国际投资学在线试题库英文版M02-SOLN9695-06-TB-C02

Chapter2ForeignExchangeParityRelationsNote:InthesixtheditionofGlobalInvestments,theexchangeratequotationsymbolsdifferfrompreviouseditions.Weadoptedtheconventionthatthefirstcurrencyisthequotedcurrencyintermsofunitsofthesecondcurrency.Forexample,€:$1.4indicatesthatoneeuroispricedat1.4dollars.Inpreviouseditionsweusedthereversedconvention$/€1.4,meaning1.4dollarspereuro.Allproblemsinthistestbankstillusetheoldconventionandhavenotbeenadaptedtoreflectthenewquotationsymbolsusedinthe6thedition.QuestionsandProblemsThecurrentSwissfranc/U.S.dollarspotexchangerateis2Swissfrancsperdollar,orCHF/$2.Theexpectedinflationoverthecomingyearis2%inSwitzerlandand5%intheUnitedStates.Whatistheexpectedvalueforthespotexchangerateayearfromnow,accordingtopurchasingpowerparity?SolutionAccordingtothepurchasingpowerparityrelation,whichstatesthatspotexchangerateadjustsperfectlytoinflationdifferentialbetweentwocountries,theexpectedvaluefortheexchangerate,ayearfromnow,isgivenby:S21.021.9429 CHF/$.1 1.05ThespotexchangerateisCHF/$2.00.Theone-yearinterestrateisequalto4%inSwitzerlandand8%intheUnitedStates.Whatshouldthecurrentvalueoftheforwardexchangeratebe?SolutionAccordingtotheinterestrateparityrelation,theforwarddiscount(orpremium)isequaltotheinterestratedifferential.WithFbeingthecurrentvalueoftheone-yearforwardexchangerate,wehave:F2.1.041.9259 CHF/$.1.08The¥/€spotexchangerateis130yenpereuro.InflationratesinJapanandGermanyaresimilar.Overthepastyearthe¥/€ratemovedfrom110to130.IsthisgoodnewsorbadnewsforJapanesefirmscompetingwithGermanfirmsintheautomobilemarket?10 Solnik/McLeavey•GlobalEditionSolutionTheweakeningoftheyenagainsttheeuroisgoodnewsforJapanesecompetitorsintheautomobilemarket.ForthesameamountofeurosearnedfromtheirsalesinGermany(forinstance€1billion),theJapanesecompanieswillhavethepossibilitytoconverttheirearningsintoagreateramountofyen(130billionyen)thantheyusedto(110billionyen).Also,theirrelativecoststructureimprovescomparedtotheirGermancompetitors.Shouldnominalinterestratesbeequalacrosscountries?Whyorwhynot?SolutionThenominalinterestratecanbedefinedasthesum(ormorepreciselythecompounding)oftherealinterestrateandtheexpectedinflationrateoverthetermoftheinterestrate.AlthoughtheinternationalFisherrelationclaimsthatrealinterestratesareequalacrosstheworld,weknowthatexpectedinflationcanbeverydifferentfromonecountrytoanother.Therefore,thereisnoreasonwhynominalinterestratesshouldbeequalacrosscountries.Shouldrealinterestratesbeequalacrosscountries?Canafinancialarbitragetakeplaceincaseofsignificantandpersistentrealinterestratedifferences?Toanswerthisquestion:Firstassumethatexchangeratesarefullypredictableandfollowpurchasingpowerparity(PPP).ThenassumethattheyareuncertainbutthatPPPholds.Finally,assumethatexchangeratesareuncertainandthatPPPdoesnothold.SolutionNotnecessarily.Thiscanbeshownbyobservingthatnorisk-freearbitragecanexploitdifferencesinrealinterestrates.Let’sstartwithasimpleworldandprogressivelyaddmorecomplexrealities.AssumethattherealratesoneurosandU.S.dollarsarerespectively2%and4%.Let’susethelinearapproximation:ExchangerateisfullypredictableandPPPholds.Differencesinrealinterestratescanbearbitragedaway.Onecansimplyborrowin€,transferthe€in$atthespotexchangerateandlendthe$.Itcaneasilybeseenthatthisstrategyyieldsexactlytherealinterestratedifferential(2%)withoutanycapitalinvestment.SincetheexchangerateisfullypredictableandfollowsPPP,weknowforsurethatitsfuturedepreciationisexactlyequaltothe(certain)expectedinflationdifferential.Thenetresultontheinvestmentstrategyistherealinterestratedifferential.ExchangerateisuncertainbutPPPholds.Weknowthatthefutureexchangeratewillexactlyreflecttheobservedfutureinflationdifferential(PPP)butwearenotsureaboutfutureinflationrates.Theinterestratedifferentialisequaltotherealinterestratedifferentialplustheexpectedinflationdifferential,whiletheexchangeratedepreciationwillbeequaltotheex-postrealizedinflationdifferential.Thedeviationbetweenexpectedandrealizedinflationmakestheabovearbitrageuncertain.However,thedeviationislikelytobesmallforshorthorizons,soarbitragewillinsurethattheshort-termrealinterestratedifferentialissmall.PPPdoesnothold.Realexchangeratescanbeveryvolatileintheshortrun.Norisklessarbitragecantakeplacetotakeadvantageofrealinterestratedifferentials.Chapter2ForeignExchangeParityRelationsPAGE15Chapter2ForeignExchangeParityRelationsPAGE15PAGE14Solnik/McLeavey•PAGE14Solnik/McLeavey•GlobalInvestments,SixthEditionHerearesomestatistics:Inflation(annualrate)One-yearinterestrateSpotexchangerate(CHF/£)Expectedexchangerate(inoneyear)One-yearforwardexchangerate(CHF/£)

GBP(£)10%12%

CHF4%?%3%?%?%Basedonthelinearapproximationofinternationalparityrelations,replacethequestionmarkswiththeappropriateanswers.SolutionAssumingthatinternationalparityrelationshold,herearetheappropriateanswers(linearapproximation):GBP(£) CHFInflation(annualrate)10%4%One-yearinterestrate12%6%Spotexchangerate(CHF/£)3%Expectedexchangerate(inoneyear)2.84%One-yearforwardexchangerate(CHF/£)2.84%Calculationscanalsobeperformedwithoutthelinearapproximation.Pafisasmallcountry.ItscurrencyisthepifandtheexchangeratewiththeU.S.dollarwas2pifsperdollarin1980.Theinflationindexesin1980wereequalto100intheUnitedStatesandinPaf.Twentyyearslater,theinflationindexeswereequalto400intheUnitedStatesand200inPaf.Thecurrentexchangerateis0.9pifsperdollar.WhatshouldthecurrentexchangeratebeifPPPprevailed?IsthePifover/undervaluedaccordingtoPPP?SolutionAccordingtothepurchasingpowerparityrelation,whichstatesthatthespotexchangerateadjustsperfectlytoinflationdifferentialbetweentwocountries,theexpectedvaluefortheexchangerate,twentyyearsfromnow,isgivenby:S221Pif/$.1 4AccordingtoPPP,thePifisovervalued.FundamentalValueBasedonAbsolutePPP.Ideally,onewouldliketocomparedirectlythepriceofgoodsintwocountriestoseeifanexchangerateconformstoabsoluteorwhetheritisovervaluedorundervaluedinrealterms.AsmentionedinChapter2,thiscanonlybedoneforsomeindividualgoodsthatareclearlycomparable(“lawofoneprice”),andtheestimationfordifferentgoodscanleadtoopposingconclusions.InChapter2,weprovideananalysisbasedonthewell-knownBigMacreportofTheEconomist.Ofcourse,theBigMacisaveryparticularproductandafundamentalPPPvaluecanbecomputedonawiderangeofproducts.Theresultsareoftenconflicting.Forexample,onecanlookatproductionpricesratherthanconsumptionprices.Somestudiesareconductedbylookingatlaborcosts.Ratherthanlookingatunitlaborcostsforunskilledworkers,asisoftendone,theexhibitbelowreportstheaverageannualremunerationofthechiefexecutiveofficer(CEO)ofindustrialcompanieswithannualrevenuesof$250millionto$500millionintenselectedareasoftheworld.ThefiguresarealsofromApril1998.Theyincludeallformsofcompensation,suchasbonuses,perks,andstockoptions,butarenotadjustedfordifferenttaxesorcostsofliving.ThefirstcolumngivesthetotalCEOcompensationmeasuredinU.S.dollarsusingtheactualexchangerate,whichisindicatedinthesecondcolumn.ThethirdcolumngivesthefundamentalPPPvalueofeachcurrency,impliedbythenationalCEOcompensations.ItistheexchangeratewiththedollarthatwouldmakeCEOcompensationidenticalinallcountries.Thefourthcolumngivestheactualovervaluation(ifpositive)orundervaluation(ifnegative)ofthelocalcurrencyrelativetoitsfundamentalvalueintermsofCEOcompensation.EXHIBIT:DeterminingaFundamentalPPPValueBasedonCEOs’RemunerationTotalCompensationinUS$

ActualExchangeRate(1US$)

FundamentalPPPValue(1US$)

Undervaluationin%SouthKorea150,711147420786Germany398,4301.840.6863Japan420,8551355361Mexico456,9028.543.6457Canada498,1181.420.6654France520,3896.172.9951U.K.645,5400.60240.362640HongKong680,6167.754.9237Brazil701,2191.140.7535U.S.A.1,072,40011Source:TotalcompensationdatacomesfromTowersPerrin,1998.Whatconclusionscanyoudrawfromthisexhibit?SolutionThereisawidedispersioninthedollarremunerationofCEOsacrosstheworld.AmericanCEOsarethebestpaid,followedbytheirBrazilianandHongKongcounterparts.KoreanandGermanCEOshaveverylowcompensationsrelativetoAmericans.TheimpliedPPPexchangeratessuggestthatallcurrenciesarestronglyundervaluedrelativetotheU.S.dollar.Theyreflectabasicinternationaldifferenceinmanagementcultureacrosstheworld,ratherthananenormousdollarovervaluation.Actually,recentinternationalmergers(e.g.,theacquisitionofAmocobyBritishPetroleum,ortheacquisitionofChryslerbyDaimlerBenz)highlighttheproblem,asGermanandBritishmanagersareenviousoftheirU.S.counterparts,whothemselvesfearlosingpartoftheirremuneration.ItislikelythattheapparentovervaluationofthedollarasreflectedintheexhibitwillpartlybecorrectedbyatrendtowardgreaterinternationalharmonizationofCEOs’remuneration.Intheexhibit,theBrazilianrealisovervaluedrelativetoamajorityofcurrencies,especiallythoseofotheremergingcountries.Itwasnotsurprisingtoseetherealdevaluebysome40%inJanuary1999.Inpractice,noonewouldestimatethefundamentalvalueofacurrencybyapplyingabsolutePPPtoasinglegood,especiallyanontradedone,andtheabovediscussionisonlyanecdotal.Theexhibitbelowpresentsthe1997balanceofpaymentsstatisticsforFrance,Germany,Japan,theUnitedKingdom,andtheUnitedStates.ThevariousbalanceofpaymentsitemshavebeenaggregatedusingthepresentationoutlinedinChapter2.EXHIBIT:1997BalanceofPaymentsofFiveMajorCountriesBillionsofU.S.DollarsFrance

Germany

Japan

U.K.

U.S.A.CurrentAccount391947167Exports284510409279680Imports256436308300877TradeBalance287410121197BalanceofServices1741541587NetIncome32561918CurrentTransfers9329739CapitalandFinancialAccount3318811168DirectInvestments1233232111PortfolioInvestments2452922308OtherFinancialandCapitalFlows2361282532NetErrorsandOmissions5134797OfficialReserveAccount62641AdaptedfromInternationalMonetaryFinancial1998Yearbook.ProvideananalysisoftheU.S.balanceofpayments.ProvideananalysisoftheBritishbalanceofpayments.ProvideananalysisoftheFrenchbalanceofpayments.ProvideabriefanalysisoftheJapanesebalanceofpayments.ProvideabriefanalysisoftheGermanbalanceofpayments.SolutionTheUnitedStateshasbeenrunningaverylargecurrentaccountdeficitformanyyears,andthe1997deficitreached$167billion.ApositivebalanceforservicesandnetincomereceivedfromabroadarefarfromcompensatingahugedeficitintheU.S.merchandisetradebalance($197billion).TheU.S.capitalandfinancialaccountisinsurplus($168billion),despitethefactthatAmericanshavebeennetdirectinvestorsabroadbillion).The1997surplusintheU.S.capitalandfinancialaccountisexplainedbythefactthatforeignersarehappytomakeportfolioinvestmentsandlendmoneytotheUnitedStates(portfolioinvestmentsof$308billion).Thesurplusinthecapitalandfinancialaccountissufficienttocoverthehugecurrentaccountdeficit.Twopointsareworthnoting.First,theitem“Neterrorsandomissions”(statisticaldiscrepancy)isenormous,makingtheinterpretationquiteimprecise.Second,theInternationalMonetaryFund(IMF)changeditsdefinitionofreservesin1997:Anitemlabeled“Liabilitiesconstitutingforeignauthoritiesreserves”wasdeletedfromofficialreservesandmovedtothecapitalflowsaccount.ThisfiguretracedtheamountofdollarreservesinvestedbyforeigncentralbanksintheUnitedStates.Forexample,foreignmonetaryauthoritiesinvestsomeoftheirofficialreservesinU.S.Treasurysecurities,becauseofthespecialroleofthedollarasareservecurrency.Sinceimportsaregreaterthanexports,theUnitedKingdomsuffersfromanegativetradebalanceat$21billion.Thisfigureissomewhatoffsetbya$15billionexcessofexportedservicesoverimportedservices.Nonetheless,thebalanceofgoodsandservicesisnegativeat$6billion.Netincomereceivedispositiveanditovershadowsanegativeamountofunrequitedtransfers(currenttransfers).Thebalanceofallcurrenttransactionswithforeignersisthereforepositiveat$7billion.Bothdirectinvestmentsandportfolioinvestmentsarenegative.InvestmentsrepresentafinancialoutflowfortheUnitedKingdomsinceitsresidentsinvestmoreactivelyabroadthanforeignersinvestinthecountry.Thebalanceforportfolioinvestmentsisnegativeat$22billion,reflectingtheUnitedKingdom’straditionalinvolvementininternationalbanking.Othercapitalflows,whichincludeshort-termcapitaldepositedindomesticbanks,donotcompensateforthisfinancialoutflowat$25billion.Adjustedforneterrorsandomissions,thecapitalandfinancialaccountremainsnegativeat$11billion.Thebalanceofthecurrentaccountandthecapitalandfinancialaccountcausesadecreaseinofficialreservesby$4billion,whichshowsasapositiveofficialreserveaccount.At$284billion,Frenchexportsofgoodsexceedimportsby$28billion.Exportsofservicesalsoexceedimports,by$17billion.Altogether,exportsofgoodsandservicesexceedimportsby$45billion.Thispositivefigureisstrengthenedbypositivenetincomereceived,butpartlyoffsetbynegativeunrequitedtransfers,leadingtoa$39billionpositivecurrentaccount.$39billionistheamountofmoneythatFrancehasreceivedfromallcurrenttransactionswithforeignersin1997.Directinvestmentis$12billion,showingthattheamountofdirectpurchasesofcompaniesorrealestatemadebyforeignersinFranceisinferiortotheamountofdirectpurchasesmadebyresidentsabroad.Thesameconclusioncanbedrawnforportfolioinvestmentsat$24billion.Othercapitalflows,whichincludeshort-termdepositsmadebyforeignersinFranceandbyresidentsabroad,isnegativeat$2billion.Thiscorrespondstoafinancialoutflow.Adjustedforneterrorsandomissions,thecapitalandfinancialaccountremainsnegativeat$33billion,reflectingthefactthatFrenchresidentshaveinvestedmorecapitalabroadthanhavebeeninvestedbyforeignersinFrance.Thebalanceofthecurrentaccountandthecapitalandfinancialaccountcausesanincreaseinofficialreservesby$6billion,whichshowsasanegativeofficialreserveaccount.Japanhasaverydifferentbalanceofpaymentsstructure.Japanrunsahugetradesurplus,withacurrentaccountsurplusof$94billion.ThisallowsJapantoinvestheavilyabroadwhileretainingabalancedreserveaccount.Actually,itsreservesincreasedby$6billion.Germanyhasasurplusinitstradebalancebutadeficitinitsbalanceofservices,pluslargeunrequitedtransfers(currenttransfers).Withaslightcapitalandfinancialaccountdeficit($1billion),theGermancentralbankhastouseitsreserveassetstocoverthedeficitoftheoverallbalance($2billion).Becauseoftherelativeriseinlocalproductioncostsbroughtaboutbytheappreciationoftheyen,manyJapanesecorporationshavedecidedtotransferproductionabroad.WhatshouldbetheimmediateandfutureimpactontheJapanesebalanceofpayments?SolutionTransferringproductionabroadmeansthatJapanesecapitalisinvestedabroad.Itwillimmediatelyresultinadeteriorationofthecapitalandfinancialaccountinthebalanceofpayments.Thisdeteriorationwillhavetobebalancedbytheofficialreserveaccount,thatis,adecreaseinofficialreserves.ThisisnotaprobleminJapanbecauseofitscurrentaccountsurplus.Inthelongerrun,exportswilldropbecausetheproductionofgoodsthatusedtobeexportedistransferredabroad.Importsshouldalsodrop,asgoodsneededintheproductionprocessneednotbeimportedanymore.Overall,onecanexpectadropinthetradebalance,whichwilleventuallyshowasadropinthecurrentaccountofthebalanceofpayments.Ontheotherhand,incomereceivedfromtheseadditionalforeigninvestmentswillcontributepositivelytotheJapanesecurrentaccount.TheJapanesebalanceofpaymentsfrom1987to1993isasfollows.AllnumbersarereportedinbillionsofU.S.dollars.Thelastlinegivestherealeffectiveexchangerateindexoftheyenrelativetoothercurrencies.Anincreaseintheindexmeansarealappreciationoftheyen.1987198819891990199119921993Merchandise:Exports224260270280307331351Merchandise:Imports128165193217203198210Services:Credit29354041454852Services:Debit48647582859093Income:Credit5177104125144146152Income:Debit376085106121114115CurrentTransfers44461256DirectInvestments18354545291514PortfolioInvestments91533314352866OtherFinancialandCapitalFlows64213039786424NetErrorsandOmissions4322218100ReserveAccountRealEffectiveYenRate128135128114122127160Calculatethetradebalance,currentaccount,capitalandfinancialaccount,andofficialreserveaccountforeachyear.UsethesenumberstodescribewhathashappenedintermsofJapanesefinancialtransactionswiththerestoftheworld.SolutionThevariousaccountsaregivenbelow:1987198819891990199119921993TradeBalance96957763104133141CurrentAccount8779573575118131CapitalandFinancialAccount4964704180117104OfficialReserves38151365127TheJapanesetradebalance,whichhasbeenconstantlypositiveoverthetimeperiod,worsenedfrom1987to1990andimprovedfromthenon.Thecurrentaccounttrackedthetradebalance.Thissurpluswasmostlyusedtoinvestabroad(negativecapitalandfinancialaccount).Thedecreaseinthecurrentaccountfrom1988to1990ledtoadropinofficialreserves(positivereserveaccount)andaweakeningoftheyen.ItsrealeffectiveexchangeratedepreciatedfromPAGE18Solnik/McLeavey•PAGE18Solnik/McLeavey•GlobalEditionChapter2ForeignExchangeParityRelationsPAGE19Chapter2ForeignExchangeParityRelationsPAGE19135to114.ThisimprovementinthetermsoftradeledtoanincreaseoftheJapanesetradebalanceintheearly1990s.In1991and1992,theincreasedcurrentaccountsurpluswasusedtoincreaseforeigninvestmentsbytheJapanese(thecapitalandfinancialaccountdeficitincreasedfrom41billionin1990to117billionin1992).In1993,thecurrentaccountincreasedto131billionbutnetforeigninvestmentsaccountedtoonly104billion.Hence,Japanesereservesincreasedby27billion(anegativeofficialreserveaccount).Thisledtoastrongappreciationoftheyen.TheJapanesebalanceofpaymentsfrom1994to1997isasfollows.AllnumbersarereportedinbillionsofU.S.dollars.Thelastlinegivestherealeffectiveexchangerateindexoftheyenrelativetoothercurrencies.Anincreaseintheindexmeansarealappreciationoftheyen.1994199519961997Merchandise:Exports386429400409Merchandise:Imports2241229723172308Services:Credit58656869Services:Debit2106212321302123Income:Credit155192225222Income:Debit2115214821722166CurrentTransfers26282929DirectInvestments217222223223PortfolioInvestments22823624229OtherCapitalFlows24125362128NetErrorsandOmissionsReserveAccount21814134RealEffectiveYenRate169175146137Calculatethetradebalance,currentaccount,capitalandfinancialaccount,andofficialreserveaccountforeachyear.UsethesenumberstodescribewhathashappenedintermsofJapanesefinancialtransactionswiththerestoftheworld.SolutionThevariousaccountsaregivenbelow:1994199519961997TradeBalancurrentAccount1311106594CapitalandFinancialAccount104492888OfficialReserves2761376TheJapanesetradebalance,whichhasbeenconstantlypositiveoverthetimeperiod,decreaseddramaticallyfrom1994to1996.Thecurrentaccounttrackedthetradebalance.Thissurpluswasmostlyusedtoinvestabroad(negativecapitalandfinancialaccount).Ineachyear,thecurrentaccountsurplusexceededthecapitalandfinancialaccountdeficitandofficialreservesincreased.In1994and1995,theyenkeptappreciatinginrealterms(itsrealeffectiveexchangeratewas127in1992andmovedupto175in1995).ThestrongyenhurttheinternationalcompetitivenessofJapananditstradebalancestronglydeteriorateduntil1996.Underasystemoffixedexchangerates,anationexperiencinganexcessofimportsoverexportscantrytoremedythissituationby:Adoptingtariffsandquotas.Reducingitsincomefrominvestmentsabroad.Applyinganexpansionarymacroeconomicpolicytodrivepricesupandinterestratesdown.BuildingupitsreservesofforeigncurrenciesandreservebalanceswiththeInternationalMonetaryFund.Solutiona. Adoptingtariffsandquotas.Underasystemoffixedexchangerates,anationcantrytoremedyitsbalanceofpaymentsdeficitby:Applyingexpansionarymacroeconomicpolicytodrivepricesupandinterestratesdown.Applyingrestrictivemacroeconomicpolicytokeeppricesdownandinterestratesup.Reducingitsincomefrominvestmentsabroad.BuildingupitsreservesofforeigncurrenciesandreservebalanceswiththeInternationalMonetaryFund.Solutionb. Applyingrestrictivemacroeconomicpolicytokeeppricesdownandinterestratesup.In1994,theUnitedStateswasexperiencingafairlystrongeconomicrecovery,aheadofothernations.Fearsofanoverheatingeconomyledtosuddeninflationaryfearsforthenextfewyears.WouldyouexpectU.S.interestratestoriseordrop?Wouldyouexpectthedollartodepreciateorappreciate?WouldyouexpectaforeignbondportfoliotobeagoodinvestmentcomparedtoaU.S.dollarportfoliounderthisscenario?SolutionInflationaryfearswillcauseinterestratestorise.Economicgrowthcouldalsoleadtohigherrealinterestrates.Thedollarislikelytodepreciatebecauseofhigherexpectedinflation.Thiscouldbeoffsetbyhigherrealinterestrates,whichcouldattractforeigncapitalflows.TheriseofU.S.interestrateswillcausethemarketpriceofU.S.bondstofall.ItisthereforeappropriatetoinvestinforeignbondsratherthanU.S.bonds.Thelikelydepreciationofthedollarmakessuchaninvestmentevenmoreinteresting(th