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Question 1

The two types of trade, intertemporal and pure asset swap ________ perfect substitutes, because ________.

Answer 1

The two types of trade, intertemporal and pure asset swap could possible be perfect substitutes, because different economic states occur at different points in time

Question 2

People who are risk averse value a collection of assets on the basis of what?

Answer 2

value a collection of assets not only on the basis of its expected returns but also on the basis of the risk of that return.

Question 3

Risk averse people may hold bond denominated in several different currencies?

Answer 3

yes

Question 4

Imagine that there are two countries, Home and Far Far Away, and that residents of each own only one asset, domestic land yielding an annual harvest of mangoes. Assume that the yield on the land is uncertain. Half the time, Home’s land yields a harvest of 5,000 tons of mangoes at the same time as Far Far Away’s land yields a harvest of 2,500 tons. The other half of the time the outcomes are reversed. The average for each country mango harvest is

Answer 4

= (0,55000)+(0,52500)

= 3750

Question 5

Describe three types of gains from trades?

Answer 5

trades of goods or services for goods or services, trades of goods or services for assets, and trades of assets for assets

Question 6

What is the basic motive for asset trade?

Answer 6

increase expected returns and reduced risk

Question 7

Using international asset trade, can countries eliminate all risk?

Answer 7

no, never really eliminate all risk

Question 8

What are the three types of gains from international transactions between the residents of different countries?

Answer 8

(1) Gains due to comparative advantage and economies of scale.
(2) Gains due to inter-temporal trade, which is the exchange of goods and services for claims to future goods and services, which is for assets.
(3) Gains due to trades of assets for assets, such as the exchange of real estate located in London for U.S. Treasury bonds.

Question 9

How international trade in assets can make both countries better off?

Answer 9

By allowing them to reduce the riskiness of the return on their wealth and by allowing the two parties to diversify their portfolios, i.e., to divide their wealth among a wider spectrum of assets, and thus reduce the amount of money placed on one specific asset.

Question 10

Suppose you are offered a gamble in which you win $1,000 1/3 half the time but lose $800 2/3 half the time. If you are risk lover will you take the gamble? What will your expected payoff be?

Answer 10

The expected payoff would be:
1/3 (+$1,000) + 2/3 (-$800) = -$200.
From this calculation, we know that risk-neutral individuals would not take the gamble, but it is not clear what a risk-loving individual would do.

Question 11

The following simple two-country question illustrates how countries are made better off by trade in assets. Imagine that there are two countries, Home and Foreign, and that residents of each own only one asset, domestic land yielding an annual harvest of kiwi fruit. Assume that the yield on the land is uncertain. Half the time, Home’s land yields a harvest of 100 tons of kiwi fruit at the same time as Foreign’s land yields a harvest of 50 tons. The other half of the time the outcomes are reversed. The Foreign’s harvest is 100 tons, but the Home harvest is only 50. Calculate the average, for each country of kiwi harvest.

Answer 11

The average for each country of kiwi harvest is: 0.5 ∗ 100 + 0.5 ∗ 50 = 75 tons of kiwi

Question 12

As a country begins to liberalize its capital account, what would you expect to happen to the difference between the interest rates for similar assets in this country and another country with open capital markets?

Answer 12

get smaller

Question 13

After Bretton Woods period, countries chose to control

Answer 13

fixed exchange rate and freedom of international capital movements.

Question 14

Eurocurrencies trading occurs everywhere except …

Answer 14

the United States.

Question 15

Eurodollars are

Answer 15

dollar deposits located outside the United States.

Question 16

Besides world trade growth, what can explain the growth of international banking since the 1960s?

Answer 16

desire of depositors to hold currencies outside the jurisdiction of the countries that issue them

Question 17

What are the types of institution banks used to conduct foreign business?

Answer 17

agency offices, subsidiary banks, and foreign branches

Question 18

The scale of transactions in the international capital market has

Answer 18

grown more quickly than world GDP since the early 1970s.

Question 19

If a country chooses to have a monetary policy oriented toward domestic goals and a fixed exchange rate, then

Answer 19

it cannot have the freedom of international capital movements.

Question 20

If a country chooses to have a monetary policy oriented toward domestic goals and the freedom of international capital movements, then

Answer 20

it cannot have a fixed exchange rate.

Question 21

Regulatory asymmetries can explain why the following places have become main Eurocurrency centers

Answer 21

London, Luxembourg, and Hong Kong.

Question 22

What do you expect would be the effects of 9/11 on the size of the Eurocurrency markets?

Answer 22

Will increase due to fear that foreign deposits in the U.S. will be frozen unless coordinated efforts by all countries.

Question 23

Explain why a London Eurobank has a competitive advantage over a bank in New York in attracting dollar deposits.

Answer 23

It can pay more because the London bank is not subject to any reserve requirements (neither American nor British), whereas the New York bank is subject to U.S. reserve requirements.

Question 24

What is the difference between the minimum interest rates each bank can offer and still make a profit if the deposit is $500 for 1 year?

Answer 24

1.6%

Question 25

is bank failure limites to banks that have mismanaged their assets?

Answer 25

Bank failure is NOT limited to banks that have mismanaged their assets.

Question 26

T o F: Bank failures inflict serious financial harm on individual depositors, but fortunately do not harm the macroeconomic stability of the economy.

Answer 26

False. Bank failures inflict not only serious financial harm on individual depositors, but also harm the macroeconomic stability of the economy.

Question 27

Banks in the U.S.

Answer 27

are prevented from holding assets that are “too risky.”

Question 28

A bank faced with the wholesale loss of deposits is likely to shut down despite fundamentally sound balance sheet. Why could this be?

Answer 28

Many bank assets are illiquid and cannot be sold quickly to meet deposit obligations without substantial loss to the bank.

Question 29

The main problem with securitization is that

Answer 29

governments are not able to monitor bank assets or to asses a bank’s risk to the soundness of the international banking system.

Question 30

The case where people purposely act in a careless way, for example, driving recklessly because they are insured, is called

Answer 30

moral hazard.

Question 31

Capital markets of poor developing countries that liberalized their financial systems to allow private asset trade with foreigners are called

Answer 31

emerging markets.

Question 32

What is a difficulty encountered in regulating international banking?

Answer 32

absence of reserve requirements

Question 33

What is an appropriate definition for “securitization”?

Answer 33

the repackaging of bank assets into readily marketable forms

Question 34

What caused a major economic shock in August 2007?

Answer 34

U.S. mortgage market

Question 35

Observers believe that the largely unregulated nature of global banking activity leaves the world financial system vulnerable to bank failure on a massive scale. Is this a real threat? If so, what measures have governments taken to reduce it?

Answer 35

Yes, this is a real threat. A high level of inter-bank depositing implies that problems affecting a single could be highly contagious and could spread quickly to banks with which it is thought to do business. In response to this threat, the Basel Committee was created in 1974 to coordinate the surveillance and regulation among bank regulators from different countries.

Question 36

“Bank failure may not be limited to banks that have mismanaged their assets.” Explain why?

Answer 36

A sound bank faced with the wholesale loss of deposits is likely to close its door even if the asset side of its balance sheet is fundamentally sound because many bank assets are illiquid and cannot be sold quickly to meet deposit obligations without substantial loss to the bank. Students should stress the atmosphere of financial panic, which will lead to self-fulfilling expectations.

Question 37

Describe the extensive “safety net” that has been set up in the United States in order to reduce the risk of bank failure.

Answer 37

(1) Deposit insurance
(2) Reserve requirements
(3) Capital requirements and asset restrictions
(4) Bank examination
(5) Lender of last resort facilities

Question 38

Explain the difficulties in regulating international banking.

Answer 38

(1) No deposit insurance, in particular, inter-bank deposits are unprotected
(2) Absence of reserve requirements
(3) bank examination more difficult to enforce
(4) not clear which group of regulators has responsibility for monitoring a given bank’s assets
(5) not clear which central bank, if any, is responsible for providing Lender of Last Resort assistance.

Question 39

What are three things to measure for in evaluating the performance of the capital markets?

Answer 39

level of portfolio diversification, intertemporal trade, efficiency of foreign exchange

Question 40

In the Interest Parity Condition, Rt - R
t = (- Et)/Et + xt, where Rt - Rt is the interest rate differential and (- Et)/Et is the expected change in the exchange rate, what does xt stand for if it potentially is a market efficient difference between the two?

Answer 40

risk premium

Question 41

Why might a country’s savings rate have a high positive correlation to its investment rate?

Answer 41

governments’ regulation to avoid large current account balances

Question 42

Large differences in interest rates between countries would indicate that

Answer 42

there are unrealized gains from trade.

Question 43

Statistical studies of the relationship between interest rates and later depreciation rates show that the interest difference is or isn’t a good predictor of large swings in the exchange rates

Answer 43

the interest difference has been a very bad predictor in the large swings of exchange rates.

Question 44

Explain why large interest rate differences would be strong evidence of unrealized gains from trade.

Answer 44

The difference between onshore and offshore interest rates on similar assets denominated in the same currency should be small if information about global investment opportunities is transmitted efficiently. Data show that this is the case for the U.S., Germany, Japan and the Netherlands.