ProblemSet3_solution

# ProblemSet3_solution - International Financial Management...

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Prof Choi Problem Set 3 Spring 2008 This problem set is due Wednesday, March 17. Remember to show any calculations. 1. Suppose Mexico decides to stabilize its currency by maintaining a peg to the US dollar at the current exchange rate (10.932 pesos/\$) for the next year. The Mexican interest rate is 7% whereas the US interest rate is 5%. What will happen to the dollar currency reserves of the Mexican government over the course of the year? Because the currency is pegged for the year, the 1 year forward rate is exactly equal to the spot rate. US investors facing higher rates abroad will convert dollars into pesos and invest in Mexico. This will cause an increase in Mexican government dollar reserves as they buy dollars and sell pesos. Default risk or risk that the exchange rate may devalue could alter this. 2. (From Eun & Resnick 3.12) Show how each of the following transactions will be classified and recorded in the debit and credit of the U.S. balance of payments: a) A Japanese insurance company purchases U.S. Treasury bonds and pays out of its bank account kept in New York City. Credit: Foreign purchase of US Treasury bonds Debit: Withdrawal by foreigner from bank account in NYC b) A U.S. citizen consumes a meal at a restaurant in Paris and pays with her American Express card. Credit: American Express liability to French restaurant (foreign holding of US asset) Debit: Import of meal c) An Indian immigrant living in Los Angeles sends a check drawn on his LA bank account as a gift to his parents living in Bombay. Credit: LA bank liability to Indians (foreign holdings of US assets) Debit: Unilateral aid d) A U.S. computer programmer is hired by a British company for consulting and gets paid from the U.S. bank account maintained by the British company. Credit:

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ProblemSet3_solution - International Financial Management...

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