Parth Patel Test 2 July 27, 2017

A. Problem

 The inflation rate is 3% in Euroland and 8% in Japan. The spot ER between

Japanese yen and Euro is Yen100/euro1. What is the forward or expected spot
exchange rate among the 2 currencies?
 F = Forward rate of foreign Currency
S= Spot Rate
ID = Domestic Inflation rate
IF = Inflation rate in foreign country
Equation: F = S (1+ID) / (1+IF)
F = 100 (1+0.08) / (1+0.03)
= 104.85Yen / Euro1.
1 What are the five institutions comprising the World Bank.
The World Bank comprises the international bank for reconstruction and
development, the international finance corporation, the international development
association, the international Centre for settlement of investment disputes, and the
multilateral investment guarantee agency. Each serves a different function as an
organization. The international bank for reconstruction and development is the largest
development bank in the world. It purpose is to provide financial products and policy
guidance to help countries reduce poverty and extend the benefits of sustainable growth
to all of their people. It was created in 1944 to help rebuild Europe after World War II.
IBRD provides guidance related to better healthcare programs, cash for students, and
creating jobs. The international finance corporation provide advice about investment to
private sectors advice development. It helps private sectors with getting capital and
resources so that they can do better business. The international development association
provides interest free loans or as they refer as credits to the governments of poorest
countries. The international centre for settlement of investment disputes international
facilities for conciliation and arbitration of investment disputes. The multilateral
investment guarantee agency was created in 1988 to promote foreign direct investment
into developing countries to support economic growth, reduce poverty, and improve
people’s lives. In conclusion, each institution of the World Bank helps countries in the
process of development.

2 Describe membership organization and functions of the World Bank.

There are currently 189 member countries that are shareholders in the IBRD,
which is the primary arm of the World Bank Group. In order to become a member, a
country must first join the IMF. Membership in IDA, IFC, and MIGA are conditional on
membership in IBRD. The member countries governs the World Bank through board of
governors, the board of executive directors and the advisory committee, the loan
 committee and the president and other staff members. These are the people who makes all
the major decisions for the organizations. The board has one Governor and one
alternative Governor appointed for five years by each member country. Each Governor
has the voting power which is related to the financial contribution of the Government
which he represents. The Board of Executive Directors consists of 21 members, 6 of them
are appointed by the six largest shareholders such as the USA, the UK, West Germany,
France, Japan and India. The rest of the 15 members are elected by the remaining
countries. World Bank has many functions and some of the main functions are provides
various technical services to the member countries, granting loans to a member country
up to 20% of its share in the paid-up capital, To provide guarantee for loans granted to
small and large units and other projects of member countries. The World Bank also
provides long-run capital to member countries for economic reconstruction and
development.

3 Analyze the fundamental factors which determine exchange rates.

There are few fundamental factors that determines exchange rates. The factors are
inflation rate, balance of trade deficit, government debt, and economic stability. A country
with a consistently lower inflation rate exhibits a rising currency value, as its purchasing
power increases relative to other currencies. Those countries with higher inflation
typically see depreciation in their currency in relation to the currencies of their trading
partners. A deficit in the current account shows the country is spending more money on
foreign trade than it is earning. Borrowing capital from foreign sources to make up the
deficit. In other words, the country requires more foreign currency than it receives
through sales of exports, and it supplies more of its own currency than foreigners demand
for its products. Government debt plays major part in determination of the exchange rate.
A government may print money to pay part of a large debt, but increasing the money
supply inevitably causes inflation which can eventually affect currency exchange rate.
Countries that have unstable economy will attract less investors. Foreign investors
inevitably seek out stable countries with strong economic performance in which to invest
their capital. If the country has unstable economy, it will have trouble increasing the
value of its currency. This can also have a major effect on the exchange rate.

4 Compare and Contrast fixed and flexible exchange rates.

In contrast fixed rate exchange rate is a country's exchange rate regime under
which the government or central bank ties the official exchange rate to another country's
currency or to the price of gold. The purpose of a fixed exchange rate system is to
maintain a country's currency value within a very narrow band. On the other hand,
flexible or also known as floating exchange rates exchange rate is a regime where
the currency price is set by the forex market based on supply and demand compared with
other currencies. Fixed rate changes in currency in price by devaluation and revaluation.
Flexible rate changes in currency price by depreciation and appreciation. Fixed rate
operates through variation in supply of money, and domestic interest rate and price. On
the other hand, flexible rates operates to remove external instability by change in forex
 rate. In conclusion, both exchange rate systems are different from each other and it is
hard to compare them as they both have different functions.

5 Define the IMF as well as membership and organization and resources.

International Monetary Fund is an organization of 189 countries, working to
foster global monetary cooperation, secure financial stability, facilitate international
trade, promote high employment and sustainable economic growth, and reduce
poverty around the world. It was created in 1945, the IMF is governed by and
accountable to the 189 countries that make up its near-global membership. It was
formed at the Bretton Woods Conference. The Board of Governors, the highest
decision-making body of the IMF, consists of one governor and one alternate
governor for each member country. The governor is appointed by the member country
and is usually the minister of finance or the governor of the central bank. The IMF is
composed of 24 Directors, who are elected by member countries or by groups of
countries, and the Managing Director, who serves as its Chairman. The resources for
IMF includes: members currencies, SDR holdings, Gold Holdings, Other Assets,
Other borrowing and arrangements.

6 Explain the monetarist approach to exchange rates.

There are three monetarist approach to exchange rates. First approach is
Purchasing Power Parity (PPP). The most widely accepted of all exchange rate
determination theories, the theory of (PPP) states that the long-run equilibrium
exchange rate is determined by the ratio of domestic prices relative to foreign prices.
There are various PPP including: the Law of One Price, Absolute Purchasing Power
Parity, and Relative Purchasing Power Parity. PPP is thought to be the most relevant
to possibly explaining what drives exchange rate values. Second approach is Balance
of Payments approach. The basic balance of payments approach argues that the
equilibrium exchange rate is found when the net inflow (outflow) of foreign exchange
arising from current account activities matches the net outflow (inflow) of foreign
exchange arising from financial account activities. Third approach is monetary
approach. Monetary approach states that the exchange rate is determined by the
supply and demand for national monetary stocks, as well as the expected future levels
and rates of growth of monetary stocks. These are the three monetarist approach to
exchange rates.

7 We have an unemployment with a current account deficit. Also, the level of infrastructure
and technology usage is low. Moreover the per capita capital is low. Expound on policies
to correct the above.
There are many ways to correct unemployment with a current account deficit.
One of the policy is monetary policy. Monetary policy would involve cutting interest
rates. Lower rates decrease the cost of borrowing and encourage people to spend and
invest. This should also help to increase GDP and reduce demand deficient
unemployment. Fiscal policy can also help in this situation. Fiscal policy can decrease
unemployment by helping to increase aggregate demand and the rate of economic
 growth. The government will need to pursue expansionary fiscal policy; this involves
cutting taxes and increasing government spending. Lowering taxes so that there is
increase in disposable income. By empowering local government and state will have
them spend money on infrastructures and technology and federal programs such as
Transportation Infrastructure Finance and Innovation Act (TIFIA) that provides low-
interest loans for projects will help solve the concern of level of infrastructure.
Increasing education and training improve labor productivity and
increase technological usage. Also, by improving on “human capital” such as skills
and knowledge, through education and training improves the performance of the
workforce by enabling them to do more complex and more productive tasks. This can
improve GDP of the nation because now the people of the nation are well educated
and trained to do stuff that other nations might not able to do so. In conclusion, these
are just some of the ideas that help make the situation bit better.

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