Problem Set # 3 (318)

Fall 1995

ECONOMICS 318

J.G. Gonzalez

Problem Set # 3

This problem set is due Wednesday, December 6, at the beginning of the class period. Problem sets done on notebook paper or unstapled will not be accepted. Late problem sets are unacceptable also.

1. You are given the following figures for the international transactions of Germany in 1994 (in DM -Deutsche Marks- billions):

1. Statistical discrepancy (+)	400
2. Change in DM official reserves by foreign Central Banks (decrease)	800
3. Royalty payments to U.S. movie studios	1,600
4. Repatriated earnings by foreign direct investment in Germany	10,800
5. Sales of foreign based companies by German investors	11,400
6. Purchases of German assets by foreigners (private)	7,400
7. Payments to Brazilian soccer players	800
8. Gifts made to foreign nations	4,200
9. Exports of goods	27,000
10. Gifts received from foreigners	1,800
11. Interest payments received from other countries	1,000
12. Repatriated earnings on German direct investments abroad	3,600
13. Sales of German private assets by foreigners	3,000
14. Payments to German tennis players by foreigners	8,000
15. Imports of goods	38,000
16. Purchase of Japan's Government bonds by German investors (private)	5,200

Calculate the:
a) Balance on merchandise trade.
b) Balance on services.
c) Balance on investment income.
d) Balance on goods, services, and income.
e) Balance on current account.
f) Capital account balance.
g) Change in Germany's official reserve holdings and the official reserves transaction balance (Hint: You have to find the official reserves transactions balance first).
f) Was the Bundesbank (the German Central Bank) intervention in the foreign exchange market pushing the value of the Deutsche Mark up or down with respect to foreign currencies? How do you know?

2. The following schedules represent the demand and supply for Sucres (Ecuador's currency) in Venezuela (whose currency is the Bolivar).

Exchange Rate	Quantity	Quantity
(Bolivars/Sucre)	Demanded	Supplied
42	1000	16000
34	3000	13000
26	5000	10000
18	7000	7000
10	9000	4000
2	11000	1000

a) Suppose that Ecuador and Venezuela are under a system of flexible exchange rates. What would the equilibrium exchange rate be? How many sucres would be traded in this period. Illustrate your answer by using a diagram.

b) Using your diagram explain how the bolivar/sucre exchange rate would be affected by each of the following events (in each case assume that "all other things are constant"): i. A sharp rise in Venezuela's interest rates.
ii. The appearance of hyperinflation in Ecuador (while Venezuela's inflation remains at a low level)
iii. Rapid economic growth in Venezuela.
iv. Expected fall in the value of the bolivar.

3. Suppose that in Munich you can exchange one U.S. dollar for 13 Schillings (Austria's currency), while in London you can get 156 Drachmas (Greece's currency) for one U.S. dollar, and in Athens one Schilling is being exchanged for eight Drachmas.

a) If you have US $100,000 and you want to make some money without any risk, what can you do in the international foreign exchange market? Make sure that you are specific about where you are buying and where you are selling. What is your net profit after you are done with your transactions?

b) How would your answer to part a) change if in Athens the exchange rate is now one Schilling equals 20 Drachmas.

c) What exchange rate between the Drachma and the Schilling is the only one that could prevail in the long run after arbitrage exhausts any prospective profits (assume that the other two exchange rates are fixed)?