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National Income Accounts
In an economy that has a GNP of 100, C=70, I=40, G=20, and EX =20.
Where,
GNP= Gross national products
C= consumption
I= Investment
G= Government spending
EX= Export
Using National Income Identity, Find the Value of Imports (IM).
GDP= C+ I+ G+ (EX-IM)
100= 70+40+20+ (20-IM)
100= 150-IM
IM (Value of Imports) =50
What is Current Account Balance?
CA= EX-IM
CA= 20-50
Current Account= -30
What is the (Economy-Wide) Savings Rate?
S= Y-C-G
S= 100-70-20
S= 10
 
What Would be the Government, Private, and Total Savings Rate be if the Government Reduced Taxes T=10 While the Other Variables Remain Unchanged?
Y= 100
Y= C+S+T+ (EX-IM)
100= 70+ S+ 10- 30
S (Savings) = 50
Public saving rate= 10 (Equal to tax)
Private Savings Government expenditure= 40 (50-10)
Balance of Payments Transactions
Explain how each of the following transactions generates two entries in the American Balance of Payment Accounts. Describe how each entry would be classified in any of current financial or capital account.

  • A U.S. resident buys shares of a Portuguese company paying via wire transfer from her Wells Fargo account to a Portuguese bank.

Step 1

  US Balance of Payments ($)
  Credit (+) Debit (-)
Current Account    
Financial Account Amount of USD converted to buy shares ($) Converted amount to buy shares (Euro)

The US residents buys the Euro using USD, which results in debiting of Euro and crediting of USD.
Step 2

  US Balance of Payments ($)
  Credit (+) Debit (-)
Current Account   Shares of Portuguese Company
Financial Account Converted amount to buy shares (Euro)  

            The trader uses the Euro to purchase shares, which results in crediting of Euro and debiting of shares in the current account (Suranovic, 2004).

  • A U.S.-owned company in Britain uses local earnings to buy an additional machine

Step 1

  US Balance of Payments ($)
  Credit (+) Debit (-)
Current Account    
Financial Account Converted USD amount needed to buy new machine Amount of Sterling Pounds converted to USD to buy new machine ($)

This step entails first purchasing USD using the British Sterling Pound. The US dealer credits the USD amount and debits the Sterling pound.
Step 2

  US Balance of Payments ($)
  Credit (+) Debit (-)
Current Account New Machine sold to Britain’s Company  
Financial Account   Converted USD amount needed to buy new machine

            The sale of the machine results in a credit balance from the US sellers and a debit in the converted USD account.

  • An Australian tourist rents a car in the U.S. and pays with her credit card.

Step 1

  US Balance of Payments ($)
  Credit (+) Debit (-)
Current Account    
Financial Account Amount of Australian dollars converted to pay rental fee The converted Australian dollars in USD ($)

The first step entails the Australian tourist buying USD from her Australian currency. This results in a crediting of Australian dollars and debiting of USD.
Step 2

  US Balance of Payments ($)
  Credit (+) Debit (-)
Current Account   Car Rental Fees paid in USD ($)
Financial Account The converted Australian dollars to USD ($)  

            The second stage entails transferring of converted Australian dollars to USD to the seller, hence crediting the customer and acquisition of car rental service.
Savings and Current Account
S p= I+ CA+ (G-T)
How much would higher US barriers to import affect its Private Saving, Domestic Investment, and Government Deficit? Do You Agree that Import Restriction Would Necessarily Reduce a U.S. Current Account Deficit?
The imposition of barriers to trade, which could result in trade restrictions, has the effect of making a country to forego various advantages that are due to free trade such as specialization. As a result, trade restriction would result in a reduction in living standards of a country. In addition, there is a possibility of reiteration of similar policies by foreign countries. These policies would result in a reduction in private savings. Due to a weakened local economy and reduced purchasing power, the rate of domestic investment would reduce (Varian, 2014). The government deficit would not necessarily reduce since a trade restriction would not by itself make a country’s products competitive in the international market (Suranovic, 2004). Therefore, a country can still have a huge current account deficit despite having import restriction. Based on the aforementioned, import restriction would not necessarily reduce a U.S. current account deficit.
Exchange Rates

  1. Munich’s, Bratwurst Cost Compared to That of a Hot Dog in Boston
  2. Bratwurst 5 euros, hot dog $ 4, exchange rate $1.05

Bratwurst in dollars (5*1.05= $ 5.25)
Bratwurst to Hot dog 5.25/4= 1.3125   {1.3125 hotdogs equal 1 bratwurst}

  1. Bratwurst 5 euros, hot dog $ 4, exchange rate $1.25

Bratwurst in dollars (5*1.25= 6.25)
Bratwurst to Hot dog 6.25/4= 1.5625   {1.5625 hotdogs equal 1 bratwurst}
The hot dog has become less expensive relative to the bratwurst

  1. Effect of Appreciation of Yuan Against Dollar for Chinese Oil Importer.

Since petroleum is imported in dollars, a change in the exchange rate between the Chinese yuan and the USA dollar has an effect on the cost that a Chinese oil importer pays. An appreciation of the yuan against the dollar has the effect of reducing the amount of yuan needed to import a specified volume of petroleum. Therefore, the company will make profits due to a reduction in the cost of importing petroleum.

  1. The effect of depreciation of the dollar when in an American company that has outsourced its business.

When the dollar depreciates, American produced products become cheap in the international markets. Therefore, they are more demanded, which makes company producing them to earn more profits. However, if a company has outsourced in a country where the dollar has depreciated relative to the currency in the outsourced country, its products become relatively expensive in the international market. Accordingly, these products are less competitive and the business makes little profits.
Rates of Return

  1. Dollar rates of return from 10,000 sterling pounds deposit in London bank. Interest on pounds is 10%. Exchange rate of dollar to pound moves from $1.5 per sterling pound to $1.38 per sterling pound.

10% * 10,000= 1,000 (pounds)
Exchange values
Initial value in dollar: 10,000* 1.5=$15,000
End of year value: 10,000* 1.38= $13,800
Interest earned: 1,000* 1.38= $1,380
Total end of year value: 13,800+ 1,380= $15,180
Dollar Rates of Return: 15,180-15,000= $180

  1. Real rates on return on the deposits if there was a simultaneous 10% increase in dollar prices?

New price of dollar: 0.9* 1.5= $1.35
Initial value in dollar: 10,000* 1.5=$15,000
End of year value: 10,000* 1.35= $13,500
Interest earned: 1,000* 1.35= $1,350
Total end of year value: 13,500+ 1,350= $14,850
Dollar Rates of Return: 14,850-15,000= -$150
Real Rates of Return= -$150
Interest Parity Transactions

  1. If you expect Croatian currency Kuna to appreciate 5% relative to USD in 6 months. What additional information is needed to decide if it is a good time to buy the Kuna?
  • The risk premium associated with the purchase of the Kuna since making an investment in a foreign asset is risky. Generally, the risk premium depends on the level of the investor’s risk aversion and also the relative supply of the domestic and foreign assets that the investor community is cumulatively holding.

If the newspapers indicate that the interest rate on Kuna deposits is 7%, what is the expected dollar return on Kuna deposit?
UIP is simply i = i* + x
i= 7% then i+x= 7%
Expected dollar return is 7%
What must the US interest rate be if the uncovered interest parity conditions hold?
UIP is simply i = i* + x
UIP hold simultaneously, we have x = (F-S)/S
F= 7%
S= 5%
x= (7-5)/5= 0.4%
UIP= 7+ 0.4= 7.4%
 

  1. Spot rate for USD/CHF in one year?
  2. USD/CHF. One year dollar interest rate is 4%, the one-year interest rate on Swiss Francs is 2.7%. Today USD/CHF rate is $1.7

(F-S)/S = (i-i*)/(1+i*)= (F-S)/S = i – i*
4-2.7=1.3%
Spot rate for USD/CHF= 1.3%

  1. Is there an arbitrage opportunity if the electronic brokerage account has a current quote for 360-day forward rate on USD/CHF is 1.79

There is an arbitrage opportunity. Simply, I can purchase the currency locally and earn more in the deal (Rudiger 1161-1176).
I USD= 1.79 CHF
Spot rate is 1USD= (1.7 *1.013= 1.7221) CHF
Gain is (1.79-1.7221= 0.0679 CHF)
If all traders copy my method, there will be an oversupply of USD relative to CHF, which will result in a decline in the future exchange rates. Eventually, the prices will stabilize at a price equal to that of spot rate.
 
Works Cited
Rudiger, D. “Expectations and Exchange Rate Dynamics,” Journal of Political Economy, vol. 84, no. 1, 1976, pp.1161-1176.
Suranovic, S. International Finance Theory and Policy. (2004). Retrieved from http://internationalecon.com/Finance/Fch5/F5-6.php
Varian, H. Intermediate Microeconomics: A Modern Approach (9th Ed.). W.W. Norton & Company, 2014.