Paf is a small country that wishes to control international capital flows. The currency of Paf is the pif. Paf put in place an exchange control whereby all current account transactions can be transferred using the normal exchange rate, but capital account transactions must be transferred at a financial pif rate. In other words, foreigners wishing to invest in assets of Paf must buy them at the financial pif rate, whereas dividends are repatriated at the normal pif rate. The current financial pif rate is 0.8 pif per dollar or I. 25 dollars per financial pif. The financial rate in dollars per pif quotes at a premium of 25 percent over the normal rate.
a. Assume that the premium of the financial rate stays constant over time. Will a U.S. investor make the same return on investment as a resident of Paf, once the asset is resold?
b. You hear that the exchange controls may be lifted and that the financial rate may disappear. Would this be good news to an existing foreign investor?
c. Would the lifting of exchange controls and removal of the financial rate be good news to a new foreign investor?