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Name ___________________________ Homework #1 ELCBUS 463 International Finance and Trade Fall 2017 Each part of a question is worth one point (30 points total). 1. How does each of these affect the US current account? a. You pay interest on a French government bond. b. You sell a Rolex watch on eBay to a person in China. 2. Explain why a stronger dollar could cause the US current account deficit to increase. 3. Give an example using a direct quotation of the exchange rate of a weakening of the Canadian dollar relative to the US dollar. 4. Mexico’s interest rates have generally been higher than US interest rates. Yet the Mexican peso’s value has declined against the dollar over most years. What is the most likely cause? 5. Today you notice that $1 = 3 Argentine pesos and 1 Argentine peso = .50 Canadian dollars. You need to purchase 100,000 Canadian dollars with US dollars. How many US dollars will you need? 6. If the expected return on dollar assets is less than that on British pound assets, a. What would be the major effect(s) in the market for loanable funds in the UK? Why? b. Graphically illustrate the effect on the equilibrium British interest rate. 7. US Bank has purchased a 7 million one-year Canadian dollar loan that pays 8.5% interest annually. The spot rate of U.S. dollars for Canadian dollars is 0.70. It has funded this loan by accepting a Euro-denominated deposit for the equivalent amount and maturity at an annual rate of 7%. The current spot rate of U.S. dollars for Euros is 1.25. a. What is the loan amount in dollars? b. What is the deposit amount in Euros? c. What is the interest income earned in US dollars on this one-year transaction if the spot rate of U.S. dollars for Canadian dollars and U.S. dollars for Euros at the end of the year are 0.67 and 1.30, respectively? d. What is the interest expense in dollars? 8. Assume the Japanese government relaxes its controls on imports from the US. a. What would be the effect(s) in the market for Japanese yen (relative to the US dollar)? Increase in demand for Japanese yen Decrease in demand for Japanese yen Increase in supply of Japanese yen Decrease in supply of Japanese yen Why? b. Graphically illustrate the effect on the equilibrium exchange rate (dollars per yen). 9. Suppose the European central bank sells US dollars for euros in the FX market (direct FX intervention). a. What would be the effect(s) in the market for euros (relative to the US dollar)? Increase in demand for euros Decrease in demand for euros Increase in supply of euros Decrease in supply of euros Why? b. Graphically illustrate the effect on the equilibrium exchange rate (dollars per euro). 10. Suppose the exit of Great Britain from the European Union (“Brexit”) causes a reduction in confidence in the euro. a. What would be the effect(s) on the market for US dollars (relative to euros)? i. Increase in demand for US dollars ii. Decrease in demand for US dollars iii. Increase in supply of US dollars iv. Decrease in supply of US dollars Why? b. Graphically illustrate the effect on the equilibrium exchange rate (dollars per euro). 11. Suppose that both the spot and the one-year forward exchange rates for the British pound are $1.70. Suppose also that a bank can borrow or lend dollars at 4% interest and can borrow or lend pounds at 5% interest. a. Should the bank buy one million dollars forward (borrowing pounds to do so) or one million pounds forward (borrowing dollars to do so)? b. What is the bank’s profit after one year in dollars if it makes the right choice? 12. Suppose you buy $100,000 worth of euro futures with a forward exchange rate of $1.10 per euro. If on expiration the spot exchange rate is $1.12, what is your loss or gain? 13. Suppose you buy a call option on a $100,000 worth of euros with an exercise price of $1.10 per euro for a premium of $1000. If on expiration the spot exchange rate is $1.12 per euro, what is your net profit or loss? 14. Suppose you buy a put option on a $100,000 worth of euros with an exercise price of $1.10 per euro for a premium of $1500. If on expiration the spot exchange rate is $1.12 per euro, what is your profit or loss? 15. Suppose you expect a coordinated effort by the central banks of the largest countries to sell Japanese yen in the near future. a. Should you purchase or sell yen futures today? b. Should you purchase call or put options on yen today? 16. Suppose you buy a call option on 50,000 Canadian dollars with an exercise price of $.60 per Canadian dollar for a premium of $3000. What would the spot exchange rate need to be at the time the option is exercised for you to break even (zero net profit)? 17. Assume that on November 1, the spot rate of the British pound was a $1.58 and the price on a December futures contract was $1.59. If the spot rate by November 30 was $1.51, should you have purchased or sold a December futures contract in pounds on November 1? 18. If a government wanted to reduce the value of its currency relative to the dollar, a. How could it use direct FX intervention to do so? b. How could it use indirect FX intervention to do so? c. How could it use sterilized intervention to do so?
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Running head: International Finance and Trade Fall 2017

International Finance and Trade Fall 2017:
Student’s name:
Institution affiliation:
Date:

1

International Finance and Trade Fall 2017

2

Q1) First, current account of a nation is the sum of balance of trade which is exports
minus imports, net income from foreign countries and net current transfers.
a) Paying interest on a French government bond will reduce net income from foreign
countries thus it will reduce US current account.
b) Selling a Rolex watch to an individual in China will increase exports by the value of
the watch. It will increase US balance of trade and current account will also increase.

Q2) A stronger dollar will make exports expensive and imports cheaper. When the dollar
is strong, it buys more foreign currencies and more imports will be afforded. Foreign currency
will buy less dollars making exports expensive. The result is that imports will be more than
exports and US current deficit will increase.

Q3) In 2000, 1 Canadian dollar was equivalent to $0.806. Today, one Canadian dollar is
equivalent to $0.7753. It implies that in 2000, Canadian dollar was capable of buying more USD
than today. We conclude that Canadian dollar is weakening relative to USD.

Q4) The US dollar is based on a stronger economy and it is trusted all over the world thus
it is demanded more than Mexico peso making it to always have superior value.

Q5) $1= 3 Argentine pesos
1 Argentine peso =0.50CAD
$1=3(0.50CAD) =1.50CAD
100,000CAD=$(100,000/1.50) =$6,666.67

International Finance and Trade Fall 2017

3

Q6)
a) The demand for British pound will reduce. As a result, loanable interest rate for British
bounds will decrease because the demand curve will shift to the left.

b)

R

S

R1

R2

D2

D1
BRITISH POUND(Q)

Q2

Q1

Q7)
a) 0.7 x 7 million =$4.9 million
b) 4.9 million/1.25=3.92 million euros.
c) interest income= 4.9 million – (0.67 x7) million=0.21milliom
d)interest expense =3.92million euros x 0.07 X1=0.2744 million euros
=$(0.2744/1.30) million= $0.2111 million

Q8)
a) Decrease in demand for Japanese yen because Japanese traders will buy more dollars
to import from USA decreasing demand for Japanese yen.

International Finance and Trade Fall 2017

4

EXCHANGE RATE($/YEN)
b)

S
R1

R2

D2

D1
QUANTITY

Q

Q9)
a) Increase in demand for euros. Dollars will be readily available thus consumers will
demand more euros. EXCHANGE RATE($/euro)
b)

S
R2

R1

D2

D1
QUANTITY

Q1

Q2

Q10)
a) Increase in demand for US dollars. Due to reduced confidence in the euro, consumers
will opt to storing their money in terms of dollars instead of euros.

International Finance and Trade Fall 2017

5

b)

R

S
R1

R2

D2

D1
EUROS(Q)

Q1

Q2

Q11)
a) buy one million dollars forward (borrowing pounds to do so)
b) profit = interest = (5-4) % X 1000,000
= $10,000
Q12) Gain because expiration rate is higher than forwarded exchange rate.
Q13) Profit= (1.12-1.10)1000=$20
Q14) Profit= (1.12-1.10)1500=$30

Q15)
a) I will sell today because the value of yen will decrease in the future.
b) I will purchase an option today because in future more money will be required as the yen will
depreciate.

Q1) rate x 3000=50,000
Spot rate =16.67
$1=16.67CAD

International Finance and Tra...


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