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We can use the asset approach




#2) We can use the asset approach to both make predictions about how the market will react to current events and understand how important these events are to investors. Consider the behavior of the Union/ Confederate exchange rate during the civil War. How would each of the following events affect the exchange rate, defined as Confederate dollars per union dollar Ec$/$?;a) The confederacy increases the money supply by 2,900% between july and December 1861;b) The Union army suffers a defeat in Battle of Chikamauga in September 1863.;c) The confederate Army suffers a major defeat with Sherman???s March in the autumn of 1864;In 2007 the country of Ikonomia has a current account deficit of $1 billion and a non reserve financial account surplus of $750 million. Ikonomias capital account is in $100 million surplus. In addition, Ikonomian factors located foreign countries earn $700 million. Ikonomia has a trade deficit of $800 million. Assume Ikonomia neither gives nor receives unilateral transfers. Ikonomia???s GDP is $9 million.;a) What happened to Ikonomia???s net foreign assets during 2007? Did it acquire or lose foreign assets during the year?;b) Compute the official settlements balance. Based on this number, what happened to the central banks (foreign) reserves.;c) How much income did foreign factors of production earn in Ikonomia during 2007?;d) Compute net factor income from abroad;e) Using the identity BOP =CA+FA+KA, show that BOP=0;f) Compute Ikonomia???s gross national expenditure, gross national income, and gross national disposable income.;4) To answer this question you must obtain date from the Breau ofEconomic Analysis,, on the U.S balance of payments tables. Go to interactive tables to obtain annual data for 2006 (the default setting is for quarterly data). It may take you some time to get familiar with how to navigate the website. You need only to refer to table 1 on the BOP accounts. Using the following for the United States.;a) trade balance, net factor income from abroad, net unilateral transfers, and current account;b) Financial account;c) Official settlements balance, referred to as ???U.S official reserve assets??? and ???foreign official assets in the U.S???;d) Nonreserve financial account;e) Balance of payments. Note this may not equal zero because of statistical discrepancy. Verify that the discrepancy is the same as the one reported by the BEA.;5) Consider the economy of Opulenza. In Opulenza, domestic investment was $400 milion, and there was $20 million in capital gains or domestic wealth during 2007. Opulenzans purchased $120 million in new foreign assets during the year, foreigners purchased $160 million in Opulenzan assets. Assume the valuation effects $1 million in capital gains or external wealth.;a) Compute the change in domestic wealth for Opulenza;b) Compute the change in external wealth for Opulenza;c) Compute the change in total wealth for Opulenza;d) Compute domestic savings for opulenza;e) Compute Opulenza???s current account. Is the CA in deficit or surplus?;f) Explain the intuition for the CA deficit/surplus in terms of savings in Opulenza, financial flows, and its domestic/ external wealth position;g) How would a depreciation in Opulenza???s currency affect its domestic, external and total wealth? Assume that foreign assets owned by Opulenzans are denominates in foreign currency.;#6) For each of the following situations, use the IS-LM-FX model to illustrate the effects of the shock. For each case, state the effects of the shock. For each case, state the effect of the shock on the following variables (increase, decrease, no change, or ambiguous.: Y,I,E,C,I,TB. Assume the government allows the exchange rate to float and makes no policy response.;a) Foreign output decreases;b) Investors expect a depreciation of the home currency;c) The money supple increases;d) Government spending increases.;#7) Assume that initially the IS curve is given by;IS1: Y=12-1.5t-30i+2G;And that the price level P is 1, and the LM curve is given by;LM1: M=Y(1-i);The home central bank uses the interest rate as its policy instrument. Initially, the home interest rate equals the foreign interest rate of 10% or 0.1. Taxes and government spending both equal 2. Call this case 1.;a) According to the IS1 curve, what is the level of output y? Assume this is the desired full employment level of output.;b) According to the LM1 curve, at this level of output, what is the level of the home money supply?;c) Plot the IS1 and LM1 curves for case 1 on a chart. Label the axes and the equilibrium values.;d) Assume that forex market equilibrium is given by i=([1/E]-1)+.10 where the two foreign return terms on the right are expected depreciation and the foreign interest rate. The expected future exchange rate is 1. What is todays spot exchange rate?;e) There is now a foreign demand shock, such that the IS curve left by 1.5 units at all levels of interest rate, and the new IS curve is given by;IS2:=Y=10.5-1.5T-30i+2G.;The government asks the central bank to stabilize the economy at full employment. To stabilize and return output back to the desired level, according to this new IS curve, by how much must the interest rate be lowered from its initial level of 0.1? (Assume taxes and government spending remain at 2.) call this case 2.;f) At the new lower interest rate and at full employment, on the new LM curve (LM2), what is the new level of the money supply?;g) According to the forex market equilibrium, what is the new level of the spot exchange rate? How large is the depreciation of the home currency?;h) Plot the new IS2 and LM2 curves for case 2 on a chart. Label the axes and the equilibrium values.;i) Return to part e. Now assume that the central bank refuses to change the interest rate from 10%. In this case, what is the new level of output? What is the money supply? And if the government decides to use fiscal policy instead to stabilize output, then, according to the new IS curve, by how much must government spending be increased to achieve this goal? Cal this case 3.;j) Plot the new IS3 and LM3 curves for case 3 on a chart. Label the axes, and the equilibrium values.


Paper#27070 | Written in 18-Jul-2015

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