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Econ+161B++sample+midterm

Econ+161B++sample+midterm - Econ 161B Midterml I” A...

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Unformatted text preview: Econ 161B Midterml I” _ A. Sohrabian Spring 2006 Answer All Questions 1. a. As the inflation-adjusted value of the US. dollar rises, what is likely to happen to the US. balance on current account? b. What is likely to happen to the value of the dollar as the US current account deficit increases? 0. A Current account surplus is not always a sign of health; a current account deficit is not always a sign of weakness. Comment. ' 2. Suppose the Russian ruble devalues by 75% against the dollar. What is the percentage appreciation of the dollar against the ruble? Explain. 3. A foreign exchange dealer in Hong Kong normally provides quotes for spots, one month, three months, and six months. When you ask over the telephone for current quotations for the Swiss franc against the U.S. dollar, you hear:- ‘ “13100—116065, 172456, 340610.” Answer the following, base on the above quotation. What would you receive in dollars if you sold SF 1,000,000 spot? a. b. What would it cost you to purchase SF 12,000,000 forward three months for dollars? What would you make payment? c. In New York, three-month Treasury bills yield 9% per annum. Using offer quotes only for simplicity, calculate the yield on Swiss three-month bills. Assume the following rates between Swiss francs and the US dollar: Spot SF 1.8400/$ Three-month forward rate SF 1.8263f$ Three-month US. interest rate 7.00% per annum Threearnonth-Swiss interest rate 300% per annum How much can you make by a covered interest arbitrage, if you start by borrowing either $2,000,000 in the United States or its equivalent at today‘s spot market, SF 3,680,000, in Switzerland? Transaction costs are 0.15%; i.e., 15/100 of 1%, payable once at the end of the investment period on the original $2,000,000 or its franc equivalent. Show all your calculations. 1' (ti/K0 :6. la. As the inflation-adjusted value of the US. dollar rises, what is likely to happen to the US. balance on current account? ANSWER. As the inflation-adjusted or real value of the dollar rises, the nation‘s goods and services become relatively more expensive in foreign currency terms, while foreign goods and services become relatively less expensive in domestic currency terms. The result is a smaller surplus or larger deficit on the current account. Of course, this conclusion could be reversed if the reason for the rise in the real value of the dollar wasa Significant increase in US. productivity, which would facilitate exports. b. What is likely to happento the value of the dollar as the US. current-account deficit increases? ANSWER. It all depends on why the current-account deficit increases. If the deficit increases because the 13.3. economy is growing strongly, then the dollar is likely to rise in value as foreign capital comes in to take advantage of growth opportunities. 0n the other hand, if the cm‘rent-account, deficit rises because the government budget deficit is increasing, then the value of the dollar is likely to decline because of the adverse implications of a budget deficit for future economic growth. The current—account deficit could also be increasing because the exchange rate is set at too high a level. If so, then the dollar’s future prospects would be dim as well. c. A current-account surplus is not always a sign of health; a current—account deficit is not always a sign of weakness. Comment. ANSWER. A current-account surplus represents an excess of domestic savings over domestic investment. This excess savings could reflect a lack of domestic investment opportunities. For example, Japan's current-account surplus has grown since '1990, reflecting a prolonged economic slump and relatively poor domestic growth opportunities. Similarly, the Asian crisis that began in the summer of 1997 forced the various Asian nations to slow down their growth and led to outflows of capital. The flip side of a capital outflow, of course, is a current-account surplus. At the same time, countries growing rapidly are likely to face current-account deficits, as economic growth generates domestic investment opportunities that can't all be financed through domestic savings- In other Words, the faster a nation grows relative to other nations, the more likely it is to have a current-account deficit; conversely, slow economic growth is more likely to lead to a current—account surplus. ' £1-60 mm”? 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