Study Guide I

1.  Why has there been increased globalization?

2.  What are the fallacies about international trade mentioned in the text?

3.  What are the different groups who are opposed to globalization and why are they opposed?

4.  What are the advantages and disadvantages of globalization?

5.  Which transactions are credits and which are debits in balance of payments accounting?

6.  Which items are involved when dealing with the current account?

7.  Which items are involved when dealing with the capital and financial account?

8.  How does the balance of trade relate to national income accounting?

9.  What is the impact of financial flows and business cycles and economic growth on the balance of trade?

10.  When is a current account deficit a problem and when is it not?

11.  When is a country a net creditor and when is it a net debtor?

12.  What are the advantages to the U.S. of having the dollar as the reserve currency?

13.  What are the different types of foreign exchange transactions that can occur?

14.  What is the difference between foreign exchange futures, foreign exchange options, and forward contracts?

15.  What are the advantages and disadvantages of foreign exchange appreciation?

16.  What are the advantages and disadvantages of foreign exchange depreciation?

17.  How does two-point and three-point arbitrage work?

18.  How is the real exchange rate calculated?

19.  How is the premium (or discount) on the forward rate calculated?

20.  How is hedging used to cover foreign-exchange risk?

21.  How do swings in the business cycle affect the exchange rate in medium-run?  (Graph)

22.  How do relative price levels affect the exchange rate in the long-run?  (Graph)

23.  How do relative productivity levels affect the exchange rate in the long-run?  (Graph)

24.  How does preferences for domestic and / or foreign products affect the exchange rate in the long-run?  (Graph)

25.  How do trade barriers affect the exchange rate in the long-run?  (Graph)

26.  What is the Law of One Price and how does it relate to the Big Mac Index?

27.  How is the purchasing power parity of a currency determined?

28.  How does the interest rate affect the exchange rate in the short-run?  (Graph)

29.  How does an expected change in the exchange rate in the future affect the exchange rate in the short-run?  (Graph)

30.  How does the desire to diversify and and to seek safe havens affect the exchange rate?

31.  How does the short-run response in the market for a currency differ from the long-run response?  (Graph)

32.  How does a change in exchange rates affect costs and prices when there is some foreign sourcing?

33.  What is the Marshall-Lerner condition?

34.  What is the J-curve effect?  (Graph)

35.  What is the difference between complete pass-through and partial pass-through when dealing with changes in the exchange rate?

36.  According to the absorption approach to exchange-rate adjustment, what is the difference in the impact of a depreciation of a currency on  a trade deficit when there is unemployment versus when there is full employment?

37.  What are the factors that affect a country's choice of exchange-rate systems?

38.  What is the impossible trinity?

39.  How is the par value used to determine the cross exchange rate between two currencies?

40.  How is a fixed exchange rate maintained when market forces would otherwise lead to depreciation?  (Graph)

41.  How is a fixed exchange rate maintained when market forces would otherwise lead to appreciation?  (Graph)

42.  What are meant by the terms devaluation and revaluation of a currency?  (Graph)

43.  What are the pros and cons of a floating exchange rate system?

44.  How is a managed floating rate policy employed in the long-run versus the short-run?  (Graph)

45.  How is monetary policy used to deal with appreciating and depreciating currencies?  (Graph)

46.  How does a crawling peg work?

47.  What are the sources of currency crises?

48.  What are the benefits and problems with capital controls?

49.  What are the benefits and problems with a currency board?

50.  What are the benefits and problems with dollarization?

Practice Problems

Chapter 10:

1.  Indicate whether each of the following items represents a debit or a credit on the U.S. balance of payments:

a.  A U.S. importer purchases a shipload of French wine.

b.  A Japanese automobile firm builds an assembly plant in Kentucky.

c.  A British manufacturer exports machinery to Taiwan on a U.S. vessel.

d.  A U.S. college student spends a year studying in Switzerland.

e.  U.S. charities donate food to people in draught-plagued Africa.

f.  Japanese investors collect interest income on their holdings of U.S. government securities.

g.  A German resident sends money to her relatives in the United States.

h.  Lloyds of London sells an insurance policy to a U.S. business firm.

i.  A Swiss resident receives dividends on her IBM stock.

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Chapter 11:

2.  If the exchange rate changes from US$1.70 = 1£ to US$1.68 = 1£, what does this mean for the dollar?  For the pound?  What if the exchange rate changes from US$1.70 = 1£ to US$1.72 = 1£?

3.  Suppose US$1.69 = 1£ in New York and US$1.71 = 1£ in London.  How can foreign exchange arbitragers profit from these exchange rates?  Explain how foreign exchange arbitrage  results in the same dollar /  pound exchange rate in New York and London.

4.  Suppose the spot rate of the pound today is US$1.70 and the three month forward rate is US$1.75.

a.  How can a U.S. importer who has to pay 20,000 pounds in three months hedge foreign exchange risk?

b.  What occurs if the importer did not hedge and the spot rate of the pound in three months is US$1.80?

c.  Calculate the annualized premium or discount on the pound in this situation.

5.  Suppose you have the following spot exchange rates:  US$1 = 3 francs, US$1 = 4 schillings, and 1 franc = 3 schillings.  If you had US$1,000,000, how much profit could you make using three point arbitrage?

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Chapter 12:

6.  Use supply and demand analysis for the Japanese yen to analyze the effect on the exchange rate (dollars per yen) between the U.S. dollar and the Japanese yen for each of the following events:

a.  Voter polls suggest that Japan's government will be replaced by radicals who pledge to nationalize all foreign-owned assets.

b.  Both the Japanese and U.S. economies slide into recession, but the Japanese recession is less severe than the U.S. one.

c.  The Federal Reserve adopts a tight monetary policy that dramatically increases U.S. interest rates.

d.  Japan's exports to the U.S. fall.

e.  The U.S. unilaterally reduces tariffs against Japanese products.

f.  Japan encounters severe inflation, while price stability exists in the U.S.

g.  Fears of terrorism reduce U.S. tourism in Japan.

h.  The Chinese government invites U.S. firms to invest in natural resource development..

i.  The rate of productivity growth in Japan decreases sharply.

j.  An economic boom occurs in Japan, which induces the Japanese to purchase more U.S.-made autos, trucks, and computers.

k.  Ten percent inflation occurs in both Japan and the U.S.

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7.  Suppose the dollar / renminbi exchange rate equals $0.153 per renminbi.  According to the purchasing-power-parity theory, what will happen to the exchange rate under each of the following circumstances?

a.  The U.S. price level increases by 10 percent and the price level in China is constant.

b.  The U.S. price level increases by 10 percent and the price level in China increases by 20 percent.

c.  The U.S. price level decreases by 10 percent and the price level in China increases by 5 percent.

d.   The U.S. price level decreases by 10 percent and the price level in China decreases by 15 percent.

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8.  Suppose the nominal interest rate on three-month Treasury bills is 8 percent in the United Sates and 6 percent in the Eurozone, and the rate of inflation is 10 percent in the U.S. and 4 percent in the EZ.

a.  What is the real interest rate in each area?

b.  In which direction would international investment flow in response to these real interest rates?

c.  What impact would these investment flows have on the dollar's exchange value?

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Chapter 14:

9.  Suppose a U.S. auto manufacturer obtains all of its auto components in the United States and that its costs are denominated in dollars.  Assume the dollar's exchange value appreciates by 50 percent against the Mexican peso.  What impact does the dollar appreciation have on the firm's international competitiveness?  What about a dollar depreciation?

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10.  Suppose a U.S. auto manufacturer obtains some of its auto components in Mexico and that the costs of these components are denominated in pesos; the costs of the remaining components are denominated in dollars.  Assume the dollar's exchange value appreciates by 50 percent against the peso.  Compared to your answer in the previous question, what impact does the dollar appreciation have on the firm's international competitiveness?  What about a dollar depreciation?

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11.  Assume the U.S. exports 1,000 computers at a price of US$3,000 each and imports 150 British autos at price of £10,000 each.  Assume the dollar/pound exchange rate is US$2 per pound.

a.  Calculate, in dollar terms, the U.S. export receipts, import payments, and trade balance prior to a depreciation of the dollar's exchange value.

b.  Suppose the dollar's exchange value depreciates by 10 percent.  Assuming that the price elasticity of demand for U.S. exports equals 3.0 and price elasticity of demand for U.S. imports equals 2.0, does the dollar depreciation improve or worsen the U.S. trade balance?  Why?

c.  Now assume the price elasticity of demand for U.S. exports equals 0.3 and price elasticity of demand for U.S. imports equals 0.2

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Answers to recommended problems