Finance 475

Solutions to Problem Set #1

1) Suppose that a BMW costs E 45,000 in Germany and that the current USD/EUR exchange rate is

.7624.  Calculate the dollar price of the BMW.

Note that the exchange rate is in terms of Euros per dollar (E/\$).  Therefore, to get the dollar price, divide by the exchange rate.

45,000 / .7624 = \$59,024.  Notice the units.....(E/BMW)/(E/\$) = (1/BMW)/(1/\$) = (\$/BMW)

2)  Consider the following exchange rates:

EUR/USD  = 1.2500 (\$/Euro)

How could you use this information to make money in the currency markets?

First, calculate the implied cross rate between USD and Euros.    1.355 (CAD/Euro) / 1.10 (CAD/\$) = 1.23 (\$/Euro).  Therefore, the Euro is overpriced

in the market (relative to dollars).  Any profitable  trade will involve selling Euros and buying dollars.  For example:

CAD 1.10 / 1.3550 (CAD/Euro) = .812 Euros.  Now Convert to Dollars .812 Euros * 1.25 (\$/Euro) = \$1.014 (1A 1.4% return).

3) Suppose that you took a short position on 12,500,000 Japanese Yen future (remember, a short

position involves selling Yen) at a price of 104.5 Yen/\$.  If the spot rate on the contract's expiration date

was 103.45 Yen/\$, calculate your profit/loss from the futures contract.

Your short position allows you to sell Yen at a price of 104.5 Yen/\$.  At a spot rate of 103.45 (Yen/\$), you would need to spend

Y12,500,000/103.45(Y/\$) = \$120,831 to acquire 12,500,000 Yen.  Then you would turn around and sell them for 104.5(Y/\$) which leaves you with

12,500,000/104.5 = \$119,617.  This is a loss of \$1,214.

4)   Consider the following balance of payments data. (in billions of dollars)

 Merchandise Exports \$100 (+) Merchandise Imports \$125 (-) Service Imports \$90 (-) Service Exports \$80 (+) Income received from abroad \$110 (+) Income payments to foreigners \$150 (-) Increase in US ownership of private assets abroad \$160 (-) Increase in foreign ownership of private US assets \$200 (+) Increase in home official reserve assets \$30 (-) Increase in foreign official assets in US \$35 (+)

Assuming that unilateral transfers are zero, find the trade balance, the current account balance,

the capital and financial accounts balance, the Balance of Payments, and the statistical discrepancy.

Trade Balance = Sum of first 4 lines = -\$35

Current Account = Sum  of first 6 lines = -\$75

Balance of Payments = Sum of all 10 Lines = -\$30

Statistical Discrepancy = -(BOP) = \$30.

5) .  Suppose that the U.S. sells F-16 fighter planes to the Israeli government.  Explain how this transaction creates

offsetting credits and debits in the Balance of Payments accounts.

The sale of the F-16 will create a (+) in the current account under merchandise exports.  This corresponding (-) will be in the capital/financial account.  The exact entry will depend on how Israel pays for the plane, but it will be under the heading "Increase in US assets help abroad".