Supplemental Problems for Homework HW #1:  Supplemental problem on the size of the Forex market See the Bank of International Settlements' Triennial Bank Survey for 2007.  How big was the foreign exchange market, including spot, forward, options, et cetera?  Compare the market size to that shown in the BIS Triennial Bank Survey for 2004, which I discussed in my lecture notes. How has the rate of growth in the forex market compared to the growth of the U.S. economy?  In what other ways has the forex market changed since 2004? HW #2:  Supplemental problem on the standard trade model 1.  Assume a country produced two types of goods, industry (Y) and agriculture (X), with a comparative advantage in industrial goods and a standard neoclassical PPF. Using the standard trade model, with X goods on the horizontal axis and Y goods on the vertical axis, show a free-trade equilibrium with balanced trade, and algebraically demonstrate that trade is balanced. Then show a free-trade equilibrium together with a net inflow of foreign savings. Assuming the transfer has no effect on the terms of trade, explain how exports and imports have changed so that the international transactions sum still to zero. 2. Using a supply and demand model for foreign currency (Forex), how would a transfer of foreign savings into the home country affect the direct exchange rate E and the trade balance?  How would a recession in the home country affect the direct exchange rate E and the trade balance? HW #3:  Supplemental problem on foreign exchange derivatives   1. Suppose you have recently signed a contract to export goods to Mexico in six months, and the contracted price is 10,000,000 Pesos (MXP), with a spot price of $0.0689 per Peso. a) If the 6-month forward discount for the Peso is 3% (not annualized), what is the forward contract price? b) Suppose you sell Pesos with a forward contract? Are you speculating or hedging?  c) Suppose you wait until August to receive your payment in Pesos, and then convert them to Dollars on the spot market. Are you speculating or hedging? d) Suppose you borrow money from a Mexican bank now at an annual rate of 7.75%.  What is the actual rate you would pay for a six-month loan?  How much could you borrow, assuming you will repay the loan with the 10 million Peso payment you receive? e) If you borrow Pesos as in (d), and sell them today on the spot market, Are you speculating or hedging?  Comparing how many dollars you receive now with how much you would have received with (b), what is your effective annual rate of return? f) Suppose you think the market is wrong, and instead of the Peso depreciating by 3%, you expect the Peso to appreciate by 1% over the next six months.  How might you speculate on this expectation? Suppose you do this, but want to protect yourself against being really wrong by buying an option. Should you buy a put or a call? Will you be the grantor or the holder? Will a strike price of $0.0660 be cheaper or more expensive that an option for $0.0690? If the strike price is $0.0660 but the spot price in six months is $0.0653, will your option be in the money? Will you make money, or will you get fired for not buying the forward contract your boss asked for? HW #7:  Supplemental problems on intertemporal trade and risk 1.  Consider a two-period intertemporal trade model (for years 0 and 1), for a large economy with a marginal product of capital investment that is significantly higher than in the rest of the world. Assume current output is already determined, but the country must choose the optimal amount of current consumption and savings. Future output is a function of current domestic investment, and for simplicity assume there is no more investment in the future (since this only a two-period model). a) Using the intertemporal PPF, show the choice for current and future consumption under savings autarky. Show the amount of domestic savings and investment and the rate of return. b) If the home country allows free international flows of savings, show and explain what would happen to investment, foreign saving flows, and the domestic interest rate? Using income and substitution effects, predict what will happen to current consumption, relative to autarky, and to current domestic savings. c) How will foreign savings affect the country’s future output? Will it consume more or less than its production in the future? Is this country better off as a result of the international trade in savings? d) How will intertemporal trade affect this country's current account in year 0? Its external wealth at the end of year 0?  Its current account in year 1? 2.  Consider problem 12 in the textbook, chapter 6(17), again: a)  How would your answers change if Pestilence and Flood were positively correlated?  Assume that whenever Lowland floods, it leads to a 50% chance of a migration of infected rats from the swamps up into Highland.  When Lowland does not flood, however, the chance of Pestilence in Highland is zero.  b) Assume again that Pestilence and Flood are independent random events, and not correlated.  What if Highland's economy benefits from a flood in Lowland?  Suppose that if Highland has pestilence, their output is 8. If neither P nor F happens, then Highland's ouput is 10.  But is P does not happen and F does, then Highland's output is 12 because it sells food to Lowland at much higher prices.  How does this affect your answers? c)  Conduct an experiment for each of the Highland/Lowland cases, by flipping coins for 20 periods, or generating random numbers in Excel (the formula =ROUND(RAND(),0) will return a 0 or 1 with 50% probability).  How do your actual results compare with your predicted probabilities?