1) \"A balance of trade deficit must always be offset by net capital inflows fro
ID: 1181689 • Letter: 1
Question
1) "A balance of trade deficit must always be offset by net capital inflows from abroad." Agree or disagree with this statement and explain.
2) Suppose a Japanese firm buys a 1 year treasury bill with a face value of $10,000 today for $9400. If the value of the dollar declined from 90 to 80 yen during the year, what rate of return does the Japanese firm earn on its investment?
6) The treasurer of a U.S. firm noted that although short run deposits in Swiss bank accounts had earned the firm only a 3% annualized return when measured in Swiss francs, in dollars the firm had realized a 12% rate of return. Explain as precisely as possible how this was possible.
7) In recent years the exchange rate of the $ has been noticeably high against the yen. If for some reason investors around the world now decide that this increase is a temporary phenomena and that the $ will fall relative to the yen in coming months, what would be the effect on prices of U.S. Treasury Securities? Explain.
8) Do US producers of tradable goods prefer a strong dollar or a weak dollar in currency markets? Explain.
Explanation / Answer
1)True. BP (Balance of payments)= KA (Capital Account Surplus) +CA (Current Account Surplus)
In BP accounting, the balance is always zero so KA=-CA. So a trade deficit (-CA) will be accompanied by a capital account surplus (KA) which means inflows from abroad.
2) The T-Bill would have cost 9400*90 or 846,000 yen. The rerurn would be 10,000*80 or 800,000 yen. Thus there would have been a 46,000 loss. 46,000/846,000= a 5.44% loss.
6) If the Swiss Franc had appreciated against the dollar then the Swiss francs deposited would have bought more dollars when the investment matured. That would have boosted the rate of return from 3% to 12%.
7). If the dollar is going to fall against the yen, this makes investments in US Dollars less attractive to Japanese investors because their investment will be worth less in yen at maturity. This will cause demand to drop and thus prices to fall.
8) U.S. producers favor a weak dollar because the foreign buyer can purchase more of their goods in terms of his own currency, because it has appreciated against the dollar. This will cause an increase in demand for exports from the U.S. to the foreign buyer.
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