A country exhibits the paradoxical situation of having negative net investment income (NII) of -100 and a

positive net international investment position (NIIP) of 1000. Economists opinions about this are divided.

Group A thinks that the explanation lies in the fact that, because of the bad reputation of the country

in world financial markets, foreign investors charge a higher interest rate when they lend to this country,

relative to the interest rate the country receives on its investments abroad. Group B believes that domestic

investors inflate their gross international asset positions to look like big players in the world market.

1. Calculate the interest-rate premium that would explain the paradox under group As hypothesis, assuming

that the interest rate on assets invested abroad is 5 percent and that the countrys gross

international asset position is 4000.

2. Calculate the amount by which domestic investors inflate their gross foreign asset positions under group

Bs hypothesis assuming that the interest rate on assets and liabilities is 5 percent