International Economics: Finance

Exercises

Textbook Problems

I strongly recommend that you do the end-of-chapter problems in your textbook. However, these are not required.

I recommend that you work these problems with a partner or a study group. (It need not be the same group every time.)

For theory questions, do not give short, purely descriptive answers! Make sure your answers are economic explanations.

Spreadsheet Exercises

GDP Bar Chart

Review the creation of vertical-bar charts in spreadsheets. (In Excel, these are called column charts.)

Video tutorial: https://www.gcflearnfree.org/excel2016/charts/1/

Verbal tutorial: https://subversion.american.edu/aisaac/notes/spreadsheet-intro.xhtml#bar-charts
Get current NIPA data for the US: gross domestic product (GDP), consumption (C), investment (I), government expenditures (G), and net exports (NX).
Make a bar chart from your data.
Transform C, I, G, and NX to percentages of GDP. Make a bar chart from your transformed data.

Real GDP Time-Series Chart

Do the Real GDP Time-Series Chart spreadsheet exercise.

Data-Exploration Exercises

Zaire's Hyperinflation

To produce a nice graph, we want a nice data format, and we need to normalize the data (to make it comparable across variable.)

Get the data; load it into Excel.
Select any cell in the data range, and then press ctrl+t to create a table from the data. Name it table01.
Excel cannot recognize the date data as dates. So we are going to create a column with a fully specified date varable. Start by creating the column. Add a table column to the right of the table Select a data cell in your table. Right click to get the context menu. Pick Insert » Table columns to the Right.
Because the date data specifies only a month and year, Excel does not recognize the date data as dates. We will add a day field to that it can do so. Use the DATEVALUE function to create dates as follow. In a cell in your new column, add the formula:
```
=DATEVALUE([date]&"-15")
```
(The choice of mid-month for the day was arbitrary.) Note how this formula uses structured references rather than explicit ranges.
Our use of DATEVALUE filled our new column with “date-time” values. We want these to display in a familiar date format. Select the data, right click to get a context menu, pick Format Cells, and pick a date format to your taste.
Rename the new column as zdate.
Next we want to normalize our data. Here is how to do that for the spot rate. Create a new column, names nspot, and then enter the following formula:;

=[spot]/INDEX([spot],1)

As a side note, this formula is not database compatible, because it indexes by a particular row number rather than by a row identifier that is part of the table (in the case, the date). We do this for spreadsheet simplicity, but if you wish, you can change the INDEX expression to get:
```
=[spot]/INDEX([spot],MATCH("1990-01",[date],0))
```
Create a time-series plot of your normalized data against the date, changing the y-axis to a ratio scale. (Use lines wihout markers.)

HW 3

Go to the BEA's interactive tables to get the data for this exercise. Report the US current account for the past decade in current dollars and as a percentage of nominal GDP. As a general tendency, has the current account getting “worse” or “better”? What about most recently? Justify your assessment carefully.
What is the significance of a country's international investment position (IIP)? What is the relationship between the IIP and the current account (CA)? Go to the Bureau of Economic Analysis and retrieve a decade of time series data for the IIP and CA. Plot them together in a single graph. Discuss the relationship between the two. Comment on any historical trends.
Explain why our DD curve slopes upward in (Y, E)-space. Start your explanantion with a depreciation of the domestic currency (i.e., an increase in E). You may refer to figures in your text if you wish.

Hint: When you are working on the DD curve: treat E as exogenous. So do not ask why E changes, just ask what happens if E changes.
Explain why our AA curve slopes downward in (Y, E)-space. Start your explanantion with an increase in the real income Y. You may refer to figures in your text if you wish.

Hint: When you are working on the AA curve: treat Y as exogenous. So do not ask why Y changes, just ask what happens if Y changes.
Using your AA-DD model of a floating exchange rate, discuss the effects of a permanent increase in M. (This is a change in the level of the money stock; you do not need to not worry about inflation expectations.) What change if any is there from our asset-markets-only results?
Using your AA-DD model of a fixed exchange rate, explain the sense in which fiscal policy is more effective than monetary policy, given high capital mobility and a fixed exchange rate. How does your explanation shed light on the “impossible trinity”?

HW 2

Data-based HW: Long-Run Purchasing Power Parity parts 1-6.
Without worrying about data quality, retrieve about a decade of monthly money, price, and exchange rate data for Zimbabwe from the International Financial Statistics. Explain (step by step!) how you get this data into your software application. Create a beautiful and informative graph, containing all three series. Comment on the relationships you see in the data, relating them to our discussions in class. Things to think about include the following.
1. Do you want your “y axis” to measure natural units or a log scale?
2. Do you want one scale for all variables (a single vertical axis) or multiple scales?
3. If you see any anomalies in your graph, can you explain them by reference to the data?
4. Based on the monetary approach model, did you expect to find the relationships in the data that you see?
Explain the difference between absolute purchasing power parity, relative purchasing power parity, and expected purchasing power parity. Summarize the basic intuition behind relative purchasing power parity, and then summarize the reasons we might expect deviations from relative purchasing power parity even in the long run.

Consider the following data from the IFS:

SE: 1948-2007
=============
 Initial q: 39.05
                      Item:      Gross    Percent
              US Inflation:       8.61     760.89
            Home Inflation:      16.76    1575.76
    Predicted Depreciation:       1.95      94.66
       Actual Depreciation:       1.78      78.17
 Final q: 35.74
 Real depreciation: -8.47%

The data collected are for E, P, and P*. What country is this data for? What is meant by "predicted depreciation"? What is illustrated by this data?

HW 1

Data-based HW: First Steps

If you did the above exercises carefully, you have learned a lot about using gretl. Remember to list familiarity with gretl on your resume!

Unfortunately forward rate data are bit hard to find free online. But at least for the moment, UBC at the website http://fx.sauder.ubc.ca/CAD/forward.html offers a summary of forward rates at various maturities. Use these data for the following exercises. (You should submit your spreadsheet and the document containing your write up.)
1. Enter the spot and forward exchange rates into a single column of your spreadsheet. (The spot rate is 0 months forward.)
  
  Examples:
  
  On 2011-11-24 I found reported the following exchange rates (spot and forward):
  
  Months Fwd
  
  Rate
  
  0
  
  0.9539
  
  1
  
  0.9533
  
  2
  
  0.9527
  
  3
  
  0.9522
  
  6
  
  0.9511
  
  9
  
  0.9505
  
  12
  
  0.9494
  
  24
  
  0.9457
  
  The data are not always so complete. (Missing values were typical during the global financial crisis.) Naturally, your numbers will depend on the date you access the webpage. Be sure to document your date of access and the date specified for the data.
2. Use your spot and forward rate numbers to compute the rest of the table you see at this website. That is, add the appropriate formulae (from the website) to your spreadsheet in order to compute the forward premium points on CAD (also called the swap rate) and the implied foreign interest rate differential. Note that you are not supposed to find the formulae in your book or notes: you are to use what you have learned to figure these out by reading this website. (The premium is just a scaled arithmetic difference, and FIRD is defined on the UBC page.) In your homework document (not your spreadsheet), please explain the formulae that you use.
3. Produce a graph similar to the UBC graph of forward premium points but with one difference: plot your computed values of the implied foreign interest rate differential instead of the forward premium points.
4. Based on your graph and data, how would you describe the market's expectations about how the USD-CAD exchange rate will behave over time? Explain carefully.
  
  Note
  
  The website formula already produces a percent value, so do not use your spreadsheet to do this a second time (e.g., by setting the cell formatting).
  
  Note
  
  Computations in the UBC table sometimes appear slightly off at short horizons. I inquired about this and was told it is due to rounding error in the exchange rate reporting. And actually, you can see that the data are rounded by looking carefullly at the accompanying graph, which is apparently based on the raw data.
  
  Note
  
  Do not fill your graphs with fancy “fluff” (like 3-D images). (If effective presentation of data is likely to be part of your work, you may want to read the work of Edward Tufte.)
  
  Note
  
  If you are going to speak of an “exchange rate depreciation”, make sure it is clear which exchange rate (CAD-USD or USD-CAD) you mean. It is generally better to speak, e.g., of a USD appreciation or depreciation.
Your US company is expecting a payment from an EU firm of 1M EUR in 3 months. How can you hedge your exposure to exchange rate risk in the forward market? Consider the following scenario. The EUR-USD spot rate is 1.48. Your bank offers you a EUR-USD 3-month forward rate of 1.50. Your EUR-USD (3 month) expected future spot rate is 1.48. If you contract today what do you pay your bank on the settlement date? Does it matter if your expectations prove correct or incorrect?

Your US company is expecting a payment from a CN firm of 1M CNY in 3 months, but since CNY are nondeliverable you will receive instead the US value of 1M CNY on that date. The Chinese forward market for CNY is restrictive and unattractive, but there is an active offshore market in nondeliverable forward contracts. How can you hedge your exposure to exchange rate risk in the nondeliverable forward market? Consider the following scenario. The USD-CNY spot rate is 6.82. Your bank offers you a USD-CNY 3-month NDF rate of 6.75. Your USD-CNY (3 month) expected future spot rate is 6.82. If you contract today what if anything do you pay your bank on the settlement date? Does it matter if your expectations prove correct or incorrect? (Be very specific about the details, so that it is clear that you understand the difference between an NDF contract and a forward contract.) You may find the follwing helpful: http://www.bis.org/publ/cgfs22fedny5.pdf
Consider our very first short-run model of exchange rate determination, which is simply based on the uncovered interest parity relation. Suppose we are in an initial equilibrium at E1, where it happens that the expected exchange rate E ^e equals the current exchange rate. This equilibrium is disturbed by a rise in the expected exchange rate. (I.e., a depreciation of the expected future value of the domestic currency---in this case, the USD.) Ceteris paribus, precisely how does the equilibrium spot rate change in this model, and why?
Analyze our first exchange-rate “overshooting” model, which uses the uncovered interest parity relation to explain exchange rates in the short run and the the neutrality of money to explain exchange rates in the long run. Suppose we are in an initial equilibrium at E1, where it happens that the expected exchange rate equals the current exchange rate. Next, this equilibrium is disturbed by a one-time permanent rise in nominal money stock. In the short run, precisely how does the equilibrium spot rate change in this model, and why? In the long run, precisely how does the equilibrium spot rate change in this model, and why? Describe the transition from the short run to the long run. What is the relevance of this distinction between the short-run and long-run effects to our understanding of the influence of monetary policy on the behavior of exchange rates?

Months Fwd	Rate
0	0.9539
1	0.9533
2	0.9527
3	0.9522
6	0.9511
9	0.9505
12	0.9494
24	0.9457

Introduction to gretl

Some homework assignments require the use of gretl, the Gnu Regression, Econometrics and Time-series Library. This is a free (GPL), cross-platform, open-source regression package. Almost every gretl command introduced in these homeworks is discussed in the excellent gretl manual. Be sure to <em>read about each command</em> before you use it.

Starting gretl

Make sure you are using a computer that has gretl installed. (If you are using your own computer, you can download gretl for free; the installation is simple.) Double-click the gretl icon. You will see the main gretl window appear.

Data Sets

There is a special data format for gretl. (But see the discussion of CSV.) Save the your gretl datafile to your working directory. (E.g., g:\thisclass\mygretldata.gdt.) If you are working in a lab computer, be sure to save it to your network drive, not to the c: drive!

Now you will open your datafile. You can do this three ways (try all!).

First way: pick from the menus File/Open_data/user_file, type in the file name, e.g., g:\thisclass\mygretldata.gdt and click Open. In the main gretl window you will see a list of your datafile contents. Before trying the next method, remove this data set by choosing File/Clear_data_set from the menus.
open the gretl console by picking from the menus Utilities/Gretl_console. At the console type open g:\canada.gdt and press the Enter key. Looking in the main gretl window, you will see a list of your datafile contents. Clear it as before.
pick from the menus: File/New_command_file/regular_script. You will see a new program window. Type into this window the following: open g:\canada.gdt Choose SaveAs from the command-script window icons (or menus if available), and then name your program g:\lastname.gretl_intro.inp (where 'lastname' is your last name). Save the file and then choose Run from the command script window icons (or menus if available). A gretl console window opens up to run your script. Looking in the main gretl window, you will see a list of your datafile contents. Clear it as before.

Now open your working copy of the data and examine the data. If I have given you a gretl data set, you can click once on the variable name. This highlights the variable name and some additional information about the series. Pay attention to this information!

You can also double click any variable name. A window opens displaying the values of the series.

CSV

The comma-separated value (CSV) format is an almost universal data exchange format. To import CSV data into gretl, make sure it has the right format. Your file should have variable names (a name has no spaces!) on the first line and a rectangular data matrix on the remaining lines. That is, each row after the first represents an observation (one period), and each column represents a variable (all periods, sequentially).

You can use the menus: File/OpenData/Import/CSV. For your scripts, use the import command.

Study Questions

Financial Markets

Countries have surprisingly varied policies toward providing free access to macroeconomic data produced with tax payer dollars. For example, detailed Canadian time series data are sold by Statistics Canada, while South Africa makes a substantial amount of data freely available. Suppose I need a time series for the CAD-USD exchange rate, and I do not have funds to buy it from StatCan. How could I use the data at http://www.resbank.co.za/economics/histdownload/histdownload.htm to produce this? Be sure to describe the following:
1. What data will you want to use? (That is, which series will you select?)
2. How will you get the raw data into your data analysis application (e.g., your spreadsheet)? (Optional: do it for one series, and describe what you did.)
3. What would you need to do with the raw data to produce usable time series? (You are not asked to produce an entire series; just discuss this.) What could go wrong as you try to use 2 time series to produce one new one? (Do not worry much about that fact that that you cannot have data for every day; that is true of the existing series. Worry about matching them up correctly.)
4. Be specific about any computation you will do. Illustrate with an actual compuation, using data from a single date of your choosing. (You are not asked to produce a complete time series.)
5. What features of international financial markets enable you to do this?
Note

Be careful with your notation: the CAD-USD exchange rate is the number of USD it takes to buy a CAD. The first currency in the pair (the CAD in this case) is the base currency; the second currency in the pair (the USD in this case) is the quote currency.
Go to the table of currency cross rates at http://marketwatch.nytimes.com/custom/nyt-com/html-currencies.asp and make the following checks:

a. for the USD versus the GBP, EUR, and JPY check for consistency of the direct and indirect (i.e., reverse) quote.

b. for the GBP, EUR, and JPY check for consistency of the reported cross rates with the synthetic cross rate you can construct by going through the dollar.
In class we showed that covered interest parity should always hold when capital mobility is high. We usually work with the approximation

R - R* = F / E - 1;

the exact expression is

F/ E = (1+ R)/(1+ R*).

Suppose the three-month interest rate on XYZ deposits is 3.1%/year. The three-month interest rate on USD deposits is 1.5%/year. Suppose the present spot exchange rate is USD 0.9 per unit of XYZ. Compute the three-month XYZ-USD forward rate, and explain your computation in detail.

Our first exchange-rate “overshooting” model uses the uncovered interest parity relation to explain exchange rates in the short run and the monetary approach to explain exchange rates in the long run. Suppose we are in an initial equilibrium at E_1, where it happens that the expected exchange rate E ^e equals the current exchange rate. Next, this equilibrium is disturbed by a permanent rise in nominal money stock. In the short run, precisely how does the equilibrium spot rate change in this model, and why? In the long run, precisely how does the equilibrium spot rate change in this model, and why? Briefly describe the transition from the short run to the long run. What is the relevance of this distinction between the short-run and long-run effects to our understanding of the influence of monetary policy on the behavior of exchange rates?
Define the following terms and comment on their significance: Marshall-Lerner condition, elasticity pessimism, J-curve.

Purchasing Power Parity

Explain the difference between absolute purchasing power parity, relative purchasing power parity, and expected purchasing power parity. Summarize the basic intuition behind relative purchasing power parity, and then summarize the reasons we might expect deviations from relative purchasing power parity even in the long run.
Find the "Pink Book" at the UK's Office for National Statistics (http://www.statistics.gov.uk) and repeat the PPP exercise with UK data.

Balance of Payments

Go to the Bureau of Economic Analysis (BEA) website (http://www.bea.gov/) and find the Balance of Payments data. What is the latest quarterly reported value for the U.S. current account, computed at an annual rate? What does this say about the production and spending of the US? Explain. In this same report, find the data for the components of the current account (the balances on goods, services, income, unilateral transfers). State each balance in dollars and as a percentage of the total. Which of these balances accounts for most of the current account deficit?
Use the BEA's BoP tables by Area to answer these questions. What proportion of the US current account deficit in 2003 was with the European Union? What proportion of the US current account deficit in 2003 was with Japan? Now take a more detailed look at the regional accounts vs. Japan. Does it look like there was US foreign exchange intervention vis a vis the yen in 2003? Explain.
What is the significance of a country's international investment position (IIP)? What is the relationship between the IIP and the current account (CA)? Go to the Bureau of Economic Analysis and retrieve a decade of time series data for the IIP and CA. Plot them together in a single graph. Discuss the relationship between the two. Comment on any historical trends.

AA-DD Model

Explain why our DD curve slopes upward in (Y, E)-space. Start your explanantion with a depreciation of the domestic currency (i.e., an increase in E). You may refer to figures in your text if you wish.

Hint: When you are working on the DD curve: treat E as exogenous. So do not ask why E changes, just ask what happens if E changes.
Explain why our AA curve slopes downward in (Y, E)-space. Start your explanantion with an increase in the real income Y. You may refer to figures in your text if you wish.

Hint: When you are working on the AA curve: treat Y as exogenous. So do not ask why Y changes, just ask what happens if Y changes.
Using your AA-DD model of a floating exchange rate, discuss possible policy responses to a temporary fall in domestic demand. Give a detailed account of the pros and cons of responding with monetary or fiscal policy.
Using your AA-DD model of a floating exchange rate, discuss possible policy responses to a temporary fall in domestic demand. Give a detailed account of the pros and cons of responding with monetary or fiscal policy.
Using your AA-DD model of a fixed exchange rate, discuss the following from the perspective of China's macroeconomic performance. (Note that the AA-DD model assumes perfect capital mobility. Analyze these questions under that assumption. You can then add qualifications if you wish.)
1. The effects of intervening to maintain the current parity.
2. The effects of trying to sterilize interventions undertaken to maintain the current parity.
3. The effects of an expected devaluation (or revaluation; your choice).
4. The effects of an actual devaluation (or revaluation; your choice).

International Economics: Finance

Exercises

Textbook Problems

Spreadsheet Exercises

GDP Bar Chart

Real GDP Time-Series Chart

Data-Exploration Exercises

Zaire's Hyperinflation

HW 3

HW 2

HW 1

Introduction to gretl

Starting gretl

Data Sets

CSV

Study Questions

Financial Markets

Purchasing Power Parity

Balance of Payments

AA-DD Model

Other Questions