International finance questions

short answers questions

Questions for the final exam. Question 1 Consider the following statement: \"In order to stabilize the international monetary system we should set the exchange rates at their purchasing power parity (PPP) rates. Once the exchange rates are aligned (according to PPP), central banks around the world would adjust monetary policy so as to maintain them.\" Assuming that there all countries can easily achieve the necessary price levels for such a policy, carefully (and fully) describe the problems that might arise from using the PPP rate as a guide to the equilibrium exchange rate. Question 2 During the late 1980s Japanese interest rates were 400 basis points below the U.S. rates. This big difference prompted some real estate developers in the U.S. to borrow in Yen to finance their projects. Comment on their strategy (hint: think about the international Fisher effect and issues when borrowing in a foreign currency). Question 3 Suppose that U.K. government bonds are currently paying higher interest rates than comparable U.S. Treasury bonds. Suppose the Bank of England (the central bank) eases the money supply to drive down interest rates. How is an American investor in U.K. government bonds likely to fare? Question 4 Explain the purchasing power parity, both the absolute and relative versions. What causes the deviations from the purchasing power parity? Give four possible reasons for these deviations briefly explaining each. Question 5 What is the uncovered interest rate parity (UIRP)? Derive the equation for the UIRP by considering $1 investment in the U.S. at i($) versus an investment in GBP at i() (be sure to explain how S, the exchange rate, is measured). Rewrite the equation with S(t) in the left-hand side. Discuss the implications of the interest rate parity for the exchange rate determination. Question 6 Briefly explain the uncovered and covered interest rate parities. What does unbiasedness hypothesis state? Explain the conditions under which the forward exchange rate will be an unbiased predictor of the future spot exchange rate. Question 7 Explain and derive the international Fisher effect. Question 8 What is the prediction of the CAPM for the relationship between the forward exchange rate and the expected future spot exchange rate? Question 9 If the CAPM explains deviations of the forward exchange rate from the expected future spot exchange rate, explain why one party involved in a forward contract would be willing to enter into a contract with an expected loss. Question 10 It is often argued that forward exchange rates should be unbiased predictors of future spot exchange rates if the foreign exchange market is efficient. Is this true or false? Why? Question 11 Why is it true that the hypothesis that the forward exchange rate is an unbiased predictor of the future spot exchange rate is equivalent to the hypothesis that the forward premium (or discount) on foreign currency is an unbiased predictor of the rate of its appreciation (or depreciation)? Question 12 If the actual exchange rate for the euro value of the British pound is less than the exchange rate that would satisfy absolute PPP, which of the currencies is overvalued and which is undervalued (according to PPP)? Why? Question 13 Why is it better to use a PPP exchange rate to compare incomes across countries than an actual exchange rate? Question 14 What is the real exchange rate, and how are fluctuations in the real exchange rate related to deviations from absolute PPP? Question 15 If the nominal exchange rate between the Mexican peso and the U.S. dollar is fixed, and there is higher inflation in Mexico than in the United States, which currency experiences a real appreciation and which experiences a real depreciation? Why? What is likely to happen to the balance of trade between the two countries? Question 16 Suppose that the international parity conditions all hold and a country has a higher nominal interest rate than the United States. Characterize the country's inflation rate compared to the United States, the country's expected exchange rate change versus the dollar, the country's currency forward premium (or discount) versus the dollar, and the country's real interest rate compared to the U.S. real interest rate. Question 17 Describe how three macroeconomic fundamentals - money supply, real income and the current account - affect exchange rates. Question 18 Will a MNC issuing debt in low-interest rate currencies necessarily lower its cost of funds? Why? Question 19 Should a MNC borrow primarily short term when short-term interest rates are lower than long-term interest rates? Or should it keep the maturity the same but use a floating-rate loan rather than a fixedrate loan? Explain. Question 20 Define foreign bonds, Eurobonds and global bonds. What type of regulations apply to them? Question 21 What kind of activities do international banks engage in? Give two reasons for why central banks around the world think there is a need for international banking regulation. Question 22 What is the difference between a Eurocredit, a Euronote, and a Euro-medium-term