Question 1

4/21/12

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

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

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

Question 2

4/21/12

1. Given Jims expectations, forecast whether the pound will appreciate or depreciate against the dollar over time.

4/21/12

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

2. Given Jim's expectations, 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

4/21/12

3. The terrorist attract son the United State on September 11,2011. were expected to weaken U.S economic conditions and reduce U.S interest rates. How do you think the weaker U.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.S interest rates would have affected the value of the

weaken U.S economic conditions Income level U.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

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

Question 4
Click to edit Master subtitle style

4/21/12

a.

U.S. inflation has suddenly increase substantially, while Country Ks inflation remains low.

4/21/12

U.S. inflation increased U.S. goods become more expense U.S export reduce Demand of U.S dollar reduce U.S import increase Supply of U.S dollar increase U.S dollar depreciate

4/21/12

b. U.S. interest rates have increased substantially, while Country Ks interest rates remain low. Investors of both countries are attracted to high interest.

4/21/12

U.S interest rates increase Return on U.Ss assets increase U.S dollar become more attractive Demand of U.S dollar increase Supply of U.S dollar reduce U.S dollar appreciate

4/21/12

c. The U.S. income level increased substantially, while Country Ks income level has remained unchanged.

4/21/12

U.S income increase U.S increase the demand of foreign goods U.S import increase Supply of U.S dollar increase U.S dollar depreciate

4/21/12

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

4/21/12

U.S impose tariff U.S Import reduce Supply of U.S dollar reduce U.S dollar appreciate

4/21/12

e. Combine all expected impacts to develop an overall forecast.

4/21/12

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

Question 5

4/21/12

a. 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

Blue Demon Bank borrow 70million pesos Convert it into U.S$ at $.15 = 70,000,000 peso*$.15 = US$10,500,000

Deposit into US bank account After 10 days, amount of US bank:

= US$10,500,000*(1+.08*10/365) = US$10,523,013.70

Convert back to peso at $.14

4/21/12

= US$ 10,523,013.70/$.14

Profit after deduct interest (8.7%) and principle

= 75,164,383.57peso 70,000,000peso*(1+.087*10/365) = 75,164,383.57peso 70,166,849.31peso = 4,997,534.26peso

4/21/12

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

4/21/12

Blue Demon Bank borrow US$10 million Convert it into peso = $10,000,000/$.15 = 66,666,666.67peso

Deposit into Mexican bank account After 30 days, amount of Mexican bank account

= 66,666,666.67peso*(1+.085*30/365) = 67,132,420.09peso
4/21/12

Convert back to peso at $.17

Profit after minus interest (8.3%) and principle

= $11,412,511.42 $10,000,000*(1+.083*30/365) = $11,412,511.42 - $10,068,219.18 = $1,344,292.24

4/21/12

Question 6

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. There is a substantial amount of trade between the United states and the country of Krendo and no capital flows. How will high inflation and high interest rates affect the value of the Kren (Krendos currency)? Explain.
4/21/12

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