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FINM8007 International Finance
Research School of Finance, Actuarial Studies & Statistics
EXAMINATION – Suggested Answer Key
FINM8007 TOPICS IN INTERNATIONAL FINANCE
Writing Time: 2 hours
Reading Time: 15 minutes
Exam Conditions:
Central Examination
Students must return the examination paper at the end of the examination
This examination paper is not available to the ANU Library archives
Materials Permitted In The Exam Venue:
(No electronic aids are permitted e.g. laptops, phones)
Paper Based Dictionary
Non-Programmable Calculator
Materials to Be Supplied To Students:
Script books (20 page)
Instructions to Students:
1. This exam paper comprises a total of 13 pages. Please ensure your paper has the correct number of
pages.
2. The exam includes a total of 7 questions with subparts. The questions are of unequal value, with marks
indicated for each question. You must attempt to answer all questions.
3. Do not round calculations until providing your final answer to each question. Final answers should be
rounded to 4 decimal places. Penalty of 0.5 mark will apply for every violation.
4. Include all workings for each question. Marks will not be awarded for answers that do not include
workings.
5. For short answer questions, be sure to answer in point form only.
6. Ensure to include your student number on your answer book.
7. You should start your solutions to each question on a new page.
8. Organize your answers to sub-parts in the same order as they appear on the exam paper.
Total Marks = 75 marks
This exam counts towards 34% of your final assessment.
Semester 2 - Mid-Semester, 2017 FINM8007 International Finance
Page 2 of 9
Question 1 (10 marks)
For each of the following questions, record the letter for the correct answer on your booklet.
a. China has been tightening its capital control over the past few years to prevent drawdown on its
foreign exchange reserve as the Chinese current account is no longer running on a large surplus,
which of the following is true? (2.5 marks)
A) China is trying to achieve the impossible trinity.
B) China is trying to give up exchange rate stability to achieve the other two policy goals.
C) China is trying to give up monetary independence to achieve the other two policy goals.
D) China is trying to give up full financial integration to achieve to other two policy goals.
Answer: D
(Topic 2 Extension Slides 3-8, Practice Question 1, Week 3)
b. An Australian bank decides to issue 2-year Euro denominated bonds to take advantage of the
low interest rate in the Eurozone. If the bank is concerned that the Euro might strengthen
substantially over the two years as the bonds mature, how can it protect itself from such
risk? (2.5 marks)
A) By buying the Euro forward.
B) By selling the Australian dollar forward.
C) By selling the Euro forward.
D) By buying the Australian dollar forward.
Answer: A
(Topic 4: Forward & Covered Interest Arbitrage + Midsemester Review)
c. The current market quotes for the GBP against the USD are 1.3208/11. You are the managing
director of FX in a major FX dealer, and based on the ongoing inability of the British government
to reach a consensus on the Brexit plans and increasing the likelihood of a hard Brexit, you
believe that the uncertainty will lead to a depreciation of the GBP. You want to hold less GBP in
inventory and accumulate more USD instead, so you are going to quote a different price from
the market price, what should you quote? (2.5 marks)
A) GBP/USD 1.3209/10
B) GBP/USD 1.3207/10
C) GBP/USD 1.3209/11
D) GBP/USD 1.3207/12
Answer: B
You want attract customers to come to you to convert their USD in return to clear your GBP
inventory; and you want to hoard USD, so you don’t want to attract customers who wants to
convert GBP for USD. To achieve the former, you want to sell GBP for less USD than the rest of
the market, so you quote a lower ask price on the GBP/USD quote. To achieve the latter, you
want to buy GBP by paying less USD than the rest of the market, so you quote a lower bid price.
(Topic 1 Extension Slides 11-12, Practice Question 2, Week 2)
Semester 2 - Mid-Semester, 2017 FINM8007 International Finance
Page 3 of 9
d. Which of the following statements is correct? (2.5 marks)
A) All else equal, a country with the free floating regime is less insulated from inflation and
unemployment of other countries.
B) Trade imbalances would self-correct under the gold standard because disequilibrium in
price levels in one country will be offset by a counteracting flow of specie that would equalize
prices between trading partners and bring balance of trade back to zero.
C) All else equal, the free floating regime can help to improve conditions for a country that
has high inflation or high unemployment.
D) The Bretton Woods System specifies that each country sets a fixed rate that its currency
could be converted to a given weight of gold (e.g., $20/Oz, or £4/Oz), and that the FX rate
between any two currencies will be determined by their gold content.
Answer: B
A country with the free floating regime is more insulated from inflation and unemployment
of other countries. (slides 43-46 on Topic 2’s class annotated notes)
The free floating regime can adversely affect a country that has high inflation or high
unemployment. (slides 47-50 on Topic 2’s class annotated notes)
Each country sets a fixed rate that its currency could be converted to a given weight of gold
(e.g., $20/Oz, or £4/Oz), and that the FX rate between any two currencies will be determined
by their gold content. The definition is for the gold standard. (slide 20, Topic 2 notes)
(Topic 2: International Monetary System)
Question 2 (26 marks)
a. An Australian previously bought U.S. government bonds. This year, she receives USD500 in
coupon payments from her investment. The coupon payment is deposited to her USD bank
account in New York. How are these recorded on the Australian balance of payment? (8 marks)
Australian receives coupon payments as a result of her portfolio investment. This is a conceptual
inflow of foreign currency (USD) to Australia, increasing the supply of USD in the FX market.
(1 mark) This is hence recorded as a credit in the current account.
The coupon is deposited to the Australian’s USD bank account in New York, which increases
Australian ownership of foreign assets. (1 mark) This conceptually involves converting AUD for
USD and hence increasing demand of USD in the FX market, or an outflow of USD from
Australia. (1 mark)
Australian BOP Credit Debit
Coupon receipts from U.S. bond (1 mark)
Current account, interest income (1 mark)
$500
(1 mark)
Increase in Australian ownership of U.S. assets
Capital account, portfolio investment (1 mark)
$500
(1 mark)
(Topic 2 BOP, Practice questions 1 &2; Topic 2 Extensions, Practice question 2; Problem Set #1,
Q7)
Semester 2 - Mid-Semester, 2017 FINM8007 International Finance
Page 4 of 9
b. What is the effect on the Australian balance of payments of the following set of transactions?
ANU’s Centre for Arab and Islamic Studies received a $2.5 million donation from the Al-Maktoum
Foundation in Dubai in 2000 to fund the centre’s building as well as positions in Arab and Islamic
Studies. The donation was paid through the foundation selling Australian government bonds it
held. (10 marks)
ANU receives the gift from Dubai. The Dubai foundation is effectively seeking to improve
relations with Australia, hence seeking for Australia to export goodwill to Dubai. (1 mark) This
creates a conceptual supply of foreign exchange (Arab Emirate Dirham, AED) in the FX market,
i.e. to pay for the good will, so it’s a conceptual inflow of foreign currency (AED) to Australia.
(1 mark) This is hence recorded as a credit in the current account.
The payment is financed by selling Australian bonds held by the Dubai foundation. This payment
represents a decrease in foreign ownership of Australian assets. (1 mark) Conceptually, it
would involve converting AUD for AED and hence increasing the demand of AED in the FX
market, and outflow of AED from Australia. (1 mark) It is therefore recorded as a debit in the
capital account.
Australian BOP Credit Debit
Australian exports goodwill to Dubai. (1 mark)
Current account, current transfers (1 mark)
$2.5 million
(1 mark)
Sale of Australian bonds (1 mark)
Capital account, portfolio investment (1 mark)
$2.5 million
(1 mark)
(Topic 2 BOP, Practice questions 1 &2; Topic 2 Extensions, Practice question 2; Problem Set #1,
Q7)
c. The US current account has been consistently in deficit since 1982 to be the largest in the world
and stands at $124 billion in the third quarter of 2018. The fact that the U.S. holds a current
account deficit with many of its trading partners have been considered to be “unfair” by some
U.S. policy makers advocating for trade wars; according to them, the size of the current account
deficit is harmful to the U.S. economy. Discuss whether you consider a large current account
deficit such as the case of the U.S. to be harmful, be sure to include arguments discussed in class.
(8 marks)
The context of how the deficit is built up matters in the discussion. It involves a trade-off
between whether the deficit arises from 1) a country living beyond its means, such that national
consumption exceeds national savings, where the excess consumption is based on debt
borrowed from the rest of the world, or 2) a country attracts abundant capital investments from
the rest of the world because the economy offers many profitable investment opportunities and
higher risk-adjusted returns from the rest of the world. (2 marks)
Borrowing from the rest of the world to invest can boost national economy if there are good
positive NPV investment that generate sufficient profits after interest and debt repayment. It
would be harmful to the national economy, if the sum of expected future returns is not sufficient
to cover interest and principal payments on the debts (i.e., not enough positive NPV project
around). (2 marks)
Semester 2 - Mid-Semester, 2017 FINM8007 International Finance
Page 5 of 9
In the U.S. case, many consider that the deficit reflects a vote of confidence from the rest of the
world, in its highly productive economy to make good use of capital. The USD is also widely used
to settle trade, so the demand for USD denominated assets will remain strong. Additionally,
most debt that the U.S. holds is denominated in USD, so the U.S. is not exposed to FX exposure
on repaying their debts. (2 marks)
However, this is not to say that the U.S. is immune to loss of confidence, in which case, foreign
investors may reduce their demand of U.S. assets, leading to a fall in international capital inflow
that cutting financing to positive NPV projects, in this case the deficit will be a problem.(2 marks)
Overall, a current account deficit may not be all about underlying economic difficulties.
(Topic 2 BOP, Practice questions 1 &2; Topic 2 Extensions, Practice question 2; Problem Set #1,
Q7)
