PS#1 all the question I. National Income Accounts Suppose an economy’s national accounts are GNP = 100, C = 70, I = 40, G = 20 and EX = 20 where GNP is gross national product, C is consumption, I is i
E CON 1 71 1 E CON 1 71 Inter national Finance Problem Set # 1 Due: August 3rd , 20 20 ( 11:59 p m) Instructions : Please provide complete answers to the following questions. You must submit your solutions by 11 : 59 p m on Monday , August 3 rd . Note that it is plagiarism if your answers look remarkably similar to someone else’s and you do not indicate the group work. A group - work is strongly enco uraged to do this problem set, but you will have to submit your own solutions. W rite your answers as CLEARLY as possible . Illegible answers may lose points. Lastly, make sure to accompany appropriate reasoning or calculation as part of your solutions if it is required to understand your conclusion. I. National I ncome A ccounts Suppose an economy ’ s national accounts are GNP = 100, C = 70, I = 40, G = 2 0 and EX = 20 where GNP is gross national product, C is consumption, I is investment, G is government spending, and EX is exports. Using the national income identity, find the value of imports (IM).What is the current account balance? What is the (economy - wide) savings rate (note: saving rate = S /Y) ? What would the government, private, and total savings rate be if the government reduced taxes T = 10 while the other variables remain unchanged? II. B alance of P ayments Transactions Explain how, if at all, each of the following transactions generates two entries (a credit and a debit) in the American balance of payments accounts, and describe how each entry would be classified in any of current, financial or capital account : (a) A U.S. resident buys shares of a Portuguese company paying via wire transfer from her Wells Fargo account to a Portuguese bank. ( b ) An Australian tourist rents a car in the U.S. and pays with her credit card. (c) A U.S. - owned factory in B ritain uses local earnings to buy additional machinery. III. Saving and Current Account E CON 1 71 2 Read the article “White House preparing for trade crackdown” by Andrew Restuccia and Doug Palmer (Jan. 7, 2018) available at https://www.politico.com/story/2018/01/07/trump - trade - crackdown - 327283 . (a) If the Trump government decides to take an aggressive action by imposing harsh tariffs on Chinese imports, what is the motivation beh ind? In other words, what kinds of economic benefits President Trump is expecting when imports from China are reduced? Now, let’s check if import tariffs would do an expected job. Consider national income identity: Y = C + I + G + CA (b) Solve for CA a s a function of private saving ( S p ) , investment (I), and government budget ( T – G ). (c) How would higher U.S. tariffs on Chinese imports affect its private saving, domestic investment, and government deficit? Do you agree that import restrictions would necessarily reduce a U.S. current account deficit? I V. Exchange R ates ( Note : y ou can just choose one to answer in this section ) 1. In Munich, a bratwurst costs 5 euros ; a hot dog cots $4 at Boston’ s Fenway Park. At an exchange rate of $1.05/euro, what is the price of a bratwurst in terms of a hot dog? All else equal, how does this relative price change if the dollar deprec i ates to $1 .25/euro? Compared with the initial situation, has a hot dog become more or less expensive relative to a bratwurst? 2. Suppose you are a producer of asphalt located in China. Petroleum is one of the major inputs for asphalt. Your company must import petroleum which is sold in a world market and priced in U.S. dollars. How are the profits of your company affected when the yuan appreciates against the dollar? 3. Multinational firms generally have production plants in a number of countries. Th is enables them to move production from expensive locations to cheaper ones in response to various economic development s – a phenomenon called outsourcing when a domestically - based firm moves part of its production abroad. If the dollar depreciates, what w ould you expect to happen to outsourcing by American companies? Explain and provide an example. E CON 1 71 3 V. Rates of R eturn 1. Calculate the dollar rates of return from a ₤ 10,000 deposit in a London bank in a year when the interest rate on pounds is 10 percent and the $/₤ exchange rate moves from $1.5 0 / ₤ to $1.38/ ₤ . 2. What would be the real rates of return on the same deposit if there was a simultaneous 10 % increase in all dollar prices? V I . Interest P arity Transactions 1. Suppose you expect the Croatian currency, the Kuna, to appreciate 5% relative to the USD over the next 6 months. What additional information would you need in order to decide whether it is a good time to buy Kuna? Suppose you find out in the newspapers that the interest rate on Kuna deposits is 7%. What is the expected dollar return on Kuna deposits? What must the US interest rate be if the uncovered interest parity condition holds? 2. You are a foreign exchange trader specialized in the US dollar Swis s franc market (USD/CHF). One morning, you notice that the one - year dollar interest rate is 4%, while the one - year interest rate on Swiss francs is 2.7%. Today ’ s USD/CHF rate is $1.7. (a) What spot rate do you expect for the USD/CHF in one year? (b) You log onto your electronic brokerage account and find that the current quote for the 360 - day forward rate on USD/CHF is 1.79. Is there an arbitrage opportunity? If so, describe how you would take profit from it and how much you would get if you invested $1. What do you anticipate if all of your fellow traders start doing the same?
