Assignment 2. MGCR 382 International Business. Fall 2015

Transcription

1 Assignment 2 MGCR 382 International Business Fall 2015 Remarks This is a group assignment with 4-5 students per group. You are assigned to a group and the groups are binding. Any group change requires explicit permission. Answer all problems in the space provided. Clearly show your work and reasoning and encircle your final answer. No information can be exchanged between members of different groups. The due date is November 26, 2 PM at Karen Robertson s office in Bronfman 517. Assignment is to be submitted in printed form. No electronic submissions accepted. Late submissions will not be accepted. Section: Group Nr.: Student 1 Name: Student No.: Student 2 Name: Student No.: Student 3 Name: Student No.: Student 4 Name: Student No.: Student 5 Name: Student No.:

2 Question 1 (Trade): We look at the market for radios. In China, the demand and supply of radios is described by In the US, demand and supply is described by D China = P China S China = P China D US = P US S US = P US Ignore the fact that the US and China have a different currency, assume they have the same currency. a. (3 Points) If no trade is allowed, what will be the prices of radios in the US and in China? Explain and support your answers with calculations. 2

3 b. (5 Points) If China and the US can trade freely, who exports radios, who imports radios, what is the world price of radios and what is the quantity of radios traded? Explain and support your answers with calculations. 3

4 c. (5 Points) The US decides to support its radio producers and introduces a general subsidy for radio production. Under this subsidy, the US pays 2 dollars per radio produced and sold to its producers (the subsidy is granted to producers regardless if the radio is ultimately sold to a US or to a Chinese consumer). What will be the new quantity of radios traded and what will be the new world price of radios? Explain how the new world price and the quantity traded are different from the answer you found in question b. Support your answers with calculations. Hint: You need to understand how the subsidy is affecting the US supply curve of radios. 4

5 The US now decides to change the structure of the general subsidy and instead only grant an export subsidy (i.e., the subsidy in question c. is replaced). Under this export subsidy, an US producer of radios will receive an additional 2 dollars for every radio that is exported. If the radio is sold in the US, the producer will not receive a subsidy but only collect the market price that prevails in US. d. (5 Points) Start by thinking about the impact of the export subsidy on market prices in the US and China. Specifically, in class, when we discussed the impact of an import tariff, we discovered a special relationship between prices in the importer and exporter country and the tariff. Can you develop a similar relationship between prices in the importer and exporter country and the export subsidy and justify it with economic arguments? 5

6 e. (5 Points) Use your insights from questions d. above and compute the new prices of radios and the quantity of trade that will obtain after the introduction of the export subsidy (remember that the general subsidy of question c. no longer exists, i.e., make sure you use the correct import demand and export supply curves). Does the export subsidy promote or restrict trade? 6

7 f. (2 Points Hard) There is a problem with the solution you found for the export subsidy in questions d. and e.. If the US implements the export subsidy as stated ahead of question d. without any other restriction or qualifications and the market prices in China and the US indeed turned out the way you calculated in question e., then there is a hidden profit opportunity (almost like an arbitrage opportunity). Can you find this profit opportunity and explain what the US would have to do in order to neutralize it? If the US failed to solve this problem, what do you think would happen to the market prices in the US and China? 7

8 Question 2 (Exchange Rates): You observe the following quotes: Quote 1: Quote 2: 1 EUR CHF 8 DKK CHF a. (2 Points) What is the cross-rate DKK implied by these quotes? EUR b. (5 Points) If the DKK appreciates by 15% against the CHF and the CHF depreciates by 15% against the EUR, does the DKK appreciate or depreciate against the EUR and by how much? 8

9 Now suppose that you cannot trade at the quotes given in question a. Instead, you can trade at the following quotes: Quote 1: Quote 2: Bid 0.9 EUR CHF 7.8 DKK CHF Ask 1.1 EUR CHF 8.1 DKK CHF c. (2 Points) If you have 2000 DKK, how many CHF can you get? d. (2 Points) If you want 50 EUR, how many CHF do you need? e. (2 Points) If you want to sell 250 EUR, how many CHF do you get? f. (2 Points) If you want 700 DKK, how many EUR do you need? 9

10 Assume you observe the additional following quote: Quote 3 Bid 7.2 DKK EUR Ask 7.3 DKK EUR g. (5 Points) Together with Quote 1 and Quote 2 (as stated before question c.), would this constitute an arbitrage opportunity? If yes, explain and compute the arbitrage profit if you have 100 EUR to trade. If no, explain why not. 10

11 h. (5 Points) Go back and consider the bid and ask prices of quote 3 (the DKK quote). Identify EUR separately all bid and ask prices for which arbitrage opportunities exist (holding constant quotes 1 and 2 as stated before question c.). Hint: Your final answer should conclude s.th. like For any bid price lower than / higher than X, an arbitrage opportunity exists or There are no possible bid prices for which an arbitrage opportunity exists given quotes 1 and 2 and explain why that is so (and likewise for the ask prices). 11

12 Question 3 (Parity Conditions): Assume that the 1-year interest rate in the US is 2% and the 1-year interest rate in Sweden is 4%. You have no additional information on the spot or the forward rate. a. Assume you observe in the market that the Swedish Kronor (SKR) trades at a forward premium to the US Dollar (USD). Is this evidence of an arbitrage opportunity? If yes, explain in detail how you would structure the sequence of trades to benefit from it and why you can be sure to generate a profit in that way (assuming you are free to borrow and invest at the stated interest rates, there is no bid-ask spread). If no, explain why not. (6 points) 12

13 b. The trading strategy you described in question a. will lead to adjustments in the market. Describe how every of the following parameters is likely to change as a result of arbitrage activity. Specifically: - What is likely to happen to the USD / SKR spot rate and why? (1 point) - What is likely to happen to the USD / SKR forward rate and why? (1 point) - What is likely to happen to Swedish interest rate and why? (1 point) - What is likely to happen to the US interest rate and why? (1 point) 13