ProblemSet1_solution

ProblemSet1_solution - International Financial Management...

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International Financial Management Prof Choi Problem Set 1 Spring 2008 This problem set is due Monday, February18. Remember to show any calculations. 1. Suppose that the pound is pegged to gold at 6 pounds per ounce, whereas the franc is pegged to gold at 12 francs per ounce. This, of course, implies that the equilibrium exchange rate should be two francs per pound. If the current market exchange rate is 2.2 francs per pound, how would you take advantage of this situation? What would be the effect of shipping costs? Suppose that you need to buy 6 pounds using French francs. If you buy 6 pounds directly in the foreign exchange market, it will cost you 13.2 francs. Alternatively, you can first buy an ounce of gold for 12 francs in France and then ship it to England and sell it for 6 pounds. In this case, it only costs you 12 francs to buy 6 pounds. It is thus beneficial to ship gold due to the overpricing of the pound. Of course, you can make an arbitrage profit by selling 6 pounds for 13.2 francs in the foreign exchange market. The arbitrage profit will be 1.2 francs. So far, we assumed that shipping costs do not exist. If it costs more than 1.2 francs to ship an ounce of gold, there will be no arbitrage profit. 2. Briefly explain the Triffin’s dilemma Under the gold-exchange system, the reserve-currency country should run BOP deficits to supply reserves to the world economy, but if the deficits are large and persistent, they can lead to a crisis of confidence in the reserve currency itself, eventually causing the downfall of the system. 3. There are arguments for and against the alternative exchange rate regimes.
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This note was uploaded on 04/20/2008 for the course STERN UNDE C15.0030.0 taught by Professor Jaewonchoi during the Spring '08 term at NYU.

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ProblemSet1_solution - International Financial Management...

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