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anh)
Chap 10,11,13, (International Economic Cooperation)
6 essays: Chọn 2: 11 và 13

CHAPTER 8 - INTERNATIONAL ECONOMIC COOPERATION

Purpose:
• An increasing number of countries using of import tariff and non-tariff
barriers to restrict imported goods.
=> It becomes difficult for a country to export their goods to another country.
• Countries can avoid or reduce the effect of tariff and non-tariff barriers by
international economic cooperation both regionally and globally.

There are at least 6 levels of international economic cooperation in the world,

which ranges from the simplest to fully integrated form:
I. Bilateral and multilateral trade agreements
• Bilateral trade agreements: Two countries agree to remove or reduce
tariff and non-tariff barriers on some goods and services.
Examples: US-Vietnam Bilateral Trade Agreement (December 10, 2001)
• Multilateral trade agreements: more than two countries agree to remove
or reduce tariff or non-tariff barriers on several goods or services traded
among the country members.
Examples: WTO
II. Free Trade Agreement (FTA)
• Member countries agree remove tariffs and non-tariff barriers on goods
traded among the members.
• Each member country reserves its own tariffs on goods imported from
non-member countries.
Example: Vietnam and Thailand join into ASEAN Free Trade Agreement (AFTA),
tariffs on steel traded between Vietnam and Thailand become 0 as they are
member countries. However, Vietnam reserves a tariff of 30% levied on steel
imported from Korea- a non-member country. Thailand reserves a tariff of 25%
imposed on steel imported from Korea.
 • Some FTAs in the world:
+ European free trade agreement (EFTA):
- EFTA Member States: Iceland, Liechtenstein, Norway and Switzerland.
- The four EFTA States are competitive in several sectors vital to the global
economy and score among the highest in the world in competitiveness, wealth
creation per inhabitant, life expectancy and quality of life.
- Switzerland is a world leader in pharmaceuticals, biotechnology,
machinery, banking and insurance.
- Liechtenstein, like Switzerland, is highly industrialized and specialized in
capital-intensive and Research & Development driven technology products.
- The Icelandic economy benefits from renewable natural resources, not
least rich fishing grounds, and has increasingly diversified into other industries and
services. Abundant natural resources also contribute significantly to Norway’s
economic strength, including oil and gas exploration and production, and fisheries,
as well as important service sectors such as maritime transport and energy-related
services.
+ Asean Free Trade Agreement (AFTA)
- Signed on 28 January 1992 in Singapore. When the AFTA agreement was
originally signed, ASEAN had six members, namely, Brunei, Indonesia, Malaysia,
Philippines, Singapore and Thailand.
- Vietnam joined in 1995, Laos and Myanmar in 1997 and Cambodia in 1999.
AFTA now comprises the ten countries of ASEAN. All the four latecomers were
required to sign the AFTA agreement to join ASEAN but were given longer time
frames in which to meet AFTA's tariff reduction obligations.
- The primary goals of AFTA seek to:
Increase ASEAN's competitive edge as a production base in the world
market through the elimination, within ASEAN, of tariffs and non-tariff barriers; and
Attract more foreign direct investment to ASEAN.
 + Comprehensive progressive agreements for trans-pacific
partnership (CPTPP)
The Comprehensive and Progressive Agreement for Trans-Pacific
Partnership (CPTPP) is a free trade agreement between Canada and 10 other
countries in the Asia-Pacific region: Australia, Brunei, Chile, Japan, Malaysia,
Mexico, New Zealand, Peru, Singapore and Vietnam. Once fully implemented, the
11 countries will form a trading bloc representing 495 million consumers and 13.5%
of global GDP, providing Canada with preferential access to key markets in Asia
and Latin America.
On December 30, 2018 the CPTPP entered into force among the first six
countries to ratify the agreement – Canada, Australia, Japan, Mexico, New
Zealand, and Singapore. On January 14, 2019, the CPTPP entered into force for
Vietnam.
III. Customs Union liên minh thuế quan

• Has characteristics of an FTA

• All member countries agree on common trade policies applied to non-
member countries.
Example: Vietnam and Thailand join into ASEAN Free Trade Agreement (AFTA),
tariffs on steel traded between Vietnam and Thailand become 0 as they are
member countries. In addition, Vietnam and Thailand agree on a common tariff of
30% levied on steel imported from Korea- a non-member country.
• Problem: There is still restriction of labor and capital moving among the
country members.
Examples: EU- Turkey Custom Union
• The effectiveness of a customs union is measured in terms of trade creation
and trade diversion.
• Trade creation occurs when the more efficient members of the union sell to
less efficient members, leading to a better allocation of resources.
 VN, US: Custom Union
Korea: efficient non - member

• Trade diversion occurs when efficient non-member countries sell fewer

goods to member countries because of external tariffs. It gives less efficient
countries in the union the opportunity to capitalize on their position and sell
more goods within the union.
IV. Common Market/ Community
• Has characteristics of a customs union
• Labours and capital move freely among the member countries.
• Citizens of a member country can go working at other member countries
without visa.
• No taxes on capital movement among the member countries.
• Problem: use different currencies.
Examples: MERCOSUR; EC; …
+ Asean Economic Community (AEC)
Was established in December 2015 between 10 member states:
Indonesia, Vietnam, Cambodia, Singapore, Malaysia, Brunei, Philippines, Laos,
Myanmar, and Thailand.
Its ultimate goal is to allow for the free movement of goods, skilled
labor, services, and investment. The AEC creates a single market and production
base within ASEAN, and it aims to facilitate freer flow of capital. This economic
union spans some 640 million people and has a combined GDP of $2.94 trillion.
The progress and growth of the AEC leaves it ranked as the 7th largest economy
in the world and the 3rd largest in Asia.
V. Economic Union
• Has characteristics of a Common Market
• Member countries agree on a common currency used among them
• Member countries agree on common economic policies applied to all the
members.
Example: EU – European Union => Common currency is Euro.
VI. Political and Economic Union
• Has characteristics of an Economic Union
• Member countries agree on common political policies applied to all the
members.
Example: Former Soviet Union

1. Bilateral and multilateral agreement: giữa 2 QG trở lên về 1 món hàng hoặc dịch vụ
2. Free Trade Agreement: Hiệp định giữa các thành viên về bãi bỏ thuế
3. Custom Union: liên minh thuế quan: FTA + đánh thuế chung với những nước không phải thành viên
4. Common market: Custom Union + labor, capital (không cần visa, giảm thuế khi đầu tư qua nước ngoài)
5. Economic Union: Common market + same currency
6. Politccal and Economic Union: Economic Union + Politcal
 Trần Đức Thành - TA International Economics

Chapter 10 - Chapter 13

Exchange Rate and Foreign Exchange Market

1. Concepts and definition
- Foreign Exchange Market: the market at which people buy and sell different currencies. One
international currency that is bought and sold popularly is the USD
- The rate at which two currencies can be exchanged for each other is called the Foreign Exchange
Rate (E).
Example: 1 USD = 23,000 VND or we write: EVND/USD = 23,000 VND/USD
In this example: VND is the “Base currency” and USD is the “Quote currency”
2. How to write the currency?
The first two letters are the country’s name. The third letter is the currency’s name.
Example: VND
Can you recognize these currencies?
THB, JPY, GBP, CNY, AUD, CAD.
- Some countries use symbols rather than letters: USD = $; GBP = £;
3. Direct Quote vs. Indirect Quote
- Direct Quote: the number of domestic currency units that are exchanged for one unit of foreign
currency. Direct quote: Home/Foreign
Example: in Vietnam: 1 USD = 23,000 VND
110 JPY/ USD Indirect quote: Foreign/Home
in Japan: 1 USD = 110 JPY
- Indirect Quote: the number of foreign currency units that are exchanged for one unit of domestic
currency. Direct Quote Indirect Quote
Example: in The UK: 1 GBP = 1.15 USD
23,000 VND/ 1 USD 0.00004 USD/ 1 VND
in the US : 1 USD = 30 THB
30 THB /USD
4. Bid Rate vs. Offer Rate
sẽ so với - Bid Rate : buying rate of Bank selling rate of Individuals (dollars)
USD Ask/
- Offer Rate: Selling rate of Bank buying rate of Individuals (dollars)
- At a bank: A: have $10,000 => JPY => 10,000 USD x 100 JPY/USD
Information = 1,000,000 JPY
other currency /USD => GBP => E = 0.89 GBP/USD
JPY: 100.0000 – 110.0000
=> A sell $10,000 => bank buy $10,000
THB: 30.0000 – 32.0000 => Bank trade 10,000 USD x 0.89 GBP/USD = 8,900 GBP
GBP: 0.8900 - 0.9400
VND: 22,500.0000 – 23,000.0000 => $ => other currency => sử dụng giá Bid
5. Cross – Rate Bid Offer => Other currency => $ => sử dụng giá Offer/Ask
- Cross Rate: the rate of exchange between two non-USD currencies
- Example: use VND to buy THB A: have 100 THB
➔ The Cross Rate: E(VND/THB) => THB/USD=32
Step 1: Use VND to buy USD => USD/THB = 1/32
Step 2: Use USD to buy THB => 100 THB x 1/32 (USD/THB) = 3.125 USD
VND => USD => THB => A buy 3.125 USD => Bank sell Dollar
JPY => USD = > GBP
E(VND/USD) = 23,000
E(THB/USD) = 30 E(VND/THB)= E (VND/USD) x E (USD/THB)=23,000 x 1/30 USD/THB=767
E(JPY/GBP)= E(JPY/USD) x E (USD/GBP) = 110 x (1/0.89)=123.6 JPY/GBP
Trần Đức Thành - TA International Economics

𝑉𝑁𝐷 𝑈𝑆𝐷 𝑉𝑁𝐷 1 1

× = × = 23,000 × = 767
𝑈𝑆𝐷 𝑇𝐻𝐵 𝑈𝑆𝐷 𝑇𝐻𝐵/𝑈𝑆𝐷 30
E(VND/THB) = 767 => 1 THB = 767 VND
- Example 2: Calculate the Cross Rate: E(JPY/GBP) = 110/ 0.89 = 123.6
1 GBP = 123.6 JPY (23,000 - 22,000)/22,000 x 100 = 4.54%
E = 22,000 VND/USD => USD appreciate against VND by 4.54%
6. Depreciation vs. Appreciation E = 23,000 VND/USD => VND depreciate against USD by 4.54%
- Because of changes in the foreign exchange market (changes in demand for or supply of the USD
in the market): 1 USD = 22,000 VND changes to 1 USD = 23,000 VND
- We say that: there is a depreciation of the VND or there is an appreciation of the USD.
- The VND is depreciated against the USD by (23000-22000)*100/22000 = 4.54%
- Example 1: The initial Exchange Rate: Eo: 1 USD = 22,000 VND; E (VND/USD) = 22,000 VND/USD
Later on: E1: 1 USD = 21,000 USD E = 21,000 VND/USD
We say that the VND is appreciated against the USD by: (21,000 – 22,000)*100/22,000 = -
(21,000 - 22,000)/22,000 x 100 = -4.54%
4.55% %E (VND/USD) = -4.54%
=> USD depreciate against VND by -4.54%
7. Devaluating vs. Revaluating => VND appreciate against USD by -4.54%
- Under the central bank’s intervention into the market ➔ 1 USD = 22,000 VND changes to 1
USD = 23,000 VND
- Vietnamese government has devaluated the VND => Increase export
8. Bilateral Foreign Exchange Rate and Nominal Effective Exchange Rate (NEER)
- Bilateral Exchange Rate is the rate of Exchange of two currencies between the two countries.
EX: E(VND/GBP) = 32,000 or 1GBP = 32,000 VND
- Nominal Effective Exchange Rate (NEER): the sum of the trade shares multiplied by the
exchange rate changes for each country.
- The amount of international trade is the sum of Export value + Import value in a period of time
(normally a year). Trade share 1 Trade share 2
EX: A Home country has 40% of international trade with country 1, 60% international trade is
with country 2. A Home’s currency appreciates 10% against country1’ currency but depreciates
30% against country 2’ currency. The Change in Nominal Effective Exchange rate will be:
= (-0.1*0.4) + (0.3*0.6) = +0.14 or 14%
- ➔ Home’s Effective Exchange Rate has depreciated by 14% against the two countries 1 and 2.
%delta E(country 1/home) =10%
9. Arbitrage => %delta E (home/country 1) = -10%
%delta E(country2/home) = -30%
=> %deltaE (home/country 2) = 30%
NEER (home/country 1 and country 2) = %delta E(home/country 1) x Trade share 1 + %delta
E(home/country 2) x Trade share 2 -10% x 40% + 30% x 60%
NEER (home/country 1 and country 2) = 14%
=> country 1 and country 2 appreciate against home by 14%
=> Home's effective exchange rate has depreciate by 14% against two countries
 Trần Đức Thành - TA International Economics

E (GBP/USD) USD => GBP

E (GBP/USD)

USD => EUR => GBP

E (USD/GBP) = 1.15 USD/GBP=> Tốn ít USD
E (USD/GBP) = E(USD/JPY) x E(JPY/GBP)
=1/105 x 135 = 1.28 USD/GBP
- Arbitrage: buying and selling of different currencies for profit. USD => JPY => GBP=> USD (1)
- Example: USD => GBP => JPY => USD (2)
At the New York Money Center: 1 USD = 105 JPY E= 105 JPY/USD
At the Tokyo Money Center: 1 GBP = 135 JPY E = 135 JPY/GBP
At the London Money Center: 1 GBP = 1.15 USD E= 1.15 USD/GBP (x)
You have 100,000 USD, how can you earn profit from this information?
➔ Use 100,000 USD to buy GBP: 100,000/1.15 = 86,956 GBP 100,000 USD x (1/1.15) (GBP/USD)
(2)  Use 86,956 GBP to buy JPY : 86,956*135 = 11,739,130 JPY 86,956 GBP x 135 (JPY/GBP)
 Use 11,739,130 JPY to buy back USD: 11,739,130/105 = 111,801 USD
 Profit to the arbitrageur: 111,801 – 100,000 = 11,801 USD 11,739,130 JPY x (1/105) x (USD/JPY)
(1) USD => JPY: 100,000 USD x 105 JPY/USD = 10,500,000 JPY
JPY = >GBP: 10,500,000 JPY x (1/135) (GBP/JPY) = 77,777.78 GBP
GBP => USD: 77,777.78 GBP x 1.15 (USD/GBP) = 89,444.44 USD
- Example 2: E(USD/GBP) = 1.3 USD/GBP
At the New York Money Center: 1 USD = 125 JPY E(USD/GBP) = E(USD/JPY) x E(JPY/GBP)
At the Tokyo Money Center: 1 GBP = 140 JPY = 1/125 x 140 = 1.12 USD/GBP
At the London Money Center: 1 GBP = 1.3 USD USD => JPY => GBP => USD (1)
You have 200,000 USD, how can you earn profit from this information? USD => GBP => JPY => USD (2)
 Use 200,000 USD to buy JPY: 200,000*125 = 25,000,000 JPY 200,000 USD x 125 JPY/USD
25,000,000 JPY x (1/140) (GBP/JPY)
(1)  Use JPY to buy GBP: 25,000,000/140 = 178,571.43 GBP
 Use GBP to buy back USD: 178,571.43*1,3 = 232,142 USD 178,571.43 GBP x 1.3 (USD/GBP)
 Profit to the arbitrageur: 32,142 USD. E (USD/GBP) = 1.3 USD/GBP (đổi trực tiếp qua GBP)
10. Foreign Exchange Risks: E (USD/GBP) =1.12 USD/GBP (đổi thông qua JPY)
- Foreign Exchange Risk: losses to exporters, importers, or investors which are caused by
fluctuation of the foreign exchange rates.
- Exporters sell their goods abroad and receive payments in terms of USD
- Importers buy foreign goods from abroad and make payments to foreign sellers in terms of USD
- Both of their performance is affected by the fluctuation of the USD.
a. Depreciation of the domestic currency causes risks to importers:
- Example: importing good X
- World price of X: Pw = 1 USD => PwxEo = 22,000 VND
- Domestic price of X: Pd= 24,000 VND
- Initial Exchange Rate: Eo(VND/USD) = 22,000 VND/USD
Nhập khẩu: Pw<Pd
E = 0.00004 USD/VND=1/Eo Profit = Pd-PwxEo=Pd - Pw/E

Xuất khẩu: Pw > AC,Ps

Profit = Pw - ACxEo
 Pw=$1
US X
Pw x Eo = 1 USD x 22,000 VND/USD=22,000 VND
Exchange rate fluctuation/risks
Trần Đức Thành - TA International Economics
Country's exchange rate depreciate=> risk to importer, encourage country's export => Vietnam import US goods
- ➔ profit per one unit of X: πo = Pd – Pw*Eo = 24,000 – 1*22,000 = 2,000 VND/unit
- Suppose there is a depreciation of VND ➔ E1: 1 USD = 23,000 VND
➔ new profit per unit: π1 = Pd – Pw*E1 = 24,000 – 1*23,000 VND = 1,000 VND/unit
- The Depreciation of VND (domestic currency) has reduced profit by 50% ➔ risk to the importer.
b. Class Assignment Profit per unit: Pwx Eo - AC = 1 USD x 22,000 VND/USD
- Given the following data of an exporter: - 18,000 VND = 4,000 VND/unit
Export the good X => Vietnam export to US
Average cost
New profit per unit: Pwx E1 - AC = 1 USD x 23,000 VND/USD
Unit cost of production of X: AC = 18,000 VND - 18,000 VND = 5,000 VND/unit
The world price of X: Pw = 1 USD => Vietnam increase export
Initial Exchange Rate Eo(VND/USD) = 22,000 VND
- Prove for the statement: if the government devaluates the domestic currency from 1USD = 22,000
VND to 1 USD = 23,000 VND, it can encourage the country’s export.
11. Foreign Exchange Market for USD
- Suppliers of USD: the banks, the exporters, foreign visitors, arbitrageurs, foreign company’s
FDI,..
- Demand for USD: the banks, the importers, the citizens who abroad for visiting, studying,
Price of USD (E (VND/USD)) S1
arbitrageurs, … S2
- Price of USD: the Exchange Rate E
- If demand for USD increases ➔ the price of USD ↑ or E ↑ andE2vice versa.
(VND/USD)
- If supply of USD increases ➔ the price of USD ↓ or E ↓ and E1 vice(VND/USD)
versa.
- Factors that cause the foreign exchange rate E to change: D2
US banks print more money/sell more USDE2 (VND/USD)
o The banks => MS increase => USD depreciate D1
BOT = Export - Import o Export and Import values M(US) increase =>BOT (US) decrease
o FDI flow into or out of the country => Demand for USD decrease
=> E decrease
o Ect.
FDI flow into the US=> Supply of dollars decrease
12. Foreign Exchange Regimes => E (VND/USD) increase
a. Fixed Exchange Rate Regime (Pegging regime) FDI flow out of the US=> Supply of dollars increase
GDP = C + I + G + EX – IM => E(VND/USD) decrease
E=22,000 VND/USD
- If the exchange rate fluctuates, it negatively affects EX and IM ➔ affect GDP national income
E=23,000 VND/USD- Some countries don’t want it ➔ they apply the Fixed Exchange Rate regime.
- The Central Bank keeps the exchange rate E fixed so that it does not affect EX and IM.
- If demand for USD increases, the price of USD ↑ ➔ E (VND/USD) ↑, the Central Bank will sell
out the USD into the market ➔ supply of USD ↑ ➔ price of USD ↓ ➔ E ↓ back to the initial
value and vice versa. Central bank keep foreign currency reserves
Foreign reserves - Advantage: the E does not negatively affect EX and IM activities.
Gold
IMFs - Disadvantage: when the Central Bank sells out the USD ➔ the country’s Foreign Reserves ↓➔
the country becomes poorer.
- Note: Every country has its foreign reserves which consists of at least 3 sources: the USDs, gold,
and the IMF’s currency (or SDRs). These foreign reserves are kept at the Central Bank of the
country.
b. Floating Exchange Rate Regime:
- The Exchange Rate E fluctuates freely in the FOREX market without intervention of the Central
Bank.
- If demand for USD ↑ ➔ E ↑ and vice versa
 Trần Đức Thành - TA International Economics

Fixed ex change rate

- If supply of USD ↑ ➔ E ↓ and vice versa. =22,000 VND/USD
- Advantage: it does not cause reduction in the country’s Foreign Reserves =22,220VND/USD (+1%)
- Disadvantage: it may cause risks to IM and EX. =21,780 VND/USD (-1%)
c. Manageable Floating Regime
- The Central Bank allows E to fluctuate freely within a frame of +/- a% specified by it.
-1%
- - a% E + a% +1%

21,780 22,000
CB’s action

CB’s take action (sell out USD)

E (VND/USD) appreciate> VND depreciate => Export (VN) increase, Import (VN) decrease
E (VND/USD) depreciate => VND appreciate=> Export decrease, Import increase
d. Crawling Peg Regime
- The Central Bank allows E to increase by less than a% every year. The a% is set by the Central
Bank.
- Applying when the country faces an increasing value of Import (IM) overtime.
e. Foreign Exchange Direct Control
- The Banking system announces the value of E every day. All the households and companies have
to follow.
- The Banking system controls the USDs. Companies and households are not allowed to buy and
sell USD directly.
- Problem: it leads to the establishment of two markets for USD: the official market for USD; the
Black Market for USD.
13. Measures to avoid or reduce the Foreign Exchange Risk
- From the example above: When E(VND/USD) = 22,000 , the profit to the importer is 2,000
VND per unit; When E1(VND/USD) = 23,000, the profit to the importer is 1,000 VND per unit.
Now after 3 months

Eo: 1 USD = 22,000 VND E?

E1= 1USD=23,000 VND
The importer receives goods from abroad VN is an importer

- If pay USD immediately (within 2 days) to the foreign seller: the importer goes to the bank to buy
USD. The bank sells USD to him at a Spot Rate Eo: 1USD = 22,000 VND. Not risk to the
importer.
- What happens if the importer makes payment after 3 months? ➔ risk if E after 3 months is 1USD
= 23,000 VND.
- To avoid the risk the importer uses Derivatives Instruments (công cụ phái sinh). There are 4
derivatives instruments:
o Forward contracts
o Options
o Futures
o SWAP
 Now 3 months
E1= 23,000 VND/USD
Eo= 22,000 VND/USD
Trần Đức Thành - TA International Economics Trả với tỉ giá FW contract
$1,000 = 22tr VND $1,000 = 23tr VND E = 22,600 VND/USD

a. Forward Contracts: (hợp đồng giao USD sau) hedge

- After receiving the foreign goods, the importer goes to his bank to sign a Forward Contract to buy
the USD today but he will receive USD after 3 months to make payment. The bank signs the
Ki FW contract forward contract to sell USD to the importer with the Forward Rate Ew: 1 USD = 22,600 VND.
với bank
E = 22,600 VND/USD - After 3 months, the importer pays the bank to receive USD at the price: 1USD = 22,600 VND. He
does not care what happens to the USD price in the market after 3 months.
- Although after 3 months, if the exchange rate in the market is 1USD = 23,000 VND, the importer
Ki options contract
pays only 22,600 VND to the bank to buy USDs.
với bank
E = 22,800 VND/USD The importer pays extra 600 VND per 1 USD to transfer the risk to the bank. 600 VND per USD
-
Trả với tỉ giá FW contract
is called “Hedging Cost”.
E1= 21,000 VND/USD E = 22,600 VND/USD
b. Options $1,000 = 21tr VND $1,000 = 22tr6 VND
E1= 23,000 VND/USD - =>What
Exercise the Options
happens if after 3contract
months(E=22,800 VND/USD)
the E reduces down to 1 USD = 21,000 VND? And the importer
E1 = 21,000 VND/USD=> Do not exercise the Options contract (E = 21,800 VND/USD)
has signed the Forward contract with the Forward Rate: 1USD = 22,600 VND.
- The importer can use Options to avoid the problem.
- Options = a Forward contract + the right not to exercise the forward contract in future.
- To buy Options the importer has to pay the bank additional cost beside the Hedging Cost.
c. Futures
- Futures are forward contracts which can be resold in the FOREX market to another importer.
- After signing the Forward contract, an importer can resell it to another importer in the FOREX
market if he thinks that he does not need these USDs in future.
- The importer can buy Futures contracts from the bank.
- Futures = the Forward Contracts which are made standardized in terms of the quantity of USD
and the time. A ký future contracts: E = 22,600 VND/USD
=> Bán cho B=> B có thể mua lại
- Examples: the bank can offer to sell:
o A 200,000 USD- 3-month- forward contract
o A 500,000 USD – 3 month –forward contract
o A 300,000 USD- 6-month- forward contract
- Even if the importer needs only 189,000 USD to pay foreign sellers, he has to buy the
200,000USD-3 month forward contract.
How firm use currency future contract?
=> Exporters want to pay in the future so the enter future contract or sell your future money to block
the value
d. SWAP
- Is applied when the importer has USDs today but he needs VNDs to operate his business.
However, he needs these USDs in future to pay the foreign sellers.
- SWAP: the importer signs a contract to sell USDs to the bank today and receives VNDs, and at
the same time, he signs a forward contract to buy back these USDs in future.
- The bank will use SWAP rate.
- Example: the importer has 100,000 USD today but he needs VNDs for his business operations.
He also knows that he has to use these 100,000 USD to pay the foreign sellers after 3 months.
The importer goes to his bank to do 2 actions for SWAP:
o Action 1: sells 100,000 USD today and receives VNDs for his business operations
o Action 2: at the same time, he signs a forward contract to buy back 100,000 USD after 3
months for paying the foreign seller. Now 3 month after
Eo=22,000 VND/USD E1=23,000 VND/USD
$=> VND => $ E = 22,600 VND/USD
$100,000 x 22,000 = 22tr VND
 Trần Đức Thành - TA International Economics
E< 1 USD/EUR => E = 0.7 USD/EUR=> CFO exercise option contract => E=1.05 USD/EUR => 1.05 million USD
E> 1 USD/EUR => E = 1.3 USD/EUR => CFO do not exercise option contract => E = 1.25 USD/EUR=> 1.25 million USD
o The Bank combines two actions into one transaction which is SWAP contract with the
SWAP rate. Now 90 days after
E = 1.1 USD/EUR E< 1 USD/EUR => E = 0.7 USD/EUR
Example 1: Hedging
A Chief Financial Officer (CFO) of a U.S. firm expects to receive payment of €1 million in
90 days for exports to France.
The current spot rate is $1.10 per euro. The Chief Executive Officer (CEO) knows that severe
losses would be incurred on the deal, if the dollar strengthened (i.e., the euro weakened) to
less than $1 per euro. 1.1 million USD (Now)
What should the CFO do? < 1 million USD (90 days after)
CFO can buy call options E = 1.05 USD/EUR
=> guarantee firms profits regardless of the falling spot rate
Example 2: Speculation
One-year euro futures are currently priced at $1.20.
You expect the dollar will depreciate to $1.32 in the next 12 months.
What should you do? Buy these futures

Calculating the Forward rate:

The uncovered interest parity (UIP)

(𝟏 + 𝒊∗ )
𝑭 = 𝑬𝒐 ×
(𝟏 + 𝒊)
e
E
F: exchange rate after one year

When the F - rate is used as the forward rate => Covered Interest Parity (CIP)

Example:
 Trần Đức Thành - TA International Economics

A person wants to deposit his saving of 10 million VND at a bank to earn interest income. He considers
two options:

(1) deposit his saving at a bank in Vietnam;

(2) deposit his saving at a bank in the Unites States.

Bank’s Interest Rate in Vietnam: 7% i=4%

Bank’s Interest Rate in the US: 4% i* = 7%
Initial Foreign Exchange Rate: Evnd/usd = Eo= 22,500 F-rate (after 1 year)

If an importer signs a forward contract to buy USD with his bank, what will be the forward rate the bank
may offer to the importer?

If he deposits his saving at a VN bank, after one year he receives: 10,000,000 x ( 1+7%) = 10,700,000 VND

• If he deposits his saving at a bank in the United States, he has to take several steps:
10,000,000
• Step 1: He uses 10 million VND to buy USD and receives = 444.44 US dollars
22,500
10,000,000 VND x (1/22,500) USD/VND
• Step 2: He deposits 444.44 USD at a bank in the US. After 1 year, he receives
444.44 × (1 + 4%) = 462.22 US dollars

• Step 3: He exchanges 462.22 US dollars into VND and receives:

462.22 × 𝐹 = 10,700,000 VND F = 23,150 VND/USD

• If he still deposits in Vietnam bank, after 1 year he will receive:

F = 10,000,000 x (1+i*)/ (10,000,000 x (1/22,500) x(1+i)) = 22,500 x (1+i*)/(1+i) = E (VND/USD) x (1+i*)/(1+i)
10,000,000 × (1 + 7%) = 10,700,000 VND
(1+𝑖 1+0.07
• Forward rate: 𝐹 = 𝐸𝑉𝑁𝐷/𝑈𝑆𝐷 × (1+𝑖𝑉𝑁)) = 22,500 × 1+0.04 = 23,150 𝑉𝑁𝐷/𝑈𝑆𝐷
𝑈𝑆

• The bank uses Covered Interest Rate Parity (CIP) to identify the Forward Rate Bank dùng
F - rate (exchange rate Eo sau 1 năm) khi kí hợp đồng Forward sẽ giúp cho việc gửi tiền
ở bên VN hay US đều nhận số tiền như nhau tránh được rủi ro của Exchange rate

Problems: E (A$/SFr) = E (A$/$) x E ($/SFr) = 1.8215 x (1/1.5971) = 1.1405 A$/SFr

1. Doug Bernard specializes in cross-rate arbitrage. He notices the following quotes:

Swiss franc/U.S dollar = SFr 1.5971/$ 1.5971 SFr/$

Australian dollar/U.S. dollar = A$ 1.8215/$ 1.8215 A$/$

$ => A$ => SFr => $ (1) Australian dollar/Swiss franc = A$ 1.1440/SFr 1.1440 A$/SFr
$ => SFr => A$ => $ (2)
a. Ignoring transaction costs, does Doug Bernard have an arbitrage opportunity
E (A$/$) = 1.8215
E (SFr/$) = 1.5971 SFr/$
E (A$/$) = E (A$/SFr) x E (SFr/$)
E (SFr/$) = E(SFr/A$) x E (A$/$) = (1/1.1440) x 1.8215=1.592 SFr/$
=1.1440 x 1.5971 = 1.8271
=> Arbitrage opportunity is possible
Arbitrage opportunity is possible
 E ($/A$) = 1/(1.825) = 0.548 $/A$
E ($/A$) (thông qua SFr) = E($/SFr) x E (SFr/A$) = (1/1.5971) x (1/1.1440) = 0.547 $/A$
Trần Đức Thành - TA International Economics
(2) $ => SFr => A$ => $
sell $1,000,000 to buy SFr: 1,000,000 USD x 1.5971 SFr/USD = 1,597,100 SFr
based on these quotes? sell 15,971,000 SFr to buy AUD: 1,597,100 SFr x 1.1440 (A$/SFr) = 1,827,082.4 A$
Profit = 3,064.7 USD sell 1,827,082.4A$ to buy USD: 1,827,082.4 A$ x (1/1.8215) ($/A$) = 1,003,064.7 USD
b. If there is an arbitrage opportunity, what steps would he take to make an arbitrage

profit, and how would he profit if he has $1,000,000 available for this purpose.

2. Consider the United States and the countries it trades with the most (measured in trade
volume): Canada, Mexico, China, and Japan. For simplicity, assume these are the only four
countries with which the United States trades. Trade shares and exchange rates for these four
countries are as follows:
NEER ($/CA$, Peso, Yuan, Yen) = %E($/CA$) x Trade share + ...
Country (currency) Share of Trade $ per FX in 2009 $ per FX in 2010

Canada (dollar) 36% 0.9225 0.9643

0.9225 $/CA$
Mexico (peso) 28% 0.0756 0.0788

China (yuan) 20% 0.1464 0.1473

Japan (yen) 16% 0.0105 0.0112

Bilateral exchange rates:
%delta E($/CA$) = ((0.9643 - 0.9225)/ 0.9225) x 100 = 4.53% 100%
%delta E($/peso) = 4.23%
%delta E($/yuan) = 0.61% a. Compute the percentage change from 2009 to 2010 in the four U.S. bilateral exchange rates
%delta E($/yen) = 6.67%
(defined as U.S. dollars per unit of for- eign exchange, or FX) in the table provided.

b. Use the trade shares as weights to compute the percentage change in the nominal effec-
tive exchange rate for the United States between 2009 and 2010 (in U.S. dollars per foreign
currency basket).
NEER (USD/CA$, Peso, yuan, yen) = Trade share (Canada) x %delta E($/CA$) + Trade share (Mexico) x %deltaE($/peso) +....
c. Based on your answer to (b), what happened to the value of the U.S. dollar against this
basket between 2009 and 2010? How does this compare with the change in the value of the
U.S. dollar relative to the Mexican peso? Explain your answer.
NEER (USD/CA$, Peso, yuan, yen) = 36% x 4.53%+28%x4.23%+20%x0.61%+16%x6.67% =4.01%
c. USD is depreciated by 4.01% against the basket between 2009 and 2010. USD is depreciated by 4.23% against Mexican peso.
The average depreciation of US against Chinese yuan is low (0.61%) and high trade share (20%) => Then, total effect is 4.01%
3. You are a financial adviser to a U.S. corporation that expects to receive a payment of 40
million Japanese yen in 180 days for goods exported to Japan. The current spot rate is 100
yen per U.S. dollar (E$/¥ = 0.01000). You are concerned that the U.S. dollar is going to
appreciate against the yen over the next six months.

a. Assuming the exchange rate remains unchanged, how much does your firm expect to
tương tự receive in U.S. dollars?
7 Chap 10
b. How much would your firm receive (in U.S. dollars) if the dollar appreciated to 110 yen
per U.S. dollar (E$/¥ = 0.00909)?

c. Describe how you could use an options contract to hedge against the risk of losses
associated with the potential appreciation in the U.S. dollar.
a. When exchange rate unchange:
Now Next Six months 40 million Yen x E($/Yen)
E ($/Yen) = 0.01 $/Yen USD appreciate => E ($/Yen) decrease = 40 million x 0.01 = $400,000
E($/Yen) =0.01 (câu a) $400,000
E($/Yen) = 0.00909 (câu b) $360,000
 When dollar appreciate to 110 yen per USD:
40 million Yen x E($/Yen) = 40 million Yen x 0.00909 $/Yen= $360,000

E=0.00909 E=0.0095 E=0.01

When using option contracts, the firm is assumed to have the forward rate in option contract: E = 0.0095 $/Yen
+ If USD appreciate to 110 yen/USD (E$/Yen = 0.00909)=> Exercise option contract
=> Firm will receive 40 million Yen x 0.0095 $/Yen = $380,000
+ If USD unchange 100 yen/USD (E$/Yen = 0.01) => Do not exercise option contract
=> Firm will receive 40 million x 0.01 = $400,000 => But pay some additional cost
 Trần Đức Thành - TA International Economics

4. Consider a Dutch investor with 1,000 euros to place in a bank deposit in either the
Netherlands or Great Britain. The (one-year) interest rate on bank deposits is 2% in Britain
and 4.04% in the Netherlands. The (one-year) forward euro– pound exchange rate is 1.575
euros per pound and the spot rate is 1.5 euros per pound. Answer the following questions,
using the exact equations for UIP and CIP as necessary.

a. What is the euro-denominated return on Dutch deposits for this investor?

b. What is the (riskless) euro-denominated return on British deposits for this investor using
forward cover?

c. Is there an arbitrage opportunity here? Explain why or why not. Is this an equilib- rium in
the forward exchange rate market?

d. If the spot rate is 1.5 euros per pound, and interest rates are as stated previously, what is the
equilibrium forward rate, according to covered interest parity (CIP)?

e. Suppose the forward rate takes the value given by your answer to (d). Compute the forward
premium on the British pound for the Dutch investor (where exchange rates are in euros per
pound). Is it positive or negative? Why do investors require this pre- mium/discount in
equilibrium?

f. If uncovered interest parity (UIP) holds, what is the expected depreciation of the euro
(against the pound) over one year?

g. Based on your answer to (f ), what is the expected euro–pound exchange rate one year
ahead?

5. Assume you are a trader with Deutsche Bank. From the quote screen on your

computer terminal, you notice that Dresdner Bank is quoting €0.7627/$1.00 and Credit

Suisse is offering SF1.1806/$1.00. You learn that UBS is making a direct market

between the Swiss franc and the euro, with a current €/SF quote of .6395. Show how

you can make a triangular arbitrage profit by trading at these prices. (Ignore bid-ask

spreads for this problem.) Assume you have $5,000,000 with which to conduct the

arbitrage.

What happens if you initially sell dollars for Swiss francs? What €/SF price will

eliminate triangular arbitrage?

 Trần Đức Thành - TA International Economics

6. The current spot exchange rate is $1.95/£ and the three-month forward rate is $1.90/£. On
the basis of your analysis of the exchange rate, you are pretty confi- dent that the spot
exchange rate will be $1.92/£ in three months. Assume that you would like to buy or sell
£1,000,000.

a. What actions do you need to take to speculate in the forward market? What is the expected
dollar profit from speculation?

b. What would be your speculative profit in dollar terms if the spot exchange rate actually
turns out to be $1.86/£.

Chapter 11

EXCHANGE RATE 1: THE MONETARY APPROACH IN THE LONG-

RUN
The law of one price (LOOP): the price of the good in each market must be the same => Fundamental of
arbitrage principle

Key assumptions:

• No transaction costs: no cost of meetings, travelling, no transportation cost…

• No barriers to trade: no tariff and non-tariff barriers

• Identical goods in each location

• No barriers to price adjustment

Purchasing power parity (PPP): these overall price levels in each market must be the same.
Host/Foreign country
Absolute PPP Home country
e
∆E(VND/USD) E(VND/USD) - E(VND/USD)
= 𝑃𝑣𝑛
E(VND/USD) 𝐸𝑜 = E(VND/USD)=Pvn/Pus
E(VND/USD) 𝑃𝑢𝑠
Pvn,t Pvn,t-1
Relative PPP - (Pvn,t -Pvn,t-1) (Pus,t -Pus,t-1)
PUS,t PUS,t-1 -
= ∆𝐸(𝑉𝑁𝐷/𝑈𝑆𝐷), 𝑡 π (USD,t) Pvn,t-1 Pus,t-1
Pvn,t-1 = 𝜋𝑉𝑁𝐷,𝑡 − 𝜋𝐸𝑈𝑅,𝑡
PUS,t-1 𝐸(𝑉𝑁𝐷/𝑈𝑆𝐷), 𝑡
The relative price of basket of goods in Home Country compared to Host country =
Real exchange rate:

𝑃𝑣𝑛 𝑃𝑣𝑛 × 𝐸(𝑈𝑆𝐷/𝑉𝑁𝐷)

𝑞(𝑈𝑆/𝑉𝑁) = =
𝑃𝑢𝑠 × 𝐸𝑜(𝑉𝑁𝐷/𝑈𝑆𝐷) 𝑃𝑢𝑠
USDx (VND/USD)
• q=1: LOOP is hold
Pvn/ (Pus x Eo) = 1
=> Pvn = Pus x Eo
 q (US/VN) = 1.5 the basket of US/ the basket of VN
=> q decrease back to 1 => E(VND/USD) increase => USD appreciate => VND depreciate
=> hoặc E(USD/VND) decrease=> VND depreciate => USD appreciate
Trần Đức Thành - TA International Economics

• If q>1: the price in VN is more expensive (VN goods are overvalued). More US goods
needed to exchange for VN goods. Exchange Rate Eo will adjust to increase to return
back to q=1=> VND will depreciate. USD will be appreciated.
0.5 = 50%
Pvn/ P(UsxEo) = q = 1.5
• => VND is overvalued by % (as Pvn>PusxEo) Pvn = 1.5 Pus x Eo

• If q<1: the price in VN is cheaper (VN goods are undervalued). Exchange Rate Eo will
adjust to reduce to return to q=1 => VND will appreciate. USD will depreciate.
0.2 = 20%
• => VND is undervalued by % (as Pvn<PusxEo)
q (US/VN) = 0.8 the basket of US/ the basket of VN
=> q increase back to 1 => E(VND/USD) decrease => USD depreciate => VND appreciate
=> E(USD/VND) increase => USD depreciate => VND appreciate
The percentage change in Exchange rate:

%∆𝐸 = 𝜋 ∗ − 𝜋

• Inflation increases in Foreign: E increase => Foreign depreciates, Home appreciates.

• Inflation increases in Home: E decrease => Foreign appreciates, Home depreciates.

The PPP theory suggests that price levels in different countries and exchange rates are tightly
linked, either in levels or in rates of change.

The problem is that the PPP theory has several assumptions that are not in reality.

 when we determine price levels, we must consider transaction costs, traded goods and
non-traded goods, tariffs, non-tariff barriers, market structures, foreign government
policies… which affect the price of goods across countries.

Vietnam (VND) The US (USD)

Rice (kg) 20,000 1.5

Petroleum (l) 30,000 2.6

Hair cut 45,000 15

Pork meat (kg) 120,000 6

Value in the basket 215,000 VND 25.1 USD

• Pvn = 215,000 VND (overall price level in VN)

• Pus = 25.1 USD (overall price level in the US)

• Current Exchange rate: E0: 1USD = 22,000 VND VND/USD

calculate the real exchange rate q(US/VN)

q(US/VN) = Pvn/ (Pus x Eo) = 215,000/ (25.1 x 22,000) = 0.4 the basket of US/ the basket of VN
 q=0.4 < 1=> the price of VN is cheaper (VN goods are undervalued)=> VN goods are undervalued by 0.6 = 60% compared
to US goods. Due to LOOP, q increase back to 1=> Eo decrease => USD depreciate => VND appreciate

Trần Đức Thành - TA International Economics

• We identify the real exchange rate q:

𝑃𝑣𝑛 215,000
• q = 𝑃𝑢𝑠 𝑥 𝐸0 = 25,1 ×22,000=0.4 < 1

• Real depreciation (sự giảm sút trong sức mua của đồng VND).

• more VN goods are needed to exchange with the US goods ➔ the Nominal Exchange Rate Eo
will adjust to reduce so that q = 1 following the PPP theory: the price of goods in the basket must
be the same in the two countries.

• When PPP is hold: q =1 or: Pvn = Pus*Eo

• We can determine the PPP exchange rate Eo: Eo = Pvn/Pus = 215,000/25.1 = 8,565 VND/USD

Money: q=1 => Pvn/(PusxEo) = 1 => Pvn = Pus x Eo

• Stores of value
• Unit of account
• Medium of exchange

Different measures of money

• Monetary base = Currency

• M1 = Currency in circulation + demand deposits (checking accounts payable)
• M2 = M1 + other less liquid assets (savings accounts, small time deposit, and money market
mutual funds)
• We will focus on M = M1 controlled by central bank MS: Controlled by central bank
M x V = PxY
• Quantity theory: Liquidity preference Md = 1/V x P x Y (CB print money)
Liquidity Preference => MS increase
i MS1 MS2 M d
= P´Y ´ L P: price level
demand nominal income ($) a constant Y: total output (real GDP)
for money ($) PxY (nominal income)
L
i1
Md Md: i,P,Y
= L ´ Y i (interest rate): increase => Md decrease (P and Y unchange)
i2 P a constant real income
Y increase => Md increase (i and P unchange)
P increase => Md increase (i and Y unchange)
demand
MD for real Md/P = L(i) x Y Md = L(i) x P x Y
money decreasing function
M1 E ($/Euro)=Pus/Peuro = [Mdus/(L(i)xYus)] / [Mduk/(L(i)xYuk)]
𝑀
𝑃=
̅𝐿 × 𝑌

These expressions say that the price level P is determined by the ratio of nominal money
supplied M to nominal money demanded (LY).

Prices rise if there is “more money chasing fewer goods”

• A simple model of price:

 Trần Đức Thành - TA International Economics

𝜋 = %𝑀𝑆 − %𝑌

𝜋 = µ−𝑔

%𝐸 (𝑉𝑁𝐷/𝑈𝑆𝐷) = 𝜋𝑉𝑁𝐷 − 𝜋𝑈𝑆𝐷 = (%𝑀𝑉𝑁 − %𝑌𝑉𝑁) − (%𝑀𝑈𝑆 − %𝑌𝑈𝑆)

= (%𝑀𝑉𝑁 − %𝑀𝑈𝑆) + (%𝑌𝑈𝑆 − %𝑌𝑉𝑁)

𝑒
Or we can write: %𝐸𝑉𝑁𝐷/𝑈𝑆𝐷 = 𝜋𝑉𝑁𝐷 − 𝜋𝑈𝑆𝐷 = (µ𝑉𝑁𝐷 − 𝜋𝑈𝑆𝐷 ) + (𝑔𝑈𝑆 − 𝑔𝑉𝑁 )
µUSD
• Fisher Effect
Relative UIP and PPP imply
𝑒 𝑒
𝑖𝑉𝑁𝐷 − 𝑖𝑈𝑆𝐷 = 𝜋𝑉𝑁𝐷 − 𝜋𝑈𝑆𝐷

• Real interest rate parity i=r+π

=>r=i-π
𝑒 𝑒
𝑖𝑉𝑁𝐷 − 𝜋𝑉𝑁𝐷 = 𝑖𝑈𝑆𝐷 − 𝜋𝑈𝑆𝐷
𝑒 = 𝑟𝑒
𝑟𝑉𝑁 𝑈𝑆

Problems

1. Suppose that two countries, Vietnam and Côte d’Ivoire, produce coffee. The currency unit used in
Vietnam is the dong (VND). Côte d’Ivoire is a member of Communauté Financière Africaine
(CFA), a currency union of West African countries that use the CFA franc (XOF). In Vietnam,
coffee sells for 5,000 dong (VND) per pound. The exchange rate is 30 VND per 1 CFA franc, E
VND/XOF = 30.

a. If the law of one price holds, what is the price of coffee in Côte d’Ivoire, measured in CFA
francs?

b. Assume the price of coffee in Côte d’Ivoire is actually 160 CFA francs per pound of coffee.
Compute the relative price of cof- fee in Côte d’Ivoire versus Vietnam. Where will coffee traders buy
coffee? Where will they sell coffee in this case? How will these transactions affect the price of coffee
in Vietnam? In Côte d’Ivoire

2. You are given the following information. The current dollar-pound exchange rate is $2 per pound.
A U.S. basket that costs $100 would cost $120 in the United Kingdom. For the next year, the Fed is
predicted to keep U.S. inflation at 2% and the Bank of England is predicted to keep U.K. inflation at
3%. The speed of convergence to absolute PPP is 15% per year.

3. This question uses the general monetary model, where L is no longer assumed constant, and money
demand is inversely related to the nominal interest rate. Consider the same scenario described at the
beginning of the previous question. In addition, the bank deposits in Japan pay a 3% interest rate, i¥ =
3%.

a. Compute the interest rate paid on Korean deposits.

 Trần Đức Thành - TA International Economics

b. Using the definition of the real interest rate (nominal interest rate adjusted for inflation), show that
the real interest rate in Korea is equal to the real interest rate in Japan. (Note that the inflation rates
you computed in the previous question will be the same in this question.)

c. Suppose the Bank of Korea increases the money growth rate from 12% to 15% and the inflation
rate rises proportionately (one for one) with this increase. If the nominal interest rate in Japan remains
unchanged, what happens to the interest rate paid on Korean deposits?

4. Use the table that follows to answer this question. Treat the country listed as the home country and
treat the United States as the foreign country. Suppose the cost of the mar- ket basket in the United
States is PUS = $190. Check to see whether PPP holds for each of the countries listed, and determine
whether we should expect a real appreciation or real depre- ciation for each country (relative to the
United States) in the long run. For the answer, create a table similar to the one shown and fill in the
blank cells. (Hint: Use a spreadsheet applica- tion such as Excel.)

Pus xEo (VND/$)

5. You are given the following information. The current dollar-pound exchange rate is $2 per pound. A U.S.
basket that costs $100 would cost $120 in the United Kingdom. For the next year, the Fed is predicted to
keep U.S. inflation at 2% and the Bank of England is predicted to keep U.K. inflation at 3%. The speed of
convergence to absolute PPP is 15% per year.
a. What is the expected U.S. minus U.K. inflation differential for the coming year?
b. What is the current U.S. real exchange rate qUS/UK with the United Kingdom?
c. How much is the dollar overvalued/under- valued?
d. What do you predict the U.S. real exchange rate with the United Kingdom will be in one year’s time?
e. What is the expected rate of real depre- ciation for the United States (versus the United Kingdom)?
f. What is the expected rate of nominal depre- ciation for the United States (versus the United Kingdom)?
g. What do you predict will be the dollar price of one pound a year from now?
7. This question uses the general monetary model, in which money demand is inversely related tothe
nominal interest rate, L(i). Consider two countries, Japan and Korea. In 1996, Japan
experienced relatively slow output (income) growth, 1%, whereas Korea had relatively robustoutput
growth, 4%. Suppose the Bank of Japan allowed the money supply to grow by 2% eachyear, where as
the Bank of Korea chose to maintain relatively high money growth of 8% per year.Treat Korea as the
home country and Japan as the foreign country. In addition, the bank deposits in Japan pay 3%
interest; i¥ = 3%.
a. Calculate the interest rate paid on Korean deposits.
b. Using the definition of the real interest rate (nominal interest rate adjusted for inflation), showthat
the real interest rate in Korea is equal to the real interest rate in Japan. (Note that theinflation rates you
calculated in the previous question will apply here.)
c. Suppose the Bank of Korea increases the money growth rate from 8% to 11% and the
inflation rate rises proportionately (one for one) with this increase. If the nominal interest rate in Japan
remains unchanged, what happens to the interest rate paid on Korean deposits
d. Suppose Korean economy slowed down. The output growth rate became 2% with 8% for the money
growth rate in Korea. i) If the nominal interest rate in Japan remains unchanged, what happens to the
interest rate paid on Korean deposits
e. Suppose the Bank of Japan increases the money growth rate from 2% to 6% and the inflationrate
rises proportionately (one for one) with this increase. What happens to the interest rate paid on
Japanese deposits?
a. Fisher effect:
i(k) - i(j) = π(k)-π(j)
Md/P = L(i)xY
i(k) - 3% = 4% -1%
g =4% i(j) = 3% => i (k) = 6%
k
g(j) = 1%
µ(j)=2% π (k) = µ(k) - g(k)= 8%-4% =4%
µ(k)=8% π (j) = µ(j) -g(j) = 2% - 1% = 1%

b. r (k) = i(k) - π (k) =6% - 4% = 2%

r (j) = i(j) - π (j) = 3% - 1% = 2%
=> r(k)=r(j)
c. Interest rate parity: r(k) = r(j)
real interest rate is unaffected by nominal interest rate and inflation
i(k) = r(k) + π(k) = 2% + 7% = 9%
π(k) = µ(k) - g(k) = 11% - 4% = 7%
d. g(k) = 2%
µ(k) = 8%
i(k)=r(k)+π(k)

e. µ(j) =6%
π(j)=?
i (j) =?

6. Consider two countries: Japan and Korea. In 1996 Japan experienced relatively slow out- put growth
(1%), while Korea had relatively robust output growth (6%). Suppose the Bank of Japan allowed the
money supply to grow by 2% each year, while the Bank of Korea chose to maintain relatively high money
growth of 12% per year.
For the following questions, use the simple monetary model (where L is constant). You will find it easiest to
treat Korea as the home coun- try and Japan as the foreign country.
a. What is the inflation rate in South Korea? In Japan?
b. What is the expected rate of depreciation in the Korean won relative to the Japanese yen (¥)?
c. Suppose the Bank of Korea decreases the money growth rate from 15% to 12%. If nothing in Japan
changes, what is the new inflation rate in Korea?
d. Suppose the Bank of Korea wants to maintain an exchange rate peg with the Japanese yen. What
money growth rate would the Bank of Korea have to choose to keep the value of the won fixed relative to
the yen?
e. Suppose the Bank of Korea sought to implement policy that would cause the Korean won to appreciate
relative to the Japanese yen. What ranges of the money growth rate (assumingpositive values) would allow
the Bank of Korea to achieve this objective?
5. You are given the following information. The current dollar-pound exchange rate is $2 per pound.
A U.S. basket that costs $100 would cost 60 pound in the United Kingdom. For the next year, the Fed is
predicted to keep U.S. inflation at 2% and the Bank of England is predicted to keep U.K. inflation at 3%. The
speed of convergence to absolute PPP is 15% per year.
a. What is the expected U.S. minus U.K. inflation differential for the coming year?
b. What is the current U.S. real exchange rate qUS/UK with the United Kingdom?
c. How much is the dollar overvalued/under- valued?
d. What do you predict the U.S. real exchange rate with the United Kingdom will be in one year’s time?
e. What is the expected rate of real depreciation for the United States (versus the United Kingdom)?
f. What is the expected rate of nominal depreciation for the United States (versus the United Kingdom)?
g. What do you predict will be the dollar price of one pound a year from now?

E ($/pound) = 2 $/pound
π(us) = 2%
Pus = $100
π (uk)= 3%
Puk = 60 pound

a. The expected US and UK inflation differential for the coming year:

π(us) - π(uk) = 2%-3% = - 1%

b. q(US/UK) =[ Puk x E ($/pound) ]/Pus =(60 pound x $2 /pound)/$100= $120/$100=1.2 the basket of US/ the basket of UK
"1 giỏ hàng hoá của UK đổi được 1.2 giỏ hàng hoá của US)
UK is overvalued
c. USD is undervalued by (1.2 - 1= 0.2 = 20%)
d. q(US/UK) = 1.2
LOOP: q decrease back to 1 => Decrease by 20%
The speed of convergence to absolute PPP is 15% of 20% => 15% x 20%=0.03
=> q(US/UK) in one year's time = 1.2 - 0.03 = 1.17
e. -0.03 x Pus/PukxE = -0.03 x 100/120 = -2.5% => The real depreciation is 2.5%
f. nominal depreciation = real depreciation + inflation differential = -2.5% - 1% = -3.5%
g. E($/pound) = $2/pound x (1-3.5%) = $1.93/pound
q(US/UK) = [Puk x E($/pound)] / Pus
q(US/UK) = 1 (LOOP)
Puk x E($/pound) /Pus= 1
E ($/pound) = Pus/Puk = 100/60 =1.67
E decrease by -16.5% (1.67 - 2)/2 x 100=-16.5%
 Trần Đức Thành - TA International Economics

Chapter 13

BALANCE OF PAYMENTS
When a country opens to the world economy, there are various transactions between the citizens
of the country and the rest of the world.

Some transactions cause inflows of USD into the country and others cause outflows of USD out
of the country.

Example: Export causes an inflow of USD into the country because the exporters receive
payments in USD from foreign buyers. Vice versa, Import causes an outflow of USD to foreign
coutries because the importers pay USD for the goods they buy from abroad.

Thus, at the end of a year, if total inflows of USD are higher than the total outflows of USD, the
country is better off and its foreign reserves (USD) increase. The country becomes richer.

And if the total inlfows of USD are lower than the total outflows of USD, the country’s foreign
reserves reduce and the country becomes worse off in international business activities.

Why do we need balances of payments?

• Therefore, the country needs an accounting book recording all transactions that cause inflows
and outflows of USD. This accounting book is called “Balance of Payments” or BoP.
• Definition: Balance of Payments (BoP) is an accounting book that records all transactions
between the citizens of a country and the rest of the world in a certain period of time.
• Rule of recording:
• A transaction which causes an inflow of USD into a country is recorded as a Credit or with a
“+” value.
• A transaction which causes an outflow of USD out of a country is recorded as a Debit or with
a “-” value.
• Example: Export value of 120,000 USD is recorded as a Credit with + 120,000 USD.
 Trần Đức Thành - TA International Economics

Definition of balances of payments:

The Double-Entry Principle in the Balance of Payments

Components Definition Credit (+) Debit (-)

Current Accounts Record flow of Export values Import values

(CA) - Accounting goods, income or
for Asset remittances Inflow of citizen income Outflow of foreigners’s
Transactions into the country from income or remiitances out
Abroad of the country

Inflow of Official Outflow of Official

Development Assistance Development Assistance
Trade balance= EX - IM (ODA) from other countries (ODA) to other countries

+EX -IM

-EX(FS) +EX(FS) -IM(FS)

BOP = CA + KA + EO
+UT(IN) -UT(OUT)

Capital Account record Inflow of Foreign Direct Outflow of Foreign Direct

(KA) international Investment (FDI), Foreign Investment (FDI), Foreign
investment Portfolio Investment (FPI) Portfolio Investment (FPI)
transactions. It into the country out of the country
bonds and stocks bonds and stocks
measures the
country’s net Other capital transactions Other capital transactions
foreign invesment +KAin -KAout

Discrepancy/ Errors sai số

and Omissions (EO)
 Trần Đức Thành - TA International Economics

Financial Accounts record all Paying cash to abroad Receiving cash from abroad
(FA) - (Home and financial (export of assets) – Cash (import of assets)- Cash
Foreign Assets) transactions in reduces increases
cash assets
Account Receivables
Account Payables
-IM(A)
+EX(A)
 Trần Đức Thành - TA International Economics

C: Consumption (individuals)
I: Investment (business)
G: government spending

EX - IM

GNE = C+ I + G
GDP = C+I+G+TB
GNI = GDP + NFIA
GNDI = GNI +NUT
=GNE + CA
EX(FS) - IM(FS)
GNDI + FA + KA = GNE
GNE + CA +FA+KA
= GNE
=> CA+ FA+ KA =0

+UTin -UTout

CA = TB + NFIA + NUT

GNE = C+I+G
GDP = GNE + (EX - IM) = C+I+G+TB=C+I+G+(EX-IM)
GNI = GDP + NFIA = C + I +G + TB + NFIA
 Trần Đức Thành - TA International Economics

GNDI = GNI + NUT = GNE + CA

GNE = GNDI + FA + KA = GNE + CA +FA + KA

=> CA + KA + FA = 0

• Due to double entry book keeping, we always have total credits = total debits:
CA + KA + FA + EO = 0

• However: BoP = CA + K + EO

• BoP may be positive or negative

• If BoP > 0 in a period: BoP Surplus, which also means that USD Foreign Reserves of the country
increase. The country is better off. It can use this surplus to pay national debts or lend to other
countries.

• If BoP < 0 in a period: BoP Deficit, which also means that USD Foreign Reserves of the country
reduce. The country is worse off.

Example:

1. An American company buys Drills from a German corporation, 820,000 USD.

Record U.S BOP Debit (-) Credit (+)
CA: Import of German goods -$820,000
FA: Paying cash to abroad +$820,000

2. An American investor buys stocks of Samsung corp. 50,000$

Record US BOP
KA: Outflow of FPI -$50,000
FA: Paying cash to abroad +$50,000

3. The US Government grants an ODA of 500,000 USD to Cambodia to help them fight Covid
Pandemic.
CA: Unilateral transfer out -$500,000
FA: Cash reduces +$500,000
4. Ford Corp. sells 100 cars to Vietnam buyers. 4,000,000$

CA: Export US goods +$4,000,000

FA: Receiving cash from abroad -$4,000,000

5. An U.S. citizen bought stocks issued by a New Zealand Corp.. $6,000. The New Zealand company
deposits in its own U.S. bank account in San Francisco. How is this transaction is recorded in the US
Balance of Payments?
KA: Outflow of FPI -$6,000
FA: Paying cash to abroad +$6,000
 Trần Đức Thành - TA International Economics

BOP surplus and deficit:

• Surpluses and deficits can be counted for individul accounts in the BoP.

• Current Account (CA) Surplus (net lenders) v.s Currrent Account (CA) Deficits (net borrowers)

• Capital Account (K) Surplus v.s Capital Account (K) Deficits.

• Current Account Surplus means inflow of USD cash into the country is higher than the outflow of
USD cash. The country can use its surplus to reduce the national debts or to lend to other
countries (the country becomes the net lender). .

• Current Account Deficit means inflow of USD cash into the country is lower than the outflow of
USD cash. The country should find ways to reduce the national debts or to borrow more from
other countries to finance for the deficit (the country becomes the net borrower).

• Capital Account (K) Surplus means the country possess more international/ foreign capital assets
of other countries. The country’s stock of international/ foreign capital indebtedness increases.

• Capital Account (K) Deficit means other countries possess more of the country’s capital assets.
The country’s stock of international capital indebtedness reduces.

Measures to reduce BOP Deficit:

• Increasing Export

• Restricting Import

• Attracting more FDI from abroad

• Increasing Export of services (labor)

• Improving effectiveness of international relations

• Developing Stock Markets

• Increase effectiveness of Macroeconomic policies.

Problems:

1. Note the following accounting identity for gross national income (GNI):

GNI = C+I+G+TB+NFIA

Using this expression, show that in a closed economy, gross domestic product (GDP), grosss national
income (GNI), gross national expenditures (GNE) are the same. Show that domestic investment is
equal to domestic savings
 Trần Đức Thành - TA International Economics

4. How do you record the following transactions into the US. Balance of Payments (BoP) in 2020?
1. A Japanese investor bought stocks of American Airlines Corp. It is worth $45,000, in cash.
2. The US companies bought catfish from a company Vietnam. 234,000 USD. Payment willbe made after 3
months.
3. GM Corporation has decided to invest 1,354,000 USD in Vietnam.
4. Laos received 3,230,000 USD of ODA from the Unites States.
5. Vietnamese overseas sent ther part of income to their relatives in Vietmam. 456,000 USD. In cash.
GOOD LUCK!!!
US BOP Debit Credit
KA: Inflow of FPI +$45,000
FA: Receiving from abroad
-$45,000
4. How do you record the following transactions into the US. Balance of Payments (BoP) in 2020?
1. A Japanese investor bought stocks of American Airlines Corp. It is worth $45,000, in cash.
2. The US companies bought catfish from a company Vietnam. 234,000 USD. Payment will be made after 3 months.
3. General Motor Corporation has decided to invest 1,354,000 USD in Vietnam.
4. Laos received 3,230,000 USD of ODA from the Unites States.
5. Vietnamese overseas sent ther part of income to their relatives in Vietnam. 456,000 USD. In cash.

Debit Credit
2. US BOP
-$234,000
CA: import of goods
FA: paying cash to VN (Account payable) +$234,000

3. CA: Outflow of FDI -$1,354,000

FA: paying cash to abroad (cash reduce) +$1,354,000

4. CA: Outflow of ODA -$3,230,000

FA: paying cash to abroad (cash reduce) +$3,230,000

5. CA: Outflow of foreinger's income or remittances ouf of -$456,000

the country +$456,000
FA: paying cash to abroad (cash reduce)