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Question 1 Explain the concepts of “Free on Board” (FOB) and “Cost Insurance Freight” (CIF) shipping quotations

Economics

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Question 1

1. Explain the concepts of “Free on Board” (FOB) and “Cost Insurance Freight” (CIF) shipping quotations. Describe which price components are included in FOB and CIF quotations. Afterwards, use a concrete example to explain how information on FOB and CIF quotations can be used to measure transport costs. (8 points)
2. Describe the two forms in which firms can participate in global value chains (GVC). Furthermore, explain (i) under which condition(s) a country will participate in a GVC according to the model of Baldwin (2011) and (ii) how an increase in transport costs would impact the two forms of global value chain participation according to that model. (7 points)

Question 2

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

1. 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)
2. 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)
3. 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)

Question 3

1. A Dutch investor is considering an investment in Japanese government bonds with an interest rate of 12.5% per year.  The current exchange rate between the euro and the yen is 0.90 euro/yen. The investor has access to a forward contract allowing her to buy or sell euros against yen in one year from today at a rate of 0.95 euro/yen. Based on this information, compute the return on investment in Japanese bonds assuming that the investor starts with euros and wants to end up with euros. For which value of the interest rate on Dutch investments would the investor be indifferent between investing in Dutch assets and investing in Japanese bonds?    (3 points)
2. Suppose that the current spot exchange rate between the euro and the yen, measured in euro/yen, falls. How will this impact the forward exchange rate between the euro and the yen? Explain carefully the sequence of steps that will eventually lead to a change in the forward exchange rate. (9 points)
3. The figure below shows the current private supply and demand curves for euros in the absence of official interventions. Suppose the Bank of England is committed to keep the exchange rate between the pound sterling and the euro within a band of +/- 3% around the target rate 0.9 pound/euro. First, explain whether the current position of the private demand and supply curves requires official interventions of the Bank of England and, if so, what is the minimum amount of pounds and euros that the Bank of England will have to sell/buy respectively.  Then, assuming that the Bank of England will intervene in foreign exchange markets in a similar way for several periods, explain how these interventions will affect the price competitiveness of British firms. (11 points)

Question 4

1. Research has shown that most of the world’s FDI is flowing from rich countries to other rich countries and not from rich countries to poor countries. Is this patterns consistent with the theory of international capital flows and the theoretical assumption that the marginal product of capital (MPK) decreases as a firm’s or a country’s stock of capital becomes higher? Explain your answer. If you think that this observation is not consistent with the theoretical prediction, mention and discuss one possible factor that could explain why capital is ‘flowing in the wrong direction.’  (6 points)
2. Unrestricted international capital flows can contribute to financial crises. Two important measures to resolve financial crises are rescue packages and debt restructuring. First, provide the definitions of these two measures. Second, explain how (i.e. through which channels) these measures can resolve financial crises. Third, discuss the downsides of these measures in terms of creating moral hazard behavior and free-rider problems.  (14 points)
3. Suppose there are two assets, a domestic and a foreign one, that each pay a return of 10% during a boom and 2% during a recession. Suppose that there is 50% chance that the home country will experience a boom and the foreign country a recession. There is also a 50% chance that the situation will be the other way around. Based on this scenario, explain how capital controls will impact the wellbeing of investors and why capital controls may be particularly harmful for very risk-averse investors. (8 points)