Exam 3

Topics: United States dollar, Foreign exchange market, Currency Pages: 16 (5587 words) Published: January 19, 2013
The Balance of Payments, Exchange Rates, and Trade Deficits

1. Do all international financial transactions necessarily involve exchanging one nation’s distinct currency for another? Explain. Could a nation that neither imports goods and services nor exports goods and services still engage in international financial transactions?

Answer: The answer is almost certainly a yes. Only in rare cases would you find barter exchanges (goods and services for other goods and services). Yes, they could engage in financial transactions (the exchange of assets across countries).

2. Explain: “U.S. exports earn supplies of foreign currencies that Americans can use to finance imports.” Indicate whether each of the following creates a demand for or a supply of European euros in foreign exchange markets: a. A U.S. airline firm purchases several Airbus planes assembled in France. b. A German automobile firm decides to build an assembly plant in South Carolina. c. A U.S. college student decides to spend a year studying at the Sorbonne in Paris. d. An Italian manufacturer ships machinery from one Italian port to another on a Liberian freighter. e. The U.S. economy grows faster than the French economy.

f. A U.S. government bond held by a Spanish citizen matures, and the loan amount is paid back to that person. g. It is widely expected that the euro will depreciate in the near future.

Answer: American exports lead to an increase in the foreigncurrency bank deposit holdings of Americans. These holdings will be decreased through American purchases of imports. Hence, the foreigncurrency assets earned through exports can be used to finance imports. (a) A demand for euros: The U.S. airline must purchase euros before purchasing the Airbus planes. (b) A supply of euros: The German automobile firm must purchase U.S. dollars, or supply euros, before building the plant. (c) A demand for euros: The U.S. college student must purchase euros before studying in France. (d) A supply of euros: The Italian manufacturer must purchase U.S. dollars, or supply euros, to pay the Liberian freighter (which requires payment in U.S. dollars). (e) A demand for euros: Since the U.S. economy grows faster than the French economy, U.S. imports from France will grow faster than France's imports from the U.S. holding everything else constant. To buy these additional French goods the U.S. will purchase more (net) euros. (f) A demand for euros: The U.S. pays the Spanish citizen in U.S. dollars. The Spanish citizen then purchases euros so she has currency she can use in her home country. (g) A supply of euros: Since individuals holding euros expect the currency to depreciate in the near future they sell (supply) the euros today in an attempt to avoid the loss in the future.

3. What do the plus signs and negative signs signify in the U.S. balance of payments statement? Which of the following items appear in the current account and which appear in the capital and financial account? U.S. purchases of assets abroad; U.S. services imports; foreign purchases of assets in the United States; U.S. good exports, U.S. net investment income. Why must the current account and the capital and financial account sum to zero?

Answer: The plus sign (+) indicates a credit to the U.S. balance of payments. The negative sign (-) indicates a debit the U.S balance of payments. U.S. purchases of assets abroad: current account
U.S. services imports: current account
Foreign purchases of assets in the United States: capital and financial account U.S. good exports: current account
U.S. net investment income: current account
The balance on the current account and the balance on the capital and financial account must always sum to zero because any deficit or surplus in the current account automatically creates an offsetting entry in the capital and financial account. People can only trade one of two things with each other: currently produced goods and...
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