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International Trade and Financial Economics – BOP and Foreign Exchange

  1. (2.0 pts) What is the difference between the balance of payments (BOP) and the international investment position (or the balance of international indebtedness)?







  1. (5.0 pts)
  1. (3.0 pts) Assume that a Japanese subsidiary in the U.S. buys office equipment from New York for $10,000. Would this transaction affect the U.S. and the Japanese BOP? If yes! Record it in the U.S. BOP.





  1. (5.0 pts) Draw the demand and supply curves for British pounds. Measure the quantity of British pounds on the horizontal axis and the $/£ on the vertical axis. Starting from an equilibrium exchange rate, assume the following two changes occur simultaneously: (1) the U.K interest rate increases relative to the U.S. interest rate and (2) the U.S. real income increases while that of the U.K. remains unchanged. How would these changes affect the dollar price of pound (i.e., $/£)?  Will the British pound appreciate or depreciate.

Note that everything should be shown in one single graph and you must use arrows to show the effect of the change in the interest rate and real income on the demand and the supply curves.  Provide an explanation.


























  1. (4.0 pts) What would be the shape of the supply curve for foreign currency if the supply curve for exports is perfectly price inelastic? Explain and use graphs to derive the supply of foreign currency.















  1. (4.0 pts) List four differences between the futures and forward markets.


Comparison of the Forward and the Futures Markets

FeatureForward MarketFutures Market








  1. (4.0 pts) Suppose that ¥1= $0.0085 in London, €1= $1.1418 in New York, and €1 = ¥ 136.45 in Paris. If an investor begins by holding ¥1,000,000, how could he make money from these exchange rates? In which market is the dollar price of yen relatively expensive? Ignore the transaction costs.Calculate the amount of total profit in Japanese yen.

















  1. (3.0 pts) Traveling to Italy is much cheaper now than it was ten years ago, says a friend. “Ten years ago, a dollar bought 1,000 lire; this year, a dollar buys 1,500 lire.” Is your friend right or wrong? Given that total inflation over this period was 25% in the United States and 100% in Italy, has it become more or less expensive to travel to Italy? Note that the exchange rate is lire/$.











  1. (2.0 Pts) Suppose that at the end of 2014, the value of U.S.-owned assets abroad is $13,755 billion, and the value of foreign-owned assets in the United States (which are U.S. liabilities) is $16,295 billion. Calculate the U.S. net international investment position?






  1. (3.0 pts) Consider a bundle of consumer goods costs $90 in the United States. The same bundle of goods costs CNY 105 in China. Holding constant the cost of the bundle in each country, compute the real exchange rates that would result from the two nominal exchange rates. Put your numbers in the final column in the table below. Make sure to show your calculation in the answer section.
Cost of Bundle in U.S.


Cost of Bundle in China


Nominal Exchange Rate

(Yuan per dollar))

Real Exchange Rate

(Bundles of Chinese goods per bundle of U.S. goods)







  1. (3.0 pts) Complete the final column of the table by computing the dollar price of Big Mac for the countries where the amount is nor shown. Make sure to show your calculation in the answer section.






  1. (3.0 pts) )What is the exchange rate (i.e., U.S. dollar per euro) that would have equalized the dollar price of a Big Mac in the United States and the Eurozone, given that the price of a Bic Mac in the U.S. is $4.93? For this change to happen, should euro the euro appreciate or depreciate against the dollar.






  1. (4.0 pts) )Assume the market is in zone 4 of the covered interest arbitrage parity (CIAP) grid where the interest rate differential is against the U.S. and the foreign currency is at a forward discount. (1) Determine the direction of the flow of funds. (2) What will happen to the interest rate differential and the forward discount as short-term funds move from one country to another? Explain why each change is happening?




Note: i = the domestic interest rate, i* = the foreign interest rate. The exchange rate is the price of the foreign currency











  1. (4.0 pts) What happens to the exchange rate, according to the asset-market approach, when the U.K. inflation rates are expected to increase, ceteris paribus? Answer the question in terms of both short-run and long-run changes in the exchange rate ($/£). Make sure to explain the reason for each change.













  1. Given C =100+0.8Y, M=150+0.20Y, I=100, and X = 350:


  1. (4.0 pts) Determine YE algebraically using the trade balance approach.Draw a graph and label it carefully to avoid losing points. Note that S = Y – C.











  1. (5.0 pts)Starting with the algebraic and graphical results of the part (a), determine algebraically and determine graphically the effect on YE of a simultaneous decrease in S and M of 200 each. What is the size of trade balance deficit/surplus?

















  1. (4.0 pts) Suppose the velocity of money is V = 5 and nominal GDP of the nation is $500 billion. Suppose further that the domestic credit created by the nation’s monetary authorities is $20 billion dollars and the nation’s foreign reserves are $5 billion. Suppose also that the required reserve ratio is 20%. Find the size of the deficit or surplus in the BOP. How much capital inflow or outflow is required in order to eliminate the disequilibrium in the BOP? Assume a fixed exchange rate system.













Last Updated on April 27, 2019

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