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Question 1

4/21/12

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Point

1.How can persistently weak currencies be stabilized?

Latin American countries depreciate against the U.S dollar Need to attract more capital flows by raising interest rates Invest in large bank deposits do not need to worry about default risk Impose capital restrictions to prevent capital outflow 4/21/12

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Counter point Latin American countries have high inflation Encourages to purchase products from the U.S Relieve the downward pressure on their currencies by reducing inflation May have reduce economic growth Should not raise interest rate to attract foreign investment
4/21/12

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They will not attract funds

• • • • • • • Interest rate Cost of borrowing Investment Aggregate demand Output Slow down economic Nominal interest rate= real interest rate + inflation rate The relatively high interest rate may 4/21/12 reflect expectations of relatively high • .

• • • • • • • • • Inflation Real Interest rate Cost of borrowing Investment Aggregate demand Output Slow down economic Interest rate Foreigner will buy Latin American assets make arbitrage profit 4/21/12 .

the relative inflation or interest rate will be more influential.S and Latin American Looking this two countries engage in which large volume of international trade or capital flows. 4/21/12 • .• The sensitivity of an exchange rate is dependent on volume of international transactions between U.

Question 2 4/21/12 .

Given Jim’s expectations. 4/21/12 . forecast whether the pound will appreciate or depreciate against the dollar over time.1.

K consumer need pay in US$ Supply for pounds 4/21/12 • • • • • • • .K goods becomes more expensive relative to U.S goods Demand for U.• • • British inflation Price level U.K goods Export Demand for British pounds Import U.

Given Jim's expectations.2. will the Sports Exports Company be favorably or unfavorably affected by the future changes in the value of the pound? 4/21/12 .

• Jim receives payments in British pounds Unfavorably British pound depreciation British pound receivables to convert into fewer dollars • • • 4/21/12 .

Question 3 4/21/12 .

S economic conditions would have Click to edit trade flows? affected Master subtitle style How would this have affected the value of the dollar? How do you think the lower U. were expected to weaken U.2011.4/21/12 3.S economic conditions and reduce U. How do you think the weaker U.S interest rates.S interest rates would have affected the value of the . The terrorist attract son the United State on September 11.

S consumer will less buy more goods Demand for foreign countries goods Import Supply for US$ The demand for US goods not expected to change Value of US$ • • • • • 4/21/12 .S economic conditions Income level U.• • • weaken U.

S rate becomes less attractive U.S bank Demand for US$ Value for US$ 4/21/12 • • • • .S interest rates U.S investor more desire foreign countries Supply for US$ Foreigner now less desire U.• • • U.

Question 4 Click to edit Master subtitle style 4/21/12 .

a. U. inflation has suddenly increase substantially. 4/21/12 . while Country K’s inflation remains low.S.

goods become more expense U.S.• • • • • • • U.S.S import increase Supply of U.S dollar increase U.S export reduce Demand of U.S dollar reduce U. inflation increased U.S dollar depreciate 4/21/12 .

interest rates have increased substantially.b. while Country K’s interest rates remain low.S. 4/21/12 . U. Investors of both countries are attracted to high interest.

S interest rates increase Return on U.S dollar appreciate 4/21/12 .S dollar reduce U.• • • • • • U.S’s assets increase U.S dollar become more attractive Demand of U.S dollar increase Supply of U.

c. The U. income level increased substantially. while Country K’s income level has remained unchanged.S. 4/21/12 .

S dollar depreciate • • • 4/21/12 .S dollar increase U.• • U.S import increase Supply of U.S income increase U.S increase the demand of foreign goods U.

d. The United States is expected to impose a small tariff on goods import from Country K. 4/21/12 .

• • • • U.S Import reduce Supply of U.S impose tariff U.S dollar appreciate 4/21/12 .S dollar reduce U.

Combine all expected impacts to develop an overall forecast. 4/21/12 .e.

• This case assume that there a big volume of investment transactions occur between U. interest rates will have more influence on exchange rates. A change in U. the weight of international trade are small. Therefore. However. financial factors have more impact on exchange rate.S. • • • . impact of traderelated factors on exchange rates might contra each other and result a 4/21/12 small influence on exchange rates.S and Country K.

Question 5 4/21/12 .

How could Blue Demon Bank attempt to capitalize on its expectations without using deposited funds? Estimate the profit that could be generated from this strategy. 4/21/12 .a.

amount of US bank: = US$10.523.08*10/365) = US$10.15 = 70.523.70 • Convert back to peso at $.500.000 peso*$.500.14 4/21/12 = US$ 10.• Blue Demon Bank borrow 70million pesos Convert it into U.000*(1+.14 .000.013.70/$.013.000 • • • Deposit into US bank account After 10 days.S$ at $.15 = US$10.

57peso – 70.164.26peso 4/21/12 .7%) and principle = 75.166.087*10/365) = 75.383.534.• Profit after deduct interest (8.31peso = 4.997.000.57peso – 70.000peso*(1+.164.849.383.

17 in 30 days.b.15 to $. How could it attempt to capitalize on its expectations without using deposited fund? Estimate the profits that could be generated from this strategy. Assume all the preceding information with this exception: Blue Demon Bank expects the peso to appreciate from its present spot rate of $. 4/21/12 .

67peso*(1+.000/$.000.• • Blue Demon Bank borrow US$10 million Convert it into peso = $10.15 = 66.17 .420.132.666.67peso • • Deposit into Mexican bank account After 30 days.085*30/365) = 67.666.09peso • 4/21/12 Convert back to peso at $. amount of Mexican bank account = 66.666.666.

000.$10.344.068.42 .219.18 = $1.412.000*(1+.24 4/21/12 .412.511.3%) and principle = $11.• Profit after minus interest (8.511.083*30/365) = $11.42 $10.292.

Question 6 4/21/12 .

4/21/12 .Assume that the level of capital flows between the United States and the country of Krendo is negligible (close to zero) and will continue to be negligible. How will high inflation and high interest rates affect the value of the Kren (Krendo’s currency)? Explain. There is a substantial amount of trade between the United states and the country of Krendo and no capital flows.

the relative interest rates will be less influential. and Krendo engage in a large volume of international trade but a little volume of international capital flow. In this case. conversely.• The sensitivity of an exchange rate to these factors is dependent on the volume of international transactions between the two countries.S. U. the relative inflation rates will be more influential. 4/21/12 • .

• Therefore. a high inflation in Krendo will cause the value of Kren to have a substantial drop. A high interest rates in Krendo will cause the value of Kren to have slightly increase. • 4/21/12 .