The currency of Nuevo Rico is the Nuevo Rican peso, which trades one-to-one with

Question

The currency of Nuevo Rico is the Nuevo Rican peso, which trades one-to-one with the US dollar. Nuevo Rico has external assets of $300 billion, all denominated in dollars, and external liabilities of $400 billion, 80% of which are denominated in dollars. a) Is Nuevo Rico a debtor or creditor nation? What is its external wealth? b) What is the value of Nuevo Rico’s net dollar denominated assets in pesos? c) If the peso depreciates to 1.1 pesos to the dollar, what is the change in external wealth for Nuevo Rico?

Explanation / Answer

(a) Nuevo Rico has external assets of $300 billion and external liabilities of $400 billion.

Since, external liabilities of Nuevo Rico exceeds the external assets, Nuevo Rico is a debtor nation.

Calculate External Wealth -

External Wealth = External Assets - External liabilities = $300 billion - $400 billion = -$100 billion

The external wealth of Nuevo Rico is -$100 billion.

(b) Nuevo Rico has external assets of $300 billion and all these assets are denominated in dollars. It also has external liabilities of $400 billion and 80% of these are denominated in dollars.

So, dollar-denominated liabilities is (80/100 * $400 billion) $320 billion.

Calculate Value of Nuevo Rico's net dollar denominated assets -

Value = External assets denominated in dollars - External liabilities denominated in dollars

Value = $300 billion - $320 billion = -$20 billion

Nuevo Rican peso is traded as 1 to 1 with US dollar.

This means that the value of Nuevo Rico's net dollar denominated asset in pesos will be -20 billion pesos.

(c) The peso depreciates to 1.1 peso to the dollar. This depreciation will impact the external wealth denominated in dollars.

So,

Change in external wealth = Change in exchange rate * Net dollar denominated assets

                                      = 0.1 * (-$20 billion) = -$2 billion

The change in external wealth is -$2 billion. In terms of pesos, the change is -2 billion pesos.

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