Part 1 (Please choose 2 questions to answer)

1. What is BOP? Please explain each part of BOP.

2. What is PPP and the law of one price? Please explain.

3. What are the functions of foreign exchange?

Part 2 (Please choose 2 questions to answer)

4. What is the current account balance of a nation with a government budget deficit of $128

billion, private saving of $806 billion, and domestic capital formation of $777 billion?

5. For each of the following, is it part of demand for yen or supply of yen in the foreign exchange market?

a. A Japanese firm sells its U.S. government securities to obtain funds to buy real estate in Japan.

b. A U.S. import company pays for glassware purchased from a small Japanese producer. c. A U.S. farm cooperative receives payment from a Japanese importer of U.S. oranges. d. A U.S. pension fund uses some incoming contributions to buy equity shares of several Japanese companies through the Tokyo stock exchange.

6. The following exchange rates exist on a particular day.

Spot exchange rate: U.S. $1.400/euro

Forward exchange rate (90 days): U.S. $1.427/euro

The following (annualized) interest rates on 90-day government bonds also exist on this day:

Euro-denominated bonds: 8%

U.S. dollardenominated bonds: 16%

a. Financial investors in all countries have the expectation that the spot exchange rate in 90 days will be 0.7100 euro/U.S. dollar. Are investors expecting the euro will appreciate or depreciate during the next 90 days?

b. Consider the comparison between investments in U.S. dollardenominated bonds and euro-denominated bonds, with any foreign investment done as uncovered foreign investment. In which direction (between the United States and the euro area) will there be an incentive for uncovered investment to flow, based on a comparison of returns? Calculate the relevant returns and explain your answer.