ADDITIONAL CHAPTER 4 ANSWERS

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  1. 1. If the dollar is appreciating against the Polish zloty in nominal terms but depreciating against the zloty in real terms, what do we know about Polish and U.S. inflation rates?
  1. 2. Suppose the nominal peso/dollar exchange rate is fixed. If the inflation rates in the Mexico and the United States are constant (but not necessarily equal in both countries), will the real value of the peso/dollar exchange rate also be constant over time?
  1. 3. If the average rate of inflation in the world rises from 5% to 7%, what will be the likely effect on the S. dollar’s forward premium or discount relative to foreign currencies?
  1. Comment on the following statement. “It makes sense to borrow during times of high inflation because you can repay the loan in cheaper dollars.”
  1. The empirical evidence shows that there is no consistent relationship between the spot exchange rate and the nominal interest rate differential. Why might this be?
  1. During 1988, the U.S. prime rate–the rate of interest banks charge on loans to their best customers–stood at 9.5%. Japan’s prime rate, meanwhile, was about 3.5%. Pointing to that discrepancy, a number of commentators argued that the cost of capital must come down for U.S. business to remain competitive with Japanese companies. What additional information would you need to properly assess this claim? Why might interest rates be lower in Japan than in the U.S.?
  1. In the late 1960s, Firestone Tire decided that Swiss francs at 2% were cheaper than U.S. dollars at 8% and borrowed about SFr 500 million. Comment on this choice.
  1. Comment on the following quote from a story in the Wall Street Journal (August 27, 1984, p. 6) that discusses the improving outlook for Britain’s economy: “Recovery here will probably last longer than in the U.S. because there isn’t a huge budget deficit to pressure interest rates higher.”
  1. Comment on the following headline that appeared in the Wall Street Journal (December 19, 1990, p. C10): “Dollar Falls Across the Board as Fed Cuts Discount Rate to 6.5% From 7%.” The discount rate is the interest rate the Fed charges member banks for loans.
  1. 10. In late 1990, the U.S. government announced that it might try to reduce the budget deficit by imposing a 0.5% transfer tax on all sales and purchases of securities in the United States, with the exception of Treasury securities. It projected the tax would raise $10 billion in federal revenues–an amount arrived at by multiplying 0.5% by the value of the $2 trillion trading on the New York Stock Exchange each year.
  1. What are the likely consequences of this tax? Consider its effects on trading volume in the United States and stock and bond prices.
  1. b. Why does the S. government plan to exclude its securities from this tax?
  1. Critically assess the government’s estimates of the revenue it will raise from this tax.
  2. 11. It has been argued that the S. government’s economic policies, particularly as they affect the U.S. budget deficit, are severely constrained by the world’s financial markets. Do you agree or disagree? Discuss.
  1. 12. In 1991, the U. government imposed a stiff import tariff on the active-matrix LCD screens that now appear in next-generation laptop computers.
  1. Assess the likely consequences of the import duty for U.S. laptop computer manufacturers.
  1. How are these manufacturers likely to react to this import duty?
  1. “High real interest rates can be a cause for celebration, not alarm.” Discuss.
  1. 14. In an integrated world capital market, will higher interest rates in, say Japan, mean higher interest rates in, say, the United States?
  1. 15. In France in 1994, short-term interest rates and bond yields remained higher than in Germany, despite a better outlook for inflation in Fran Does this situation indicate a violation of the Fisher effect? Explain.
  1. 16. On February 15, 1993, President Clinton previewed his State of the Union message to Congress in a toughly- worded talk on television about how the growing federal budget deficit made tax increases necessa Financial markets reacted by pushing bond prices up and pummeling stock prices. President Clinton said that the rise in Treasury bond prices was a “very positive” response to his televised speech the night before. How would you interpret the reaction of the financial markets to President Clinton’s speech?
  1. 17. At the same time that it was talking down the dollar, the Clinton Administration was talking about the need for low interest rates to stimulate economic growth. Comment.
  1. 18. One idea to curb potentially destabilizing international movements of capital has been devised by James Tobin, a Nobel Prize-winning He proposes putting a small tax on foreign exchange transactions. He claims that his “Tobin tax” would make short-term speculation more costly while having little effect on long-term investment.
  1. Why would the Tobin tax have a disproportionate impact on short-term investments?
  1. Is the Tobin tax likely to accomplish its objective? Explain.
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