UNIVERSITY OF MASSACHUSETTS BOSTON

Accounting & Finance Department

AF 455 Prof. Konan

International Financial Management

Answers:

1. Balance of payments could be defined as the statistical record of an entity’s international

transactions in the double-entry bookkeeping over a certain period of time, usually quarterly
or annually. Those transactions could be made by the government, companies, and
individuals.
The balance of payments comprises three factors: the current account, the capital account,
and the financial account.
The fixed exchange rate regimes allow the government, companies, and individuals to
anticipate the exchange rate they deal with in the transactions. Those rates are likely
constant or consistent; therefore, the parties involved do not consider the impact of foreign
exchange rate fluctuations in their transactions. However, the parties will not get the benefits
from anticipating the correct FX move. No derivatives like hedging in a forward contract for
a future exchange rate should be made.
 In contrast, flexible exchange rates expose parties involved to more risks and rewards in
foreign currency transactions. Therefore, each time they perform a transaction in a foreign
currency, consideration of FX fluctuations is critical. They can enter derivative contracts
like forwarding contracts or futures, options to protect themselves from FX fluctuations.
Accordingly, they may win or lose, depending on their ability to read the FX market.
2. Classify and record transactions on the US balance of payments
a. Credit, Import, Financial account
b. Debit, Import, Current account
c. Debit Unilateral transfer, Current account
d. Credit, FDI, Current account

3. Possible strengths and weaknesses of SDRs versus the dollar as the main reserve currency.
SDR is a basket currency of five major currencies: the British pound, French franc, German
mark, Japanese Yen, and US dollar, issued and managed by IMF as the supplementary
reserve. This currency has a relatively stable exchange value. However, IMF does not have
the function to operate as the world central bank. Aside from that, the liquid bond market for
SDR has not been made available.
Meanwhile, the US dollar has deep and liquid markets. This currency is also backed by the
USA, the most powerful country in the world. However, the fiscal, trade deficits and the
USA’s declining share in the world output have weakened the dollar’s credibility as the
dominant global currency.
In the context that the USA’s rivals are struggling, like the euro of the European Union and
RMB of China, the US dollar’s dominant strength is strengthened in relation to such
currencies.
From the strengths and weaknesses mentioned above, the SDR is unlikely to replace the US
dollar as the primary global reserve currency, and the SDR should not be accepted to replace
the US dollar in this sense.