国际货币与金融经济学课后习题答案

Chapter1

1.Thebalanceonmerchandisetradeisthedifferencebetweenexportsofgoods,719andtheimports

ofgoods,1,145,foradeficitof426.Thebalanceongoods,servicesandincomeis719+279

+284-1145-210-269,foradeficitof342.Addingunilateraltransferstothisgivesacurrent

accountdeficitof391,[-342+(-49)=-391].(Notethatincomereceiptsarecreditsandincome

paymentsaredebits.)

2.Becausethecurrentaccountbalanceisadeficitof391,thenwithoutastatisticaldiscrepancy,the

capitalaccountisasurplusof391.Inthisproblem,however,thestatisticaldiscrepancyis

recordedasapositiveamount(credit)of11.Hence,thesumofthedebitsinthebalanceof

paymentsmustexceedthecreditsby11.So,thedeficitofthecurrentaccountmustbegreater

thanthesurplusonthecapitalaccountby11.Thecapitalaccount,therefore,isasurplusof391-

11=380.

3.Abalance-of-paymentsequilibriumiswhenthedebitsandcreditsinthecurrentaccountandthe

privatecapitalaccountsumtozero.Intheproblemabovewedonotknowtheprivatecapital

accountbalance.Wecannotsay,therefore,whetherthiscountryisexperiencinga

balance-of-paymentssurplusordeficitorifitisinequilibrium.

4Thecurrentaccountisadeficitof$541,830andtheprivatecapitalaccountbalanceisasurplusof

$369,068.TheU.S.,therefore,hasabalanceofpaymentsdeficit.

5Positiveaspectsofbeinganetdebtorincludethepossibilityoffinancingdomesticinvestmentthat

isnotpossiblethroughdomesticsavings;therebyallowingfordomesticcapitalstockgrowthwhich

mayallowjob,productivity,andincomegrowth.Negativeaspectsincludethefactthatforeign

savingsmaybeusedtofinancedomesticconsumptionratherthandomesticsavings;whichwill

compromisethegrowthsuggestedabove.

Positiveaspectsofbeinganetcreditorincludetheownershipofforeignassetswhichcanrepresent

anincomeflowstothecreditingcountry.Further,thenetcreditorpositionalsoimpliesanet

exportingposition.Anegativeaspectofbeinganetcreditorincludesthefactthatforeign

investmentmaysubstitutefordomesticinvestment.

6Anationmaydesiretoreceivebothportfolioanddirectinvestmentduetothetypeofinvestment

eachrepresents.Portfolioinvestmentisafinancialinvestmentwhiledirectinvestmentis

dominatedbythepurchaseofactual,real,productiveassets.Totheextentthatacountrycan

benefitbyeachtypeofinvestment,itwilldesirebothtypesofinvestment.Further,portfolio

investmenttendstobeshort-runinnature,whileFDItendstobelong-runinnature.Thisisalso

addressedinmuchgreaterdetailinChapter7.

7.DomesticSavings-DomesticInvestment=CurrentAccountBalance

DomesticSavings-DomesticInvestment=NetCapitalFlows

Therefore,CurrentAccountBalance=NetCapitalFlows

8Usingtheequationsabove,privatesavingsof5percentofincome,governmentsavingsof-1

percent,andinvestmentexpendituresof10percentwouldresultsinacurrentaccountdeficitof6

percentofincomeandacapitalaccountsurplus(netcapitalinflows)of6percentofincome.This

couldbecorrectedwithareductioninthegovernmentdeficit(toasurplus)and/oranincreasein

privatesavings.

Chapter2

1.Becauseitcostsfewerdollarstopurchaseaeuroaftertheexchangeratechange,theeuro

depreciatedrelativetothedollar.Therateofdepreciation(inabsolutevalue)was[(1.2168-

1.2201)/1.2201)100=0.27percent.

2.NotethattheratesprovidedaretheforeigncurrencypricesoftheU.S.dollar.Everyvaluehas

beenroundedtotwodecimalplaceswhichmaycausesomedifferencesinanswers.

A$£C$Sfr$

Australia-2.351.061.121.53

Britain0.42-0.450.470.65

Canada0.952.23-1.061.45

Switzerland0.902.110.94-1.37

UnitedStates0.651.540.690.73-

3Thecrossrateis1.702/1.234=1.379(€/£),whichissmallerinvaluethanthatobservedinthe

Londonmarket.Thearbitrageurwouldpurchase£587,544($1,000,000/1.702)withthe$1million

intheNewYorkmarket.Nexttheywouldusethe£587,544inLondontopurchase€837,250

(£587,544*1.425).Finally,theywouldsellthe€837,250intheNewYorkmarketfor$1,033,167(€

837,250*1.234).Theprofitis#33,167.

4.Totaltradeis(163,681+160,829+261,180+210,590)=796,280.TradewiththeEuroareais

(163,681+261,180)=424,861.TradewithCanadais(160,829+210,590)=371,419.The

weightassignedtotheeurois424,861/796,280=0.53andtheweightassignedtotheCanadian

dollaris0.47.(Recalltheweightsmustsumtounity.)

Becausethebaseyearis2003,the2003EERis100.Thevalueofthe2004EERis:

[(0.82/0.88)-0.53+(1.56/1.59)-0.47]*100=(0.4939+0.4611)*100=95.4964,or95.5.This

representsa4.5percentdepreciationoftheU.S.dollar.

5Therealeffectiveexchangerate(REER)for2003isstill100.Therealratesofexchangeare,for

2003,0.88*(116.2/111.3)=.9187,1.59*(116.2/111.7)=1.6541,andfor2004,0.82*(119.0/114.4)=

0.8530,1.56*(119.0/115.6)=1.6059.Thevalueofthe2004REERis:

[(0.8530/0.9187)*0.53+(1.6059/1.6541)*0.47]«100=(0.4921+0.4563)-100=94.84,or94.8.This

representsa5.2percentdepreciationoftheU.S.dollarinrealterms

6.ThisisanominalappreciationoftheeurorelativetotheU.S.dollar.Thepercentchangeis[(1.19-

1.05)/1.05]*100=13.3percent.

7.TheJanuary200realexchangerateis1.05*(107.5/112.7)=1.0016.TheMay2004realrateis

1.19*(116.4/122.2)=1.1335.

8InrealtermstheeuroappreciatedrelativetotheU.S.dollar.Therateofappreciationis[(1.1335-

1.0016)/1.0016]*100=13.17percent.

9AbsolutePPPsuggeststheMay2004exchangerateshouldbe122.2/116.4=1.0498.Theactual

exchangerateis1.19.Hence,theeuroisovervaluedrelativetotheU.S.dollarby(1.19-

1.0498)/1.0498]*100=13.35percent.

10RelativePPPcanbeusedtocalculateapredictedvalueoftheexchangerateas:

SPPP=1.05*[(122.2/112.7)/(116.4/107.5)]=1.0014.

11.Theactualexchangerateis1.19.Hence,theeuroisovervaluedrelativetotheU.S.dollarby(1.19

-1.0014)/1.0014]«100=18.83percent.

Chapter3

1.Rankingthevariousexchangeratearrangementsbyflexibilityisnotsoclearcut.Nonetheless

thearrangementsdescribedinthischapterare(fromfixedtoflexible):dollarization,currency

board,commodity(standard)peg,dollar(standard)peg,currencybasketpeg,crawlingpeg,

managedfloat,flexible.

2.ThetwoprimaryfunctionsoftheInternationalMonetaryFundare:surveillanceofmember

nations'macroeconomicpolicies,andtoprovideliquiditytomembernationsexperiencing

paymentsimbalances.

3.ThevalueoftheCanadiandollarrelativetogoldisCAN$69(1.38•$50)andthevalueofthe

Britishpoundrelativetogoldis£33.33($50/1.50).

4.TheexchangeratebetweentheCanadiandollarandtheBritishpoundisC$/£2.07(1.38•

1.50).

5.Thecurrencyvalueofthepesocanbeexpressedas$0.50+€.50=P1.Theexchangerate

betweenthedollarandtheeurocanbeusedtoconverttheeuroamounttoitsdollarequivalent

of$0.55.Hence,$1.05=P1,orandexchangevalueof0.952P/$.Usingtheexchangerate

betweenthedollarandtheeuroagain,theexchangeratebetweenthepesoandtheeurois

0.1.048P/€(0.952P/$•1.10$/€).

6.Because$1.05isthecurrencycontentofthebasket,asshownabove,and$0.50ofthatcontent

isattributabletothedollar,theweightassignedtothedollaris0.50/1.05=0.476,or47.6

percent.Becausetheweightsmustsumtounity,theweightassignedtotheeurois52.4

percent.

Themaindifferencebetweenthetwosystemswasthat,intheSmithsoniansystem,thedollar

wasnotpeggedtothevalueofgold.Onereasonthatthesystemwasshortwasbecause

therewaslittleconfidencethatU.S.economicpolicywouldbeconductedinamanner

conducivetoasystemofpeggedexchangerates.

8.Theprincipleresponsibilitiesofacurrencyboardaretoissuedomesticcurrencynotesandpeg

thevalueofthedomesticcurrency.Acurrencyboardisnotallowedtopurchasedomesticdebt,

actasalenderoflastresort,orsetreserverequirements.

TheLourveaccordestablishedunofficiallimitsoncurrencyvaluemovements.Inasense,it

waspegwithbandsforeachofthemaincurrencies(dollar,yenandmark).

10.Differencesinthefundamentaldeterminantsofcurrencyvaluesbetweenthepeggingcountry

andtheothercountryshouldbeconsidered.Tothispointofthetext,therateofinflationisa

goodexample.RelativePPPcanbeusedtodeterminetherateofcrawl.

11.Underacurrencyboardsystem,anationstillmaintainsitsdomesticcurrency.Hence,

policymakerscanchangeexchangeratepoliciesandmonetarypoliciesiftheysodesire.

Whenanationdollarizesanddisposesofitsdomesticcurrencyitnolongerhasthisoption.

Chapter4

1.Giventhattheexchangerateisexpressedasdollarstoeuros,wetreatthedollarasthedomestic

currency.Notealsothatinterestratesarequotedonanannualbasiseventhoughthematurityperiodis

onlyonemonth.Inthisproblemwedividetheinterestratesby12toputthemonaone-monthbasis.

a.Theinterestratedifferential,therefore,is(1.75%/12-3.25%/12)=-0.125%.Theforward

premium/discount,expressedasapercentage,iscalculatedas:

((F-S)/S)*100=((1.089-1.072)/1.072)*100=1.5858%

1.00-0.125

b.Transactioncostsareshowninthefigureabovebythedashedlinesthatinterestthehorizontalaxis

atvaluesof-1.00and1.00.

c.Thepositivevalueindicatesthattheeuroissellingatapremium.Inaddition,theinterestrate

differentialfavorstheeuro-denominatedinstrument.Hence,asavershiftfundsto

euro-denominatedinstruments.

2.Usingtheprovidedinformation:

(1.75/12)-(3.25/12)<[(1.089-1.072/1.072)]*100

-0.125%<1.5858%.

S（）

Graph2,theforwardmarketfortheeuro.

S,

Do

QoQi

RoS,

R

R|

Ro

Do

Graph4,U.S.loanablefundsGraph5,Euroloanablefunds

Ingraph1,thedemandfortheeurorisesasinternationalsaversshiftfundsintoeuro-denominated

instruments.Ingraph2,thesupplyofeurosincreasesintheforwardmarket.(ConsideraU.S.saver

thatmovesfundsintoaeuro-denominatedinstrument.Theywoulddesiretoselltheeuroforwardso

theymayconverteuro-denominatedproceedsatthetimeofmaturityintotheirdollarequivalent.)Graph

3illustratesadecreaseinloanablefundsintheUnitedStatesassaversshiftfundstoeuro-denominated

instruments.Graph4illustratestheincreaseinthesupplyofloanablefundsthatoccurswhensavers

shiftfundstotheeuro-denominatedinstrument.

4.Because(1.03125)>(1.04250)(1.4575/1.5245)=0.9967,anarbitrageopportunityexistsinthis

exampleifoneweretoborrowthepoundandlendtheeuro.Supposeyouweretoborrowone

pound,thestepsarethen:

a.Borrow£1,convertto€1.5245onthespotmarket.

b.Lendeuros,yielding€1.5245*(1.03125)=€1.5721.

c.Seeeurosforward,yielding€1.5721/1.4575=£1.0787.

d.Repaythepoundloanat£1*(1.04250)=£1.04250.

e.Theprofitis£0.0362,or3.62percent.

5.Becauseinterestratesarequotedasannualizedrates,weneedtodivideeachinterestrateby4

(12/3).Theuncoveredinterestparityequationis:

e

R-R*=(S+1-S)/S

a.Rewritingtheequationfortheexpectedfutureexpectedexchangerateyields:

e

S+i=[(R-R*)+1]S

b.Usingthevaluesgivenyieldstheexpectedfuturespotrate

e

S+i=[(0.0124/4-0.0366/4)+1]-1.5245=1.5153.

6.Giventhisinformation,wecancalculatetheforwardpremium/discountwiththeUIPcondition:

(F-S)/S=R-R*

Theinterestdifferentialis1.75%-3.25%=1.5%.Thisistheexpectedforwardpremiumonthe

euro.Hence,(F-1.08)/1.08=0.015impliesthatF=1.0962.

7.Wecanadjustfortheshortermaturitybydividingtheinterestratesby2(12/6).Nowtheinterest

differentialis0.75%,stillaforwardpremiumontheeuro.Theforwardratenowis(F-1.08)/1.08=

0.0075impliesthatF=1.0881.

8.TheU.S.realrateis1.24%-2.1%=-0.86%andtheCanadianrealrateis2.15%-2.6%=-0.45%.

Ignoringtransactioncosts,becausetherealinterestratesarenotequal,realinterestparitydoesnot

hold.

9.UncoveredinterestparityisR-R*=(Se+i-S)/S+p.

a.Usingthesameprocessasinquestion5above,theexpectedfuturespotrateis:

e

S+i=[(R-R*)+1]S,

e

S+i=[(0.075・0.035)+1]・30.35=31.564.

b.Usingthesameprocessasinquestion5above,theexpectedfuturespotrateis:

e

S+i=[(R-R*)+1-p]S,

e

S+i=[(0.075-0.035)+1-0.02]«30.35=30.957.

10.Becausetheforwardrate,30.01,islessthantheexpectedfuturespotrate,30.957,youshouldsell

thekorunaforward.Forexample,$1wouldpurcasek30.957,whichyoucouldsellforwardyielding

k30.957/30.01=$1.0316.

11.Internationalfinancialinstruments:

a.GlobalBond:longterminstrumentsissuedinthedomesticcurrency.

b.Eurobond:termislongerthanoneyearandisissuedinaforeigncurrency.

c.Eurocurrency:keywordisthatitisadeposit.

d.Globalequity:keywordisthatitisashare.

Chapter5

1.Giventhat:PB=C/(1+R)+C/(1+R)2+C/(1+R)3+C/(1+R)4+

multiplyeachsideby(1+R):PB(1+R)=C+C/(1+R)+C/(1+R)2+...;

andsubtractPBfromeachside:PB(1+R)-PB=[C+C/(1+R)+C/(1+R)2+...]-[C/(1+R)+C/(1+R)2

+..]；

Simplifying:PB*R=C.

Therefore,PB=C/R.

2.Inthissituation,annualyieldsdeclineasthetermtomaturityincreases,whichmeansthattheyield

curveslopesdownward.Accordingtotheexpectationstheoryofthetermstructureofinterestrates,

thissituationarisesbecausebond-markettradersanticipatesthatshort-terminterestrateswillfall

sharply.Thus,anaverageofcurrentandfutureshort-termrates,which,whenaddedtoanyterm

premiumapplicabletoalongermaturity,islowerthanthecurrentshort-termrate.

3.Yes,theexcessreturnontheGermangovernmentbondequals3.5percent-(5percent-3

percent)=1.5percent.

4.ParityConditions:

a.Usinguncoveredinterestparity,R-R*=(S+ie-S)/S.Becausetheleft-hand-sideis

negative,wewouldexpecttheright-handsidetobenegative,indicatingadomesticcurrency

appreciation.

b.UsingrelativePPP,B-B*=%)S.Becausetheleft-hand-sideisnegative,wewouldexpect

theright-handsidetobenegative,indicatingadomesticcurrencyappreciation.

5.Thedomesticrealinterestrateis5percentless2percent,or3percent.Theforeignrealinterest

rateis6percentless4percent,or2percent.Realinterestratesarenotequal,sotherealinterest

parityconditiondoesnothold.Wewouldexpectfundstoflowintothedomesticcountryandoutof

theforeigncountry,whichwoulddrivethedomesticrealinterestratedownandtheforeignreal

interestrateup.

6.Incontrasttoforwardcurrencycontracts,currencyfuturesrequiredeliveryofstandardquantitiesof

currencies.Inaddition,holdersofcurrencyfuturesexperienceprofitsoflossesonthecontracts

duringtheentireperiodbeforethecontractsexpire,whereasprofitsorlossesoccuronlyatthe

expirationdateofaforwardcurrencycontract.

7.Acurrencyfuturealreadyisaderivative,becauseitsvaluevarieswiththeexchangerate.The

valueofacurrencyfuturesoption,inturn,dependsontheunderlyingvalueofacurrencyfutures

contract,soitsvalueisderivedfromthefuturesderivative.Inthisway,acurrencyfuturesoptionis

a"derivativeofaderivative."

8.a.Thecompanyowes500,000Sfrandisconcernedaboutthefuturespotexchangevalueofthe

U.S.dollar-Swissfranc.Itcanthereforepurchasefuturecontractstosetalimittoitspotential

exchangeratelosses.

b.TheSfrispurchasedin125,000francincrements.Therefore,thefirmwouldwantto

purchase500,000/125,000=4futurescontracts.Giventheinitialmarginonafranccontract,

thetotalinitialmarginthefirmestablishesis:4($1,688)=$6,752.

Thedailymarginchangesareasfollows:

First:(0.6252-0.6251)(125,000)(4)=+$50.Thereforeitsmarginequals$6,802.

Second:(0.6127-0.6252)(125,000)(4)=-$6250.Thereforethemarginwouldfallto$552.

However,themaintenancemarginisequalto$1,250.Thus,themarginwillequal$1,250.

Third:(0.6115-0.6127)(125,000)(4)=-$600.Again,themarginmustremainat$1,250.

Fourth:(0.6806-0.6115)(125,000)(4)=-$1450.Again,thisdailychangewouldfallbeneath

themaintenancemargin.Thus,itremainsat$1,250.

AsthedollarcontinuestoappreciaterelativetotheSwissfranc,thevalueofthefutures

contractfalls.However,thecostof500,000francpaymentisbecomingcheaperontermsof

theU.S.dollar.

9.a.Thecalloptioniscurrentlyoutofthemoney.

b.(0.0188)(62,500)=$1,175

($1,175)(8contracts)=$9,400

NetProfit

10,600

0

9,400

OutofthemoneyInthemoney

Atthemoney

NetLoss

c.AtS=$0.96/€theoptionisnotexercisedandthefirmisout$9,400

AtS=$1.02/€theoptionisexercised.Thefirmearns$10,600

AtS=$0.9657/€,thefirmdoesnotexercisetheoptionandisout$9,400

d.Breakeven:$0.9988/€

e.SeeDiagramgiveninpart(b).

10.Theprosandconsofforwardcontractsandswapsliewithinhoweachworks.Aforwardcontract

canbearrangedbetweenapurchaserandaseller,andisdependentuponeachparticipant'sbeliefs

ofwhatwillhappeninthefuture.Sometimesitcanbedifficulttomatchcounterpartiestosuch

contracts.Swaps,ontheotherhand,directlymatchtraderswhorequireflowsofcurrenciesheldby

oneanother.Swapsmayalsoallowborrowerstoreceivebetterloanratesbyissuingdebtintheir

homecurrencyratherthaninaforeigncurrency;therebypotentiallyavoidingariskpremium.

Considerationsofthereasonforthelongpositiononacurrencyandwhichcurrencyisatissuewill

influencethedecisionofwhichderivativetouse.

Chapter6

1Thebank'scapital-assetratioisequaltoitequityof100millionyendividedbyitstotalassetsof1,000

millionyen,whichequals0.10,or10percent.Hence,thebankdefinitelymeetsthe4percent

capital-assetratiorequirement.Becausecashassetsandgovernmentsecuritiesreceiveazero

riskweight,thisbankhas800millionyeninloansthatitmustcountamongrisk-adjustedassets.

Togetherwiththeassignedexposureof400millionyenfromderivativestrading,thisyieldsatotal

amountofrisk-adjustedassetsequalto1,200millionyen.Thus,thebank'srisk-adjustedcore

capitalrationisequalto100millionyendividedby1,200millionyen,whichisequaltojustover

0.083,or8.3percent.Thus,thebank'srisk-adjustedcorecapitalratioalsomeetsthe8percent

regulatoryrequirement.

2Themainoverlapintheinstitutions1functionsisthatbothmakelong-termloansintendedtopromote

growthofdevelopingandemergingnations.TheWorldBank,however,concentratessolelyonthis

task,whereastheInternationalMonetaryFundfocusesmuchofitsattentionlendingtopromote

short-andintermediate-termstabilization.

Chapter7

1.Thedifferencebetweendirectandindirectfinancinghastodowithwhethertheborrowerandlender

seekeachotheroutorwhetheranintermediarymatchesborrowersandlenders.Directfinancing

requiresnointermediarytomatchsaversandborrowers.Aneconomywillbenefitfromhavingboth

directandindirectfinancingbecausebothareappropriatewaystosaveandinvestunderdifferent

circumstances.Asdiscussedinthetext,financialintermediariesabsorbafractionofeachsaver's

dollarthatisborrowed.Thus,theintermediarytakessomeofthefundsthatotherwisewouldhave

gonetoaborrower.However,thefinancialintermediaryprovidesanimportantservicebyreducing

informationasymmetries,allowingsaverstopoolrisk,andmatchingriskandreturn.Therefore,

whenanindividualcannotresearchtheseissuesonhis/herown,theintermediaryisnecessaryto

helpthefinancialmarketsoperate.However,astrongbondmarket,inwhichborrowersandsavers

candirectlyinteract,allowsforinformedpartiestosavethefundsthatotherwisewouldgotoan

intermediary.This,inturn,usesthesavingsmoreefficiently.

2.Portfolioflowsarerelativelyshortterminnature(haveashortertermtomaturity),involvelower

borrowingcosts,andcangeneratenear-termincome.Theyalsodonotrequireafirmtogiveup

controltoaforeigninvestor.Consequently,theymayhelptoimprovecapitalallocationwithinan

economyandhelptheeconomy'sfinancialsectordevelop.Theseareallpotentialbenefitsof

portfolioinvestments.Bythesametoken,however,theyarealsorelativelyeasytoreversein

direction,whichisapotentialdisadvantageofportfolioinvestment.

Ontheotherhand,foreigndirectinvestment(FDI)involvesomedegreeofownershipandcontrolof

aforeignfirm,aretypicallylongterminnature,andhelpprovideastabilizinginfluenceonanation's

economy.Assuch,FDIistypicallymoredifficulttoarrange.

Itisnotadvantageoustorelyoneithertypeofinvestmentexclusively,insofaraseachtype

accomplishesdifferentgoalsforaneconomy.Bothnear-andlong-termcapitalareimportantforan

economy'sgrowth.

3.AseitherportfolioinvestmentofFDIincrease,thedemandforthelocalcurrencyrises(e.g.,thereis

ashiftfromDotoDi),whichputsupwardpressureonthevalueofthecurrency,fromSotoSi.Ifthe

centralbankexpectstoholdthevalueofthecurrencyconstantatSo,itwillhavetoincreasethe

quantityofthedomesticcurrencysupplied(e.g.,accommodatetheexcessquantitydemandedatthe

initialspotrateSo)tomaintainthepeg.Theoppositewouldholdforcapitaloutflows.

4.Supposethatamultinationalbank(MNB)headquarteredinadevelopedeconomyentersa

developingeconomy.TheMNBhasgainedconsiderableexpertiseinworkingasafinancial

intermediary,andlikelyhasachievedeconomiesofscaleindoingso.Byenteringaforeignmarket,

ithelpstoallocatethesavingsmoreefficientlythroughitsintermediationservices;whichinturnwill

leadtoadditionaleconomicdevelopment.Specifically,itshouldhelptomakesurethatthebest

investmentprojectsarefunded.Moreover,thecompetitionitintroducesintothecapitalmarket

helpstoimprovethequalityoftheindigenousfinancialintermediaries.This,inturn,shouldalso

addtofinancialstability.

Saversandborrowerscanalsobenefitfromtheregulationoffinancialintermediarieswhenportfolio

capitalflowsdominateacountry'scapitalinflows.Itcanbearguedthatregulationtolimit

short-terminflowscanstabilizetheeconomyandthattheseregulationscanbegraduallyliftedasthe

economybecomesmorestable(financialmarketsdevelop)andresilienttoexternalshocks.These

regulationsdoimposecostsinthattheyrequireresourcestoenforce,andmayinhibitotherwise

helpfulcapitalinflowswhichmayaideconomicdevelopment.However,thesecostsmustbe

consideredagainstthepotentiallossesthatmaybeincurrediftheabsenceofcapitalcontrolswould

leadtomorevolatileandcapitalmarkets(whichmaydetertheinflowofforeigncapital).

6.PolicymakersshouldundertakeactionsthatattractbothportfoliocapitalflowsandFDIflows.

Actionsthatimprovetransparencyinboththeprivateapublicsectorreducesinformation

asymmetriesandtheirassociateproblemstherebymakingportfolioflowsmorestable,inother

words,reducingtheriskofmassivecapitaloutflows.Policymakersmayalsoundertakeactionsthat

promoteeducation,improvethetaxstructureandtaxcollection,andimprovethecountries

infrastructure.Theseactionsmay,inturn,attractFDI.

7.Inthefollowingtwoexamplesitisassumedthatthepolicymakermaintainsapegged-exchangerate

regimeanddoesnotoptforafloating-rateregime.Hence,thepolicymakermayeitherintervene

andmaintainthepegorchangethevalueofthepeg.Inbothcasesthereis