International Finance

Question 1

Explain a trade deficit

Answer 1

A trade deficit occurs when the value of a country’s imports exceeds the value of its exports

Question 2

Explain a trade surplus

Answer 2

A trade surplus occurs when the value of a country’s exports exceeds the value of its imports.

Question 3

Define the balance of payments

Answer 3

The balance of payments is a yearly summary of all the economic transactions between residents of one country and residents of the rest of the world.

Question 4

Explain a capital surplus

Answer 4

A country runs a capital surplus when the inflow of foreign capital is greater than the outflow of domestic capital to other nations.

Question 5

If earnings are less than spending, are you running a trade deficit or surplus?

Answer 5

Trade deficit

Question 6

The current account is the sum of three items. Name them

Answer 6

1. The balance of trade
2. Net income on capital held abroad, including interest and dividends
3. Net transfer payments, such as foreign aid

Question 7

How is the balance of payments calculated?

Answer 7

Exports minus imports of goods and services

Question 8

Define the capital account

Answer 8

The capital account measures changes in foreign ownership of domestic assets including financial assets like stocks and bonds as well as physical assets.

Question 9

The investments in the capital account are divided into 3 following categories:

Answer 9

• Foreign direct investments (When foreigners construct new business plants or set up other specific and tangible operations in the United states)
• Portfolio investments (When foreigners buy U.S. stocks, bonds, and other asset claims. Unlike FDI, this switches the ownership of already existing investments and it does not immediately create new investment on net)
• Other investments (This usually consists of movements of bank deposits. For instance, a wealthy French citizen might shift his or her bank account from Paris to New York)

Question 10

Define the official reserves account

Answer 10

The official reserves account measures reserves or currency held by the government. This can include foreign currencies, gold reserves, and also international monetary fund claims known as special drawing rights

Question 11

What are exchange rates?

Answer 11

An exchange rate is the price of one currency in another currency.

Question 12

Name 3 factors that can shift the demand and supply curves for a currency:

Answer 12

1. An increase or decrease in the demand for a country’s exports tends to increase or decrease the value of its currency.
2. The more desirable or undesirable a country is for foreign investment, the higher or lower the value of that nation’s currency.
3. An increase in the demand to hold dollar reserves boosts the value of the dollar on international markets.

Question 13

Define ‘appreciation’ in terms of exchanges

Answer 13

An appreciation is an increase in the price of one currency in terms of another currency.

Question 14

Define ‘depreciation’ in terms of exchanges.

Answer 14

A fall in the price of a currency is called depreciation.

Question 15

What’s the cause of an increase in the supply of a currency?

Answer 15

An increase in the supply of a currency causes the currency to lose some of its value.

Question 16

Explain the difference between the nominal exchange rate and the real exchange rate

Answer 16

The nominal exchange rate is the rate at which you can exchange one currency for another. The real exchange rate is the rate at which you can exchange the goods and services of one country for the goods and services to another.

Question 17

How would you calculate the real exchange rate between the United states and japan?

Answer 17

You need to know the nominal exchange rate plus the price of a similar basket of goods in both the United states and japan.

For example, an exchange rate of 1 dollar to 80 yen means very different things depending on whether an order of sushi costs 1 yen, 1 million yen, or about 240 yen. If an order of sushi costs 3 dollars in the United states and 240 yen in Japan, then the real exchange rate is about 1:1.

Question 18

Explain the Purchasing power parity theorem

Answer 18

The real purchasing power of a monetary value should be about the same, whether it is spent at home or converted into another currency and spent abroad.

In other words, the quantity of goods and services that can be obtained for a given currency should be about the same everywhere, adjusting for the costs of trading those goods and services.

Question 19

Explain the Purchasing power partiy

Answer 19

Purchase power parity is an application of the law of one price, the principle that if trade were free then identical goods should sell for about the same price throughout the world

Question 20

Is the Purchasing Power parity true in reality?

Answer 20

The PPP-Theorem is only approximately true.
Purchasing power parity is limited by the costs of trading, transacting, and shuffling resources. That is one reason why purchasing power parity holds only approximately.

Question 21

At least three constraints on trade prevent prices from being fully equalized across boarders. Name them:

Answer 21

Transportation costs,
The fact that some goods cannot be shipped at all,
Tariff Quotas.

Question 22

What’s the ‘twin defects’?

Answer 22

An appreciation makes US exports more expensive, thus reducing US exports. Thus, a budget deficit can cause a trade deficit.

Question 23

What’s the difference between a fixed and a floating exchange rates?

Answer 23

A floating exchange rate is one determined primarily by market forces. A fixed or pegged exchange rate means that a government or central bank has promised to convert its currency into another.

Question 24

What are the three forms of a fixed exchange rate system?

Answer 24

1. Simply adopting the money of another country
2. Setting up a currency union
3. Backing a currency with high levels of reserves and promising convertibility at a certain rate.

Question 25

Explain how setting up a currency union works:

Answer 25

Many European countries gave up their currencies and created the euro, a common currency under the supervision of the European Union and shared by 17 different EU countries

Question 26

What’s a dirty/ managed float?

Answer 26

A currency whose value is not pegged/ fixed, and governments will intervene extensively in the market to keep the value within a certain range.

Question 27

What’s the International monetary funds (IMF)

Answer 27

The IMF serves as an international lender of last resort.

When countries experience financial troubles, the IMF steps in to organize a rescue package, lend money, and monitor the economic situation.

Often the loans are tied to a country’s willingness to take the IMF economic advice

Question 28

What’s the World bank

Answer 28

The world bank lends money for specific projects in developing countries. This includes loans for water projects, roads, damns, health care, and environmental projects, among other activities.

Question 29

What are world bank loans tied to?

Answer 29

World bank loans are tied to the use of bank expertise and the understanding that the borrowing country will work cooperatively with the Bank