International Finance Master PEI Nicolas Coeurdacier. Sample exam

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1 International Finance Master PEI Nicolas Coeurdacier Sample exam Documents and calculator not allowed. For the essay questions, please be precise but concise in your answers. I. Multiple choice questions You have to select at LEAST one answer from the four proposed answers. You have to select ALL the correct answers, AND ONLY the correct answers to get the maximum number of points (no negative points). Here is a sample of questions from last year. Answers are at the end. 1. Over the past 20 years, the US net foreign asset position has deteriorated and from a net creditor to the rest of the world, the US has become a net debtor. This implies that over the last 20 years, on average, a. the US has been running a current account surplus b. the US has been running a financial and capital account surplus c. US receipts of capital income from the rest of the world have been less than US payments of capital income to the rest of the world. d. The US did not run the appropriate monetary policy which led to a fall in the external value of the dollar 2. The foreign assets held by the US were (at the end of 2009) valued at around 130% of its GDP and the US assets held by foreigners at around 150% of its GDP. The Net Foreign Asset position of the US was: a % of its GDP b. 0 thanks to the exorbitant privilege c. 20% of its GDP d. + 20% of its GDP 3. Suppose around 50% of foreign assets held by the US are not in dollar but that all US assets held by foreigners are in dollar (keeping the 2009 figures of the previous question). What is the effect of 10% depreciation of the dollar (with respect to all currencies) on the Net Foreign Asset position of the US in US dollars? a. 10% of GDP improvement b. 6.5% of GDP improvement c. 8.5% of GDP improvement d. 5% of GDP improvement 4. According to Purchasing Power Parity: a. the rate of change in the nominal exchange rate equals the inflation differential between two countries b. the real exchange rate is constant c. countries with low domestic inflation have a high rate of depreciation of their currency d. countries with identical nominal interest rates should have a stable nominal exchange rate

2 5. Annual inflation is 5% in Oddland and 1% in Evenland. According to Purchasing Power Parity, a. we should expect the currency of Oddland to depreciate in the long-run b. we should expect the currency of Oddland to appreciate in the long-run c. we should expect the currency of Oddland to depreciate in the short-run and appreciate in the long-run. d. we should expect interest rates to be higher in Oddland 6. According to the uncovered interest parity condition, if the one year US interest rate is 2% and the one year euro zone interest rate is 4%, the euro is expected to: a. depreciate by 2% in the following year b. appreciate by 6% in the following year c. depreciate by 6% in the following year d. appreciate by 2% in the following year 7. Changes in the real exchange rate a. are necessary for purchasing power parity to hold. b. indicate changes in the prices of goods produced in one country relative to the rest of the world c. are equal to changes in the nominal exchange rate minus the inflation rate of the country d. indicates, when it s a real depreciation of the domestic currency, a loss of competitiveness of domestically produced goods vis-à-vis the rest of the world 8. In 2007, the UK current account deficit represents 3 % of UK GDP. Which of the following would help reduce the deficit? a. a rise in world interest rates b. a decrease in world interest rates c. a depreciation of the Pound against the currencies of its trading partners d. an increase in the UK fiscal deficit if private savings and investment remain unchanged 9. When a country s currency is devalued, a. its export industries benefit b. its import industries benefit c. the trade balance should improve, at least in the medium-run d. it is a sign of strength for the home government 10. In the Mundell-Fleming model under flexible exchange rates (AA-DD model), an increase in the money supply leads to a. an increase in out put and an appreciation of the currency b. a fall in output and an appreciation of the currency c. an increase in output and a depreciation of the currency d. an increase in net exports and a depreciation of the currency 11. In an open economy under flexible exchange rates (AA-DD framework), a fiscal expansion is less efficient a. due to the crowding out of investment b. due to the crowding out of net exports c. if the economy is relying more on internal demand d. if the economy is perfectly integrated to international financial markets

3 12. Asymmetric demand shocks in a currency area can be cushioned a. if the monetary autority of the area raises interest rates b. if fiscal transfers are easily implemented in the area c. if workers mobility is restricted within the area d. if prices and wages are very flexible in the area 13. Keynesian fiscal multipliers are larger a. if the economy is more open b. if the economy is growing fast c. if the economy has a fixed exchange rate d. if Ricardian equivalence does not hold 14. International financial integration should benefit more to a. countries with low levels of total factor productivity b. capital scarce countries c. countries whose business cycles are less synchronized with the rest of the world d. countries with low marginal productivity of capital 15. Integration of international capital markets should a. increase arbitrage opportunities for investors b. allow investors to have higher expected returns on their portfolio of risky assets without taking more risk c. allow investors to keep the same expected returns on their portfolio of risky assets while decreasing the risk of their portfolio d. increase portfolio risk for investors due to currency risk 16. Goldina has the following fiscal situation in 1993: Debt-to-GDP ratio = 50%; Real interest rate = 5%; Real growth rate = 7% a. Goldina needs a primary surplus of 1% of GDP or above for the debt to be sustainable b. Goldina needs a primary deficit of 1% of GDP or less for the debt to be sustainable c. If Goldina runs a primary deficit of 2% of GDP, the debt to GDP ratio will increase up 100% and then stabilizes (keeping real interest rate and growth rate constant) d. If Goldina runs a primary deficit of 2% of GDP, the debt to GDP ratio will explode (keeping real interest rate and growth rate constant) 17. In , the real interest rates increase and the growth rate of Goldina decreased sharply. The fiscal situation of Goldina is now: Debt-to-GDP ratio = 50%; Real interest rate = 6%; Real growth rate = 1%; Primary fiscal deficit = 1% a. Goldina needs to run a primary surplus of 2.5% of GDP or above for the debt to be sustainable b. Goldina needs to run a primary deficit of 2.5% of GDP or less for the debt to be sustainable c. If Goldina does not cut spendings or raise taxes, the debt to GDP ratio of Goldina will increase up to a certain level and then stabilizes (keeping real interest rate and growth rate constant) d. If Goldina starts running a fiscal surplus of 1%, the debt to GDP ratio of Goldina will decrease to 20% and then stabilizes (keeping real interest rate and growth rate constant)

4 18. In Goldina, the currency is the Dollar Gold, whose nominal exchange rate is fixed with the US dollar. The parity is such that 1 Dollar Gold = 1 US dollar. a. If PPP is verified, inflation in Goldina should be equal to the US inflation b If inflation is higher in Goldina than in the US, the real exchange rate of Goldina depreciates with respect to the US dollar c. If inflation is persistently higher in Goldina than in the US, the Dollar Gold will be overvalued. d. If the interest rate is higher in Goldina, it is likely that investors expect the parity to be abandoned and the Dollar Gold to be devalued 19. The public debt of Goldina is mostly in US dollars. As a consequence, a devaluation of 50% of the Dollar Gold in 2001 should a. help Goldina to pay back its public debt as this will increase revenues for the government b. make the default of Goldina on its public debt more likely c. lead to a fall in the interest rates paid by the government on its US dollar debt d. leave the interest rate on debt unchanged as it is determined by US monetary policy 20. If Ricardian equivalence holds a. a tax cut should lead to a decrease in private savings b. a tax cut should lead to an increase in private savings c. a tax cut should trigger a recession d. international trade flows should increase answers: 1 b 2 c 3 b 4 ab 5 a 6 a 7 b 8 ac 9 ac 10 cd 11 bd 12 bd 13 cd 14 bc 15 bc 16 bc 17 a 18 acd 19 b 20 b

5 II. Short essays 1- The U.S. Federal Reserve announced in November 2010 its second set of quantitative easing measures (so called QE2) aimed at increasing the money supply into the US economy a. To do this policy, does the Fed need to buy or sell Treasury Bonds? b. In the present situation of zero interest rates, what are the conditions under which this policy of quantitative easing affects the Euro/Dollar exchange rate and US output? Explain in details. 2- Comment the following graph (2008 data) which shows the correlation between the deviation (for each country with respect to the dollar) of the market exchange rate from the Purchasing Power Parity rate (in percentage) and the log of the real GDP per capita. In the graph, a higher value of the exchange rate means an appreciation with respect to the dollar. 3- Using the graphs showing Average Net Capital Inflows per Capita (over the period ) as a function of GDP per capita in 1970 for two different samples of countries ( 45 emerging and developed countries and OECD countries only ) and using the concepts seen in class, explain and discuss the following paradox raised by Nobel Prize R.E Lucas: "Why doesn't Capital Flow from Rich to Poor Countries?" [Please do not use more than 1000 words]

6 Average Net Foreign Capital Inflows per Capita Sample of 45 emerging and developed countries ISR GRC ARG IND URU US JAP NOR GDP per capita in 1970 Average Net Foreign Capital Inflows per Capita Sample of OECD Countries ISR PRT GRC SPA US UK GER GDP per capita in 1970 Note: GDP per Capita in 1970 denotes GDP per Capita in USD adjusted for PPP in 1970 Average Net Foreign Capital Inflows per Capita denotes Net Capital Inflows per Head in USD averaged over the period Example: 1603 USD for Argentina means that on average over the period , 1803 USD (per head) were lent. A negative number means that on average the country was lending capital abroad (e.g Japan).

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