International Finance First Examination

First Examination

Instructions This examination will count as 30% of your grade for the course. You will write your exam at home, taking advantage of your notes, reference materials, library resources and textbooks. Any and all resources must be given full attribution. You may not collaborate with anyone in preparing your answers. If you do share your answers or ideas with other members of the class or solicit outside help in preparing your paper, you will fail the exam. At the end of the paper, please write the following and sign your name: “This paper is my own original work and all of the ideas contained in it are my own. Any outside sources that I have used have been given full credit.” Without this, I will not grade the paper.

Answers are to be limited to three (3) sides of 8-1/2 by 11 inch paper. Any excess will be ignored. No photo reduction please. Answers should be typed in a legible sized font. Be concise! Do not expect to get an “A” by reproducing every lecture note. The best papers will selectively apply only the key materials from the class to the problem. Remember that your answers must be oriented around topics covered in this class. This is not a class in international relations!

Exam papers are to be submitted by 6:20 p.m. (EDT) Tuesday, March 15, via e-mail, but only in Adobe™ Acrobat (PDF) format. Submissions should be e-mailed to “cweinberg@hifreqecon.com” and must be received by 6:20 pm (EDT) on March 15. Good luck!

Thanks to the surge in oil prices, Japan’s current account balance has turned from surplus to deficit… by ¥1.19 trillion in January according to today’s report. The local politicians are not happy. They want the current account returned to a surplus before elections. Among other measures—that are not relevant to this exam—the pols have decided that one way to return the nation to surplus is to give a package of foreign aid, in yen, to Vietnam to help rebuild its economy. In this hypothetical package…

• Japan extends ¥200 billion in agricultural credits to the Vietnamese government. These credits are 30- year loans at 2% interest which can only be used for purchases of agricultural equipment from Japanese producers. • The Japanese government also will purchase another ¥100 billion in natural gas from newly developed resources in Vietnam. • Finally, Japan offers a ¥5 billion technical assistance grant for Vietnam to hire Japanese experts on environmental cleanup.

The bad news is Fuji Bank has decided to call due—rather than roll over—some loans to Vietnam’s government. When the loans are repaid on June 15, there will be ¥10 billion in principal plus a quarterly interest payment of ¥250 million due. For this exam, assume Vietnam is operating on its production possibility frontier—full employment of capital and labor—and Japan’s economy has excess capacity and unemployment. For all questions, assume Vietnam’s dong has a fixed exchange rate and is not easily convertible to dollars in the open market except for question 3. All transactions occur this year.

1. How would Japan account for these transactions in its balance of payments for this year? Assume that the Fuji bank loans are repaid by putting bags of yen on a jumbo jet and transporting them to Tokyo. All other payments will be settled through the banking system.(5 points) (HINT: This is an accounting question, not a behavioral question!)

2. How might Vietnam’s economy and trade balance adjust after the transfer package of ag credits and technical assistance is implemented and why? How will the official settlements balance adjust? If Vietnam’s current account was in balance before these transfers—and if there are no changes in monetary or fiscal policy and the exchange rate is not changed—is there some mechanism that will push Vietnam’s external accounts back to balance after the payments are made? Should there be? Will the central bank of Vietnam find big yen balances building up in its international reserves? (10 points)

3. If you were the Finance Minister of Vietnam—which would mean that you could direct both fiscal and monetary policy and set the exchange rate—what course of action might you follow to achieve full employment, price stability and current account balance after the implementation of this package? Would you have more options if the exchange rate were not fixed? For this question and for this question only, you may assume that the exchange rate is fixed, but adjustable by the government. 10 points)

4. Will this program narrow Japan’s current account deficit? How will Japan’s Official Settlements balance be affected? Why? What response would you propose to Prime Minister Kishida-san to narrow or to eliminate the current account deficit? (5 points)