. Financial account keeps track of investment into real estate, stocks, and bonds. Finally, the official settlements account represents the intervention of the central bank.
3.Statistical discrepancy account occurs from errors, omissions, and unreported activities. Unreported activities include tax evasion, hiding money from government, or profits from illegal activities.
4.Three exchange rate regimes are the gold standard, the Bretton Woods System, and flexible exchange rates. Gold standard creates a fixed exchange rate system by setting a weight of gold to a currency's value. The Bretton Woods System was a gold standard that allowed countries to adjust their exchange rate relative to the U.S. dollar while the U.S. dollar became fixed at $35 = one ounce of gold. Finally, the flexible exchange rate regime allows supply and demand of currencies to determine exchange rates.
5.World Bank lends to developing countries, helping them invest in their infrastructure, such as new roads, dams, electric power plants, etc.
6.The IMF helps countries finance a balance-of-payments deficit. The IMF has a cache of gold and foreign currencies that it can lend.
7.Balance-of-payments deficit causes a surplus of currency on the international exchange markets. Thus, that country’s central bank must buy its currency using official asset
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reserves. If the country refuses to use reserves or devalue its currency, then black markets would form for its currency.
8.If a country devalues it currency, subsequently, the impact does not immediately reduce a trade deficit. A country’s imports continue rising while its exports fall after a devaluation and then improves after a time lag.
9.Country has too much money flowing into the country. Consequently, the central bank increases the money supply and reduces the interest rate. International investors slow down their investments in the country that reduces the financial account.
10.Capital flight is similar to a bank run on a foreign country. International investors cause a massive outflow of capital as they cash in their investments. A capital flight could lead to the collapse of a country’s currency. Investors use four methods to transfer money out of the country: bank transfers, money laundering, false invoicing for imports and exports, or converting money into precious metals.
11.This will be a very bad day indeed. If the U.S. dollar collapses in value, then the paper wealth of anyone holding dollars will disappear. Furthermore, the foreigners would stop investing in the U.S. economy and the U.S. government debt. Then trade could halt as nations and people stop accepting dollars for payment unless investors find a replacement international currency.
Answers to Chapter 16 Questions
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The Pepsi costs 2.25 dirhams. |
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2 km € 0.714 |
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=1.428 km |
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We calculated: |
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€1 |
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$1 |
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$1 |
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3.We calculated the cross exchange rate below. Did you notice the trick when I calculated the cross rate? Consequently, arbitrage is possible.
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2 km |
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€1 |
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1km |
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€1 |
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kuna 50 |
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kuna100 |
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Step 1: Trader converts the convertible markets into euros, calculated below:
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= 250,000 € |
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500,000 km |
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2 km |
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Step 2: Trader converts the euros into Croatian kunas, shown below:
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250,000 € |
kuna100 |
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= 25,000,000 kunas |
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€1 |
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Step 3: Trader converts the kunas back into Bosnian convertible marks, calculated below. Consequently, the trader earns 43,478.26 km in profits.
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1km |
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= 543,478.26 km |
25,000,000 kunas |
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kunas 46
4.Supply for U.S. dollars comes from people holding U.S. dollars, and they trade those dollars for another currency. A demand for currency in one market automatically creates a supply of currency in another market as people exchange currencies. Finally, a central bank could expand the supply of U.S. dollars.
5.Americans buy fewer Mexican made goods. Thus, the demand for pesos falls and shifts leftward. Consequently, the peso depreciates while the U.S. dollar appreciates, causing Mexican imports to decrease while exports increase.
6.The Federal Reserve must reduce the supply of U.S. dollars. It can trade euros for U.S. dollars, causing the U.S. dollar to appreciate and the euro to depreciate. However, the European Central Bank can nullify this by purchasing the supply of euros with U.S. dollars. Hence, the Federal Reserve bought U.S. dollars off the currency exchange markets while the European Central Bank injects new U.S. dollars in their place.
7.Foreign investors reduce their demand for U.S. currency, shifting the demand function leftward. Furthermore, U.S. investors invest in other countries for a higher interest rate. As they convert their U.S. dollars into another currency, the supply function for U.S. dollars increases. Consequently, the U.S. dollar depreciates while the market quantity of U.S. dollars becomes ambiguous.
8.Lower demand for the Uzbek som causes the som to depreciate against the U.S. dollar. The Uzbek central must reduce its som on the currency exchange markets by purchasing som with its official reserves. Supply for som decreases and shifts leftward, returning the som to the original exchange rate.
9.Japan has a low risk of capital flight. Most of the Japanese debt is held internally, and international investors have few investments in Japan. Consequently, if the Japanese government defaulted on its debt, the crisis would most likely remain inside of Japan.
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Answers to Chapter 17 Questions
1.Best forecast for a random walk is the previous period's value, 3 rm per U.S. dollar.
2.First, countries erected trade restrictions and barriers that prevent the free flow of goods entering or leaving a country. Second, PPP does not include transportation and transaction costs. Third, some services are not internationally traded, such as haircuts and real estate. Finally, countries define their basket of goods differently.
3.Buy the Big Macs from Russia for $2.29 and ship them to Venezuela for $7.92.
4.The Japanese yen is undervalued approximately 5.5% relative to the U.S. dollar.
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PJaoan PU .S . |
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$4.09 $4.33 |
100= -0.055 |
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Big Mac |
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PU .S . |
$4.33 |
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5.The PPP only includes the absolute price levels, while the relative PPP allows different price levels between countries because the inflation rates cause the exchange rate to change predictably.
6.Using the approximation, the U.S. dollar appreciates approximately 4% per year relative to the Russian ruble (or 7% - 3%). Using the exact formula, the U.S. dollar appreciates 3.9% relative to the ruble.
e = |
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1+ 0.07 |
1 0.039 |
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1+ πd |
1+ 0.03 |
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7. We calculated the U.S. competitive ratio below:
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1 .02 |
0.971 |
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1+πd 1 e |
1 .03 1 .02 |
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8.We assume the change in the velocity of money is zero because the problem did not refer to them. If the ringgit is defined at the home currency, the ringgit should appreciate approximately 1% per year, calculated below:
s = mUSS mMalayS vUS vMalay yMalay yUS 0.02 0.05 0.07 0.03 0.01
9. Home currency should depreciate approximately 2.5%, calculated below:
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0.05 0.10 |
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0.025 |
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360 |
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f,T |
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360 |
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10. Appreciating currency boosts your investment. Thus, we computed the return below:
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720 |
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r = |
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1+ e 1= |
1+0.16 |
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1+0.04 |
1= 0.3728 . |
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f 360 |
360 |
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11.We used the approximation formula. Thus, the forward contract expects the U.S. dollar to appreciate with an exchange rate of 0.707 € / $1.
F 0.7 € |
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1+ 0.07 0.05 |
180 |
0.707 € |
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$1 |
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360 |
$1 |
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Answers to Chapter 18 Questions
1.Spot transactions occur when a buyer and seller agree to an exchange, and they exchange immediately. A forward transaction is a buyer buys a contract today for an asset that is sold in the future for a fixed price. Then the seller is obligated to sell the buyer the asset for the contract price.
2.Derivatives obtain their value from the asset that is specified in the contract.
3.Investors use hedging to protect themselves from future volatile prices. Speculators, on the other hand, buy and sell securities to earn quick profits. As you guessed, speculators can earn large profits or massive losses from the derivatives market.
4.Once an investor buys a futures contract, the buyer is obligated to buy the asset at the specified price (i.e. long position), while the seller is obligated to sell the asset at the specified price (i.e. short position).
5.Asset's price will fluctuate daily on the spot market. If the difference between the asset price and contract price exceeds a threshold, either the buyer or seller must deposit money with the broker. Margin helps guarantee parties will honor the contract.
6.Issuer deposits10 1,000 $150 $75 = $750,000 with the exchange because the holder can buy petroleum via the futures and sell it on the spot market for a massive profit if the futures matured today.
7. Value of the contract on the spot market equals 150,000 euro $1 = $150,000 . Value of
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the futures contract is 150,000 euros |
$1 |
$100,000 . Investor pays only $100,000 by |
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using the contract, instead of $150,000. Thus, the issuer deposits money into the margin account.
8.Futures is a contract. Both the buyer and seller are obligated to carry through with the transaction. With the options contract, the holder chooses to exercise it or not.
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9.A call options give the right to the contract holder to buy an asset at the stated price, while the put option gives the holder the right to sell at the price in the contract.
10.An option's premium is affected by the volatility of an asset's price on the spot market, the magnitude of the strike price, the maturity of the option, and interest rates.
11.Your premium equals: $0.5 1,000 10 = $5,000 . You could exercise the option and pay $75 for petroleum or buy the petroleum from the spot market at $50. Consequently, you would buy the oil from the spot market.
12.Premium equals: $0.01 100 100= $100. Farmer could sell his corn for $6 per bushel on the spot market, or exercise the put option and sell his corn for $5 per bushel. Thus, farmer would sell his corn to the spot market.
13.Problem with the derivatives based on the stock market index or the volatility index is no commodity, or financial instrument is traded. Instead, the investor gambles on future index numbers. Unfortunately, the company issuing the index derivative could have a massive exposure if the stock market rapidly drops during a financial crisis.
14.Credit Default Swaps are a form of insurance. Issuer guarantees payment if a mortgage fund or company bankrupts, causing their bonds to plummet in value. Thus, risk-averse investors commit to speculative grade investments if they can buy this insurance.
15.We could not avoid this crisis. However, the impact could have been less severe. Government could tighten laws that forced mortgage companies to verify homeowners' income. Government could pass laws that prevented the layering of CDS contracts.
16.Coupon payments are $1.5 million and 2.2 million euros respectively. Implicit exchange rate is $1.5 million ÷ 2.2 million euros, which equals $0.682 per euro. Present values of the cash flows are:
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€ . |
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= 107.9 |
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We calculate the Swap's present value as:
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= 107.9 |
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= $31.4 |
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Money, Banking, and International Finance
Answers to Chapter 19 Questions
1.Transaction exposure is the impact on current transactions, such as accounts receivable and accounts payable in a foreign country when the exchange rate changes. Economic exposure is fluctuating exchange rates affect expected cash flows over time. Translation exposure is the change in a company's consolidated financial statements because accountants use different exchange rates to convert accounts into the domestic currency. Finally, changes in exchange rates influence a firm's cash flows, revenues, and costs, and thus, it affects a company's taxes.
2.This is not a good situation because you earn revenue from sales in pesos while you pay costs in dollars. Thus, the transaction exposure is your costs rise while your revenues fall. Economic exposure is the impact of an appreciating U.S. dollar on your business over time, and in this case, you would expect your profits to fall over time.
3.You calculated your gain from this transaction below:
= $1 |
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− 500,000 € = 300,000 € |
A fluctuating exchange only impacts the revenue while your hotel's costs remain constant. Thus, your profit would fluctuate between 180,000 and 420,000 euros, computed below:
= $1 |
(1 ± 0.15) |
.€ |
− 500,000 € = [180,000 €, 420,000 €] |
4.First, the company has an exchange rate risk. If the exchange rate does not change, then the company receives $4.5 million.
Second, the company eliminates the exchange rate risk and pays $5 million.
Third, the company borrows 4,938,271.60 CD today, and it would transfer $ 4,444,444.44 today using the spot exchange rate.
Fourth, the company receives $4,365,000 today.
5.First, the company has an exchange rate risk. If the exchange rate does not change, then the company receives $45,454.54.
Second, the company eliminated the exchange rate risk, and it will pay $41,666.67.
Third, the company needs 495,458.30 pesos to deposit today, and it would transfer $45,041.66 today using the spot exchange rate.
Fourth, premium equals 576.92 while the company is guaranteed a minimum of $38,461.54.
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6.The Forex Beta measures the economic exposure and is a parameter estimate of a linear regression equation. It has two sources of variation: Fluctuations in the exchange rate and the sensitivity of the asset’s price to changes in the exchange rate.
7.First, company could locate its production in countries where it sells it backpacks, trying to equal accounts payable and accounts receivable. Then it uses accounts receivables to offset its accounts payable. Second, company can shift its production to low-cost countries, especially in countries that weaken its currency.
Answers to Chapter 20 Questions
1.A firm only invests and operates a small portion of its production in a foreign country. If a firm has a conflict with the government, then only that portion of the production facility is in jeopardy. Furthermore, if a company continually updates its technology, subsequently, it could use intellectual property rights to protect its technology. In theory, the firm could deny the government to use its technology. Finally, a firm could use leverage, where it heavily borrows from banks within the foreign country. If the firm has a conflict with the government, it can exit the country and default on its bank loans.
2.A government protects its agricultural, defense/military, energy, and communication industries. These industries are critical for a modern, functioning society, and a supply disruption could cause a severe crisis within the country.
3.A firm cannot transfer its profits outside a country because the country imposed capital controls. Thus, a firm could buy a local product and export the product to recoup its profits abroad.
4.Special dispensation is government grants exceptions and favors to industries it wants, such as pharmaceutical, high-tech, electronics, and computers. These industries are prestigious and lead to a rise of skilled and educated labor force.
5.Average basis points for the CCC grade are 450. Thus, you add 4.5% to the 5%, yielding 9.5%.
6.The Risk Rating System is a method to measure a country risk. The Rating System uses four measures: Economic Indicators, Debt Management, Political Factors, and Structural Factors. We measure each factor on a scale from zero to 100. A country's score is a weighted average of the four factors. Although this method appears to be objective, the weights and measures of some factors are subjective.
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7.Qualitative measures rely on experts’ opinions. Unfortunately, experts have biases and opinions that taint their opinion. Quantitative measures use a variety of statistics and demographics of a country. Then an analyst computes a country's score.
8.Hong Kong is politically stable, and A.M. Best rated it Tier II while Coface rated it A1.
9.Ukraine is a former republic of the Soviet Union that implemented little market reforms. A.M. Best rated the Ukraine as a Tier V while Coface rated it a D.
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References
A.M. Best. 2012. Available from http://www3.ambest.com/ratings/cr/crisk.aspx (accessed on 10/16/2012)
Australian Securities Exchange. 2007. “Australian Securities Exchange – Stock Market Information, Stock Quotes – ASX.” Available at http://www.asx.com.au (access date: 11/30/07).
Bolsa Mexicana de Valores. 2007. “Bolsa Mexicana de Valores.” Available at http://www.bmv.com.mx (access date: 11/30/07).
Board of Governors of the Federal Reserve System. February 7, 2014. Assets and Liabilities of Commercial Banks in the United States (Weekly) - H.8. Available at http://www.federalreserve.gov/releases/h8/current/default.htm (access date: 02/12/14).
Borsa Italiana. 2007. “Finanza Quotazioni Azioni Eft Obbligazioni Fondi Notizie.” Available at http://www.borsaitaliana.it/homepage/homepage.htm (access date: 11/30/07).
Bureau of Economic Analysis. 2012. “U.S. International Economic Accounts.” Available at www.bea.gov (access date: 9/31/2012).
Coface. 2012. Rating Table. Available from http://www.coface.com/CofacePortal/COM_en_EN/pages/home/risks_home/country_ris ks/rating_table?geoarea-country=&crating=&brating= (accessed on 10/16/2012)
Economist, The. July 26, 2012. “Big Mac Index.” Available at http://www.economist.com/blogs/graphicdetail/2012/07/daily-chart-17 (access date: 9/26/2012).
Educational Service Bureau. 1992. How to Read Stock Market Quotations and The Dow Jones Averages: A Non-professional's guide. Dow Jones & Company, Inc.
Federal Reserve Statistical Release. March 9, 2006. “Discontinuance of M3.” Available at http://federalreserve.gov/releases (accessed on 7/3/2007).
Frankfurt Stock Exchange. “Deutsche Borse Group.” Available at http://deutscheboerse.com/dbag/dispatch/de/kir/gdb_navigation/home (access date: 11/29/07).
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