InternationalFinancialManagementSUGGESTEDANSWERSANDSOLUTIONSTOEND-OF-CHAPTERQUESTIONSANDPROBLEMSIM-1InternationalFinancialManagementCHAPTER2INTERNATIONALMONETARYSYSTEMSUGGESTEDANSWERSANDSOLUTIONSTOEND-OF-CHAPTERQUESTIONSANDPROBLEMSQUESTIONS2.Explainthemechanismwhichrestoresthebalanceofpaymentsequilibriumwhenitisdisturbedunderthegoldstandard.Answer:Theadjustmentmechanismunderthegoldstandardisreferredtoastheprice-specie-flowmechanismexpoundedbyDavidHume.Underthegoldstandard,abalanceofpaymentdisequilibriumwillbecorrectedbyacounter-flowofgold.SupposethattheU.S.importsmorefromtheU.K.thanitexportstothelatter.Undertheclassicalgoldstandard,gold,whichistheonlymeansofinternationalpayments,willflowfromtheU.S.totheU.K.Asaresult,theU.S.(U.K.)willexperienceadecrease(increase)inmoneysupply.ThismeansthatthepricelevelwilltendtofallintheU.S.andriseintheU.K.Consequently,theU.S.productsbecomemorecompetitiveintheexportmarket,whileU.K.productsbecomelesscompetitive.ThischangewillimproveU.S.balanceofpaymentsandatthesametimehurttheU.K.balanceofpayments,eventuallyeliminatingtheinitialBOPdisequilibrium.3.Supposethatthepoundispeggedtogoldat6poundsperounce,whereasthefrancispeggedtogoldat12francsperounce.This,ofcourse,impliesthattheequilibriumexchangerateshouldbetwofrancsperpound.Ifthecurrentmarketexchangerateis2.2francsperpound,howwouldyoutakeadvantageofthissituation?Whatwouldbetheeffectofshippingcosts?Answer:Supposethatyouneedtobuy6poundsusingFrenchfrancs.Ifyoubuy6poundsdirectlyintheforeignexchangemarket,itwillcostyou13.2francs.Alternatively,youcanfirstbuyanounceofgoldfor12francsinFranceandthenshipittoEnglandandsellitfor6pounds.Inthiscase,itonlycostsyou12francstobuy6pounds.Itisthusbeneficialtoshipgoldduetotheoverpricingofthepound.Ofcourse,youcanmakeanarbitrageprofitbyselling6poundsfor13.2francsintheforeignexchangemarket.Thearbitrageprofitwillbe1.2francs.Sofar,weassumedthatshippingcostsdonotexist.Ifitcostsmorethan1.2francstoshipanounceofgold,therewillbenoarbitrageprofit.9.Thereareargumentsforandagainstthealternativeexchangerateregimes.a.Listtheadvantagesoftheflexibleexchangerateregime.IM-2InternationalFinancialManagementb.Criticizetheflexibleexchangerateregimefromtheviewpointoftheproponentsofthefixedexchangerateregime.c.Rebuttheabovecriticismfromtheviewpointoftheproponentsoftheflexibleexchangerateregime.Answer:a.Theadvantagesoftheflexibleexchangeratesysteminclude:(I)automaticachievementofbalanceofpaymentsequilibriumand(ii)maintenanceofnationalpolicyautonomy.b.Ifexchangeratesarefluctuatingrandomly,thatmaydiscourageinternationaltradeandencouragemarketsegmentation.This,inturn,mayleadtosuboptimalallocationofresources.c.Economicagentscanhedgeexchangeriskbymeansofforwardcontractsandothertechniques.Theydon’thavetobearitiftheychoosenotto.Inaddition,underafixedexchangerateregime,governmentsoftenrestrictinternationaltradeinordertomaintaintheexchangerate.Thisisaself-defeatingmeasure.What’sgoodaboutthefixedexchangerateifinternationaltradeneedtoberestricted?10.Inanintegratedworldfinancialmarket,afinancialcrisisinacountrycanbequicklytransmittedtoothercountries,causingaglobalcrisis.WhatkindofmeasureswouldyouproposetopreventtherecurrenceofaAsia-typecrisis.Answer:First,thereshouldbeamultinationalsafetynettosafeguardtheworldfinancialsystemfromtheAsia-typecrisis.Second,internationalinstitutionslikeIMFandtheWorldBan...
