HW1 2021winter-1 - Homework PDF

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International Finance, Winter 2021 Problem Set 1: BOP and Exchange rate Assign Date: 25 Dec, 2021 Due Date: Jan, 2022, 11: 59pm (Note: we have 4 questions, covering the lectures in the four lectures)

Q1: BOP and NFA (30 marks) Suppose a country is represented by a household. The basic: Only two members, You and Xiaomi You are the authority, who can issue the currency RMB. RMB is used for domestic transaction At the beginning of 2020, the authority have Foreign asset 10kg gold, and foreign liability 6000 RMB. The private sector (Xiaomi) have Foreign asset 2 kg gold, and foreign liability 2000 RMB. Let us assume that the exchange rate is 1kg Gold=500 RMB. There is no statistical errors and no changes of the capital accounts. Question 1a) What is the whole household total Foreign asset and Foreign liability at the beginning of 2020? And what is the initial net foreign asset? Question 1b) During 2020, the national income account shows that CA=-2kg Gold. Consequently, the household depletes it net foreign wealth. Can you figure out: what is the consequence on the household’s NFA? Question 1c) The incremental wealth may be held by Xiaomi (Private sector) or Your (authority) If Xiaomi increases the position of Gold by -0.4 kg Gold (The non-official reserve part) Can you figure out: what is the balance of official settlement? Question 1d) At the end of th year, exchange rate turns out to be 1kg Gold=750 RMB. Can you check what is the valuation effect? And what is the net foreign asset in the end of 2020? (Hint: changes of NFA includes the valuation change and the current account).

Q2. Net international investment positions (30 marks) Hint: to finish this question, you need to read the section 1.6 of chapter 1 in the book by http://www.columbia.edu/~mu2166/UIM/suw.pdf Also, I attach the required External Wealth of Nations Database (1970-2020), which provide the data for this question. For more details on the database, check here: https://www.philiplane.org/EWN.html Question 2a).

Question 2b). Following the method using in 2a) check the sizes of valuation changes for U.S and china during the year 2019 and 2020. Is it there any different during the Covid-19 crisis?

Q3; Money and exchange rate (20 marks) Assume that output is fixed. (a) Suppose there is a permanent reduction in aggregate real money demand, that is, a permanent negative shift in the aggregate real money demand function. (i) With the help of the combined money market and foreign exchange market diagram, analyze how exchange rate and interest rate change in the short run and the long run. (ii) Draw four diagrams showing the time trajectory of the exchange rate, interest rate, price level and money supply respectively. (b) Suppose the reduction is aggregate real money demand is temporary instead. (i) What are the short run effects on the exchange rate and the interest rate? (ii) Draw four diagrams showing the time trajectory of the exchange rate, interest rate, price level and money supply respectively. (c) Compare the short run effects on the exchange rate and interest rate between the two types of changes in (a) and (b) above.

Q4. Interest Parity (20 marks) 2.1 The current Australian dollar exchange rate (Australian dollar per US dollar) is Et = 1.8; the annualized interest rate on three year bonds is 2% in Australia compared to a 1% annualized interest rate of three-year treasury bond in the US. If the uncovered interest parity theory holds, what would the market expectation of exchange rates (Australian dollar per US dollar) in three years. 2.2 Indonesia’s one year interest rate in May 2014 was 9% (i = .09). The US interest rate was zero (iF = 0). The Indonesian Rupiah-US Dollar exchange rate was Et = 11500. Calculate the one year forward rate, 2.3 Suppose the one-year forward exchange rate is 1.26 dollars per euro and the spot exchange rate is 1.20 dollars per euro. What is the forward premium on euros (the forward discount on dollars)? What is the difference between the interest rate on one-year dollar deposits and that on one-year euro deposits (assuming no repayment risk)? (Please state which one is larger.) hint: forward premium is defined as (F_t+1-E_t)/E_t...