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Question 2

Consider the following information about a country’s international transactions during the year 2020:

 Transaction Value Merchandise exports 2,740 Merchandise imports 2,380 Income received from foreigners 850 Income paid to foreigners 1,160 Unilateral transfers ? Foreign direct investment, outward 2,800 Foreign direct investment, inward 3,100 Foreign portfolio investment, outward 590
• Compute the value of the country’s financial account. Assuming that the official reserves account of the country has a value of –200 (minus(!) 200), determine the value of the country’s current account and its unilateral transfers. Does the value for unilateral transfers that you obtained imply transfers to abroad or transfers from abroad? (6 points)
• You learned in the course that in the long run exchange rates should be consistent with purchasing power parity (PPP). Does the empirical evidence support this theoretical prediction? To answer this question, describe the two ‘variants’ of PPP theory, absolute and relative PPP. Then explain how one could test empirically whether a certain exchange rate is consistent with PPP. What are the research findings regarding the empirical validity of absolute and relative PPP? (9 points)
• Consider the following three currencies: Euros (eur), Swiss Francs (CHF) and U.S. Dollar (\$). Suppose that the bilateral exchange rates between the three currencies are currently as follows: 1.1 CHF/eur, 0.9 CHF/\$, 1.3 \$/eur. First, discuss how the presence of triangular arbitrage can be determined given this information. Then, explain how one could make a profit from triangular arbitrage in this concrete case and how the presence of such profits will affect the \$/eur exchange rate. (10 points)

Type your answer in the space between the two lines (word limit: 120).

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Type your answer in the space between the two lines (word limit: 300).

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Type your answer in the space between the two lines (word limit: 200).

Pages (550 words)
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