Self-Check Quiz 1 Solutions
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University of California, Irvine *
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126
Subject
Management
Date
May 13, 2024
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Pages
3
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MGMT 144
Quiz One Mock Solution
1. Please explain how each of the following transactions would enter the U.S. balance of payments accounts? Consider only the transaction described. Do not be concerned with possible offsetting transactions.
(a) An old house purchased by an American in Italy
Answer:
Debit(
-
) in FA
Debit item implies fund outflow (fund flows out of the US), financial account records trades in existing assets, either real assets like the houses or financial assets such as stocks and bonds.
(b) The purchase of a U.S. Treasury bond by a foreigner
Answer: Credit(+) in FA
Credit item implies fund inflow (fund flows into the US), financial account records trades in existing assets, either real assets like the houses or financial assets such as stocks and bonds.
(c) The wage an American earns in a British company
Answer: Credit(+) in CA
Current account includes net income from abroad. The domestic country is the US, thus it’s income inflow.
(d) A factory built by the Japanese in the United States
Answer: Credit(+) in FA
This factory built is a direct investment made by Japan to U.S... Japan paid US to get the ownership of the factory, so it causes funds flow into US, and the factory is real asset. 2. The United States has experienced continuous current account deficits since the early 1980s, what would be the impact of such continuous current account deficits on the value of net foreign assets of the U.S.? Explain.
Answer: If U.S. current account has deficits, that is equivalent to financial account has a surplus because the sum of current account balance and financial account balance is zero. When financial account has surplus, that means in financial account funds inflow is higher than financial outflow.
In financial account, funds inflow is caused by sale of assets to foreign countries, and funds outflow is caused by purchase of assets from foreign countries. Therefore financial account surplus implies that the country sells more assets than it purchases from foreign countries, and results in a decline in the value of net foreign assets of the US.
3. Suppose the bid and ask spot exchange rates are as shown in the table below, please answer the following questions.
Ask
Bid
$/£
1.9
1.8
$/€
1.2
1.1
(a) You are planning your trip to U.K., so you want to exchange $1,000 into British pound, how much pounds will you get from the conversion?
Answer: The first row shows that the bank sells pounds at 1.9$/£
. So how much can one buy with 1000$
?
$1000
1.9$/£
= £526.3
(b) After your trip, you have £
100 left and you decide to convert them back to dollar. How much dollar will you end up with?
Answer: The bank buys pounds at 1.8$/£
. How much can we get if we sell £
100
? It is £100 ∗ 1.8$/£ = $180
(c) Suppose you have €
1,000 and want to convert it to British pound, what are your proceeds from conversion?
Answer: Convert euros to USD first. The bank buys euros at 1.1$/€
. Selling €1000
I get €1000 ∗ 1.1$/€ = $1100
Then convert the dollars to British pounds. The bank sells pounds at 1.9$/£
. Selling $1100
, I get $1100 ÷ 1.9$/£ = £578.9
4. The current spot exchange rate is $1.5/
£
and the one
-
month forward rate is $1.6/
£
. Please answer the following questions base on those information.
(a) What is the one
-
month forward premium or discount for the British pound versus the
U.S. dollar? (Assume one month has 30 days.)
Answer: 𝑓 =
1.6−1.5
1.5
×
360
30
= 0.8 = 80%
forward premium
(b) Based on your analysis on the exchange rate, you forecast with confidence that the spot exchange rate will be $1.55/
£ in one month. Assume that you would like to buy or sell £
50,000. What action do you need to take to speculate in the forward market? What is the expected dollar profit from speculation?
Answer: If you believe the spot exchange rate will be 1.55$/£
, you should short the
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