f01_ps6 - 14.02 Fall 2001 Problem Set 6 Posted Due I...

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14.02 Fall 2001 Problem Set 6 Posted October 24, 2001 Due October 31, 2001 I. True/False (explain) (30 points, 5 each) 1. Your wealthy grandmother has all her wealth invested in US government bonds. On a recent trip to the Carnival in Rio de Janeiro, your grandmother returns and enthusiastically describes to you how the interest rate on Brasilian bonds is so much more desirable in comparison to the low interest she gets on her US bonds, and that as a result she will invest her wealth in Brasilian bonds instead. Is your grandmother’s reasoning true or false? and what do you tell her? (Assume you care for your grandmother whether out of altruism or because you stand to inherit her fortune.) 2. The finance minister in Trustlesstan is fed up with the high interest payments his government has to pay on its debt. He cleverly decides to issue government debt denominated in US dollars instead. To his great surprise, the interest rate on this new debt still exceeds the interest rate on similar maturity US government debt. True or false: He should ask for his money back from Olivier Blanchard, the author of his 14.02 book. 3. In a last ditch attempt to keep his job, our friend the finance minister of Trustlesstan, is persuaded by Blanchard not to prosecute and even to order a newer snazzier edition of his textbook. Blanchard then advises him to devalue the currency in order to increase demand for domestic goods and improve the trade balance as a result. Our hapless finance minister is fired from his job a week after devaluing the currency because net exports fall as a result. He is replaced by another finance minister who is credited for increasing net exports in later months because of his patriotic speeches. True or false: the new minister is certainly effective. 4. There are two countries: Harvard and MIT and the unit of exchange in each country is the GPA of the respective country. Suppose initially that the two countries initially fix their exchange rate at one-to-one. Your current GPA is very low. A friend recommends you take 14.02 to boost your GPA for sure. But you have the choice between taking 14.02 at MIT or a similar course at Harvard. (charisma of TA does not enter your decision). If you invest one hour a week in 14.02 at MIT (a realistic assumption) the
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