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PS1 S – Solutions to lecture 1 related questions
International Financial Strategy (Queen Mary University of London)
Studocu is not sponsored or endorsed by any college or university
PS1 S – Solutions to lecture 1 related questions
International Financial Strategy (Queen Mary University of London)
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1
PROBLEM SET 1
1. Isaac Díez Peris lives in Rio de Janeiro, Brazil. While attending school in Spain he meets
Juan Carlos Cordero from Guatemala. Over the summer holiday Isaac decides to visit Juan
Carlos in Guatemala City for a couple of weeks. Isaac’s parents give him some spending
money, 4,500 Brazilian reais. Isaac wants to exchange it to Guatemalan quetzals (GTQ). He
collects the following rates:
Spot rate on the GTQ/EUR:
GTQ 9.44/EUR
Spot rate on the EUR/BRL:
EUR 0.15/BRL
a. What is the Brazilian reais/Guatemalan quetzal (BRL/GTQ) cross rate?
b. How many Guatemalan quetzals will Isaac get for his Brazilian reais?
Model Answer:
a. The spot rate on the BRL/GTQ can be calculated as follows:
BRL/GTQ = BRL/EUR x EUR/GTQ
We know that GTQ/EUR = 1 / (EUR/GTQ) and BRL/EUR = 1 / (EUR/BRL)
BRL/GTQ = (1 / 0.15) x (1 / 9.44) = BRL 0.71 / 1 GTQ
b. If you have BRL 4,500, then 4,500 x 1/0.71 = 6,338.03 GTQ
—
2. The pound fell 17% against the euro. By how much has the euro appreciated against pound?
Model Answer:
If e0 is the euro value of the pound (€/£) and e1 is the post-depreciation euro value of the pound,
then:
𝑒1− 𝑒0
𝑒0= −17%
We are looking to find sterling value of the euro (post-depreciation) minus the sterling value
of the euro (pre-depreciation) divided by sterling value of the euro (pre-depreciation):
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2
1𝑒1
⁄−1𝑒0
⁄
1𝑒0
⁄=𝑒0− 𝑒1
𝑒1=𝑒0
𝑒1− 1
From (e1 – e0) / e0 = -17% we solve for e1 and e1=0.83 e0. And,
𝑒0− 𝑒1
𝑒1=𝑒0− 0.83 × 𝑒0
0.83 × 𝑒0=0.17
0.83 = +20.48%
→ Let’s use some numbers: If at time t-1 we have €1/£ and at t €0.83/£, then:
(€0.83/£ – €1/£) / €1/£ = -17%. Or per euro:
(1/ €0.83/£ – 1) / 1=20.48%
—–
3. Assume that China and France each have 1,000 production units. With one unit of production
(a mix of land, labor, capital, and technology), China can produce either 10 containers of toys
or 7 cases of wine. France can produce either 2 cases of toys or 7 cases of wine. Thus, a
production unit in China is five times as efficient compared to France when producing toys,
but equally efficient when producing wine. Assume at first that no trade takes place. China
allocates 800 production units to building toys and 200 production units to producing wine.
France allocates 200 production units to building toys and 800 production units to producing
wine.
a. What is the production and consumption of China and France without trade?
China
France
Units of production
allocated
Toys
800
200
Wine
200
800
Output per unit
Toys
10
2
Wine
7
7
TOTAL OUTPUT=CONSUMPTION
TOTAL
Toys
8,000
400
8,400
Wine
1,400
5,600
7,000
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b. Assume complete specialization, where China produces only toys and France produces only
wine. What would be the effect on total production?
China
France
Units of production
allocated
Toys
1,000
0
Wine
0
1,000
Output per unit
Toys
10
2
Wine
7
7
TOTAL OUTPUT=CONSUMPTION
TOTAL
Toys
10,000
0
10,000
Wine
0
7,000
7,000
The combined production of both countries is 10,000 containers of toys, 1,600 more containers
of toys than before specialization, with wine production remaining unchanged.
c. China’s domestic price is 10 containers of toys equals 7 cases of wine. Assume China
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