University of New South Wales
School of Economics
International Macroeconomics
Question Set 2
NOTE: Submit Exercise 2 in the Week 3 section (online submission). Refer to Moodle for exact
submission deadline. Your assignment must be typed, not hand-written. Make sure you put your
name and zID.
Exercise 1 In an Excel spreadsheet, compute the variables you defined in Exercise 4 of Question
Set 1 (last week) for each year. You can check that your formulas are correct by summing the
current, capital account, financial a ccount, a nd t he s tatistical d iscrepancy. T he v alue s hould be
zero in principle.
Turn in one chart for each part below. The charts should be neat and carefully labelled. You
do not need to turn in a printout of your spreadsheet — only the charts should be submitted.
(a) For the years 1960–2022, plot the current account, trade balance, net factor income from
abroad, and net unilateral transfers, each as a percentage of GDP. You are actually required
to find the GDP data on your own. All four variables should be on the same plot. The x-axis
should be years.
(b) For the years 1960–2022, plot the financial and capital account balance, each as a percentage
of GDP. Both variables should be on the same plot. The x-axis should be years.
(c) Repeat part (a) and (b), but for a country other than Australia or the United States. The
starting year does not have to be 1960, but your time series should span at least 40 years.
Exercise 2 Consider a Dutch investor with 2,000 euros to place in a bank deposit in either the
Netherlands or Great Britain. The (one-year) interest rate on bank deposits is 2% in Britain and
4.04% in the Netherlands. The (one-year) forward euro-pound exchange rate is 1.575 euros per
pound and the spot rate is 1.5 euros per pound. Answer the following questions, using the exact
equations for UIP and CIP as necessary.
(a) What is the euro-denominated return on Dutch deposits for this investor?
(b) What is the (riskless) euro-denominated return on British deposits for this investor using
forward cover?
(c) Is there an arbitrage opportunity here? Explain why or why not. Is this an equilibrium in
the forward exchange rate market?
1
(d) If the spot rate is 1.5 euros per pound, and interest rates are as stated previously, what is the
equilibrium forward rate, according to covered interest parity (CIP)?
(e) Suppose the forward rate takes the value given by your answer to (d). Compute the forward
premium on the British pound for the Dutch investor (where exchange rates are in euros
per pound). Is it positive or negative? Why do investors require this premium/discount in
equilibrium?
(f) If uncovered interest parity (UIP) holds, what is the expected depreciation of the euro (against
the pound) over one year?
(g) Based on your answer to (f), what is the expected euro-pound exchange rate one year ahead?
Exercise 3 You are a financial adviser to a U.S. corporation that expects to receive a payment
of 40 million Japanese yen in 180 days for goods exported to Japan. The current spot rate is 100
yen per U.S. dollar (E$/¥ = 0.01000). You are concerned that the U.S. dollar is going to appreciate
against the yen over the next six months.
(a) Assuming the exchange rate remains unchanged, how much does your firm expect to receive
in U.S. dollars?
(b) How much would your firm receive (in U.S. dollars) if the dollar appreciated to 110 yen per
U.S. dollar (E$/¥ = 0.00909)?
(c) Describe how you could use an options contract to hedge against the risk of losses associated
with the potential appreciation in the U.S. dollar.
Exercise 4 Suppose quotes for the dollar-euro exchange rate, E$/e , are as follows: in New York,
$2.1 per euro; and in Tokyo, $2.05 per euro. Describe how investors use arbitrage to take advantage
of the difference in exchange rates. Explain how this process will affect the dollar price of the euro
in New York and Tokyo.
Exercise 5 Your U.S. firm needs 10,000 Mexican pesos to pay for imported parts one year from
today. Looking to remove the exchange rate risk from the payment, you devise two strategies.
(a) Put X in a U.S. bank account that earns 5% interest per year. Buy a forward contract to
purchase pesos at 0.2 dollars per peso in one year. What is the dollar-cost (X) of the imported
parts under this strategy?
2
(b) If covered interest parity holds, is there an advantage to the following strategy? Sell Y dollars
for pesos today and put the pesos in a Mexican bank account that earns 20% interest per year.
(c) What is the spot exchange rate (in dollars per peso) if CIP holds?
3