INTERNATIONAL MONEY AND FINANCE HW #1

Seongmin Choi (2017190129), Shelby Wu (2021848153), Ulperzent Zhanibek (2022847209)

Question 1

(a) An American university buys several park benches from Spain and pays with a $120,000 check.

CA FA
Credit Debit Credit Debit
$120,000 $120,000

(b) Floyd Townsend, of Tampa Florida, buys 5,000.00 dollars worth of British Airlines stock from
Citibank New York, paying with U.S. dollars.

CA FA
Credit Debit Credit Debit
$5,000 $5,000

(c) A French consumer imports American blue jeans and pays with a check drawn on a U.S. bank in
New York.

CA FA
Credit Debit Credit Debit
$$$ (Jeans) $$$ (Check)

(d) An American company sells a subsidiary in the United States and with the proceeds buys a
French company.

CA FA
Credit Debit Credit Debit
+++ +++

(e) A group of American friends travels to Costa Rica and rents a vacation home for $2,500. They
pay with a U.S. credit card.

CA FA
Credit Debit Credit Debit
$2,500 (Rent Service) $2,500 (Cash)
Question 2

𝑪𝑨 = 𝑻𝑩 + 𝑵𝑭𝑰 + 𝑵𝑼𝑻
𝑻𝑩 𝑪𝑨
For Argentina, > .
𝑮𝑫𝑷 𝑮𝑫𝑷

This is because Argentina’s NFI account is negative, as Argentina is indebted to foreigners and must
pay back with interest.

𝑻𝑩 𝑪𝑨
For Mexico, < .
𝑮𝑫𝑷 𝑮𝑫𝑷

This is because Mexico has a significant amount of positive NUT, which mostly comes from Mexican
employers in the United States.

𝑻𝑩 𝑪𝑨
For the Philippines, < .
𝑮𝑫𝑷 𝑮𝑫𝑷

This is because the Philippines has a significant amount of positive NUT. It is famous for the well-
developed medical systems and therefore many Filipino nurses, doctors work abroad.

Question 3

During the Great Recession in 2008, the U.S. experienced increase in Government Spending, and
decrease in Taxes.

From the GDP equation of 𝐺𝐷𝑃 = 𝐶 + 𝐺 + 𝐼 + 𝑇𝐵, we know that 𝑪𝑨 = (𝑮𝑵𝑷 − 𝑪 − 𝑻) + (𝑻 − 𝑮) − 𝑰

As change T is cancelled out, when we only take the positive change in G into account, we can
figure out that CA should have decreased.

At the same time, the U.S. forced China to overvalue Yuan to improve America’s TB.

Since 𝐶𝐴 = 𝑇𝐵 + 𝑁𝐹𝐼 + 𝑁𝑈𝑇, the overvaluing of Yuan will make Chinese exports more expensive
relative to other foreign goods and is expected to a positive impact on the improvement of the TB.
However, the global economy is much complex than we think and some counter factors could’ve
cancelled out the impact on TB. Therefore, it is unclear whether the two policies were consistent
with each other.
Question 4

a)

For the two-period model, we have the two equations:

𝐶𝐴𝑡 = 𝑇𝐵𝑡 + 𝑟𝐵𝑡−1

𝐶𝐴𝑡 = 𝐵𝑡 − 𝐵𝑡−1

- 𝑟𝐵(𝑡−1): the interest payment (receipt) on previous debt/assets (Net Foreign Income: NFI)

- 𝐵𝑡 − 𝐵𝑡−1: Change in net foreign financial assets

Let us put 1 in t and arrange in terms of 𝐵1 by using the two equations. Then we get:

𝐵1 = (1 + 𝑟)𝐵0 + 𝑇𝐵1

Similarly, when we put t=2, we get the following.

𝐵2 = (1 + 𝑟)𝐵1 + 𝑇𝐵2

When we arrange the two equations in terms of 𝐵0 , we get the following equation.

𝑩𝟐 𝑻𝑩𝟐 𝑻𝑩𝟏
𝑩𝟎 = 𝟐
− 𝟐
−
(𝟏 + 𝒓) (𝟏 + 𝒓) 𝟏+𝒓

b)

(1)

Suppose that 𝐵𝑡 = −(1 + 𝛼)𝑡−1 as t starts from 1 and goes to infinite (0 < 𝛼 < 1).

lim 𝐵𝑡 = −∞
t→∞

This is because the multiplier(1 + 𝛼) is greater than 1.

(2)

𝑪𝑨𝒕 = 𝐵𝑡 − 𝐵𝑡−1 = −(1 + 𝛼)𝑡−1 − (−(1 + 𝛼)𝑡−2 )

= −(1 + 𝛼)𝑡−1 + (1 + 𝛼)𝑡−2

= (𝟏 + 𝜶)𝒕−𝟐 (−𝜶)
(3)

In the perpetual model, we get that

∞
𝑇𝐵𝑡 𝐵𝑡
(1 + 𝑟)𝐵0 = − ∑ 𝑡−1
+ lim
(1 + 𝑟) t→∞ (1 + 𝑟)𝑡−1
𝑡=1
∞
1 𝑇𝐵𝑡 (1 + 𝛼)𝑡−1
− = −∑ 𝑡−1
+ lim
1+𝛼 (1 + 𝑟) t→∞ (1 + 𝑟)𝑡−1
𝑡=1

Ponzi condition basically means that one can spend perpetually (infinite borrowing), which can be
applied to the equation by plugging negative value of TB throughout the entire period.

𝑻𝑩
First, we get a positive value for − ∑∞ 𝒕
𝒕=𝟏 (𝟏+𝒓)𝒕−𝟏

1+𝛼 𝑡−1
Second, lim ( 1+𝑟 ) = 0 as the numerator is smaller than the denominator in the multiplier.
t→∞

Therefore, we get a positive value for the right side of the equation. However, since 0 < 𝛼 < 1, the
left side of the equation is negative value, contradicting the equation.

This proves that No-Ponzi condition holds.

Question 5

a)

Risk-averse preference can be defined as a type that has a concave utility function (utility increases
at decreasing rate). This means that a risk-averse person’s utility from obtaining the same goods is
high in the beginning, but gets lower as he gets the same goods further.

Risk-neutral preference can be defined as a type that has a straight-line utility function (utility
increases at a constant slope). This means that a risk-neutral person’s utility from obtaining the
same goods is consistent regardless of the number of the same goods obtained.
b)

Agent 1 has utility function of 𝑼(𝒄) = 𝐥𝐧 𝒄

Since the utility function is concave, agent 1 is risk-averse and therefore we must add time discount
factor into the equation (0 < 𝛽 < 1). The two-period utility function can be expressed like below.

𝑈(𝑐1 , 𝑐2 ) = ln 𝑐1 + ln 𝛽𝑐2

Here, t stands for the period and let us say that t=1 is the present. Now let’s compare the two
options.

Option 1: (1,1)

𝑈(1,1) = ln 1 + ln 𝛽 = 𝐥𝐧 𝜷

Option 2: (0.5, 1.5)

𝑈(0.5,1.5) = ln 0.5 + ln 1.5𝛽 = −0.6931 + 0.4055 + ln 𝛽 = −𝟎. 𝟐𝟖𝟕𝟖 + 𝐥𝐧 𝜷

Since the utility for option 1 is greater than option 2 by 0.2878, we can say that agent 1 prefers the
option 1.

Agent 2 has utility function of 𝑼(𝒄) = 𝒄

Since the utility function is a straight line, agent 1 is risk-neutral and therefore he does not discount
future consumption. The two-period utility function can be expressed like below.

𝑼(𝒄𝟏 , 𝒄𝟐 ) = 𝒄𝟏 + 𝒄𝟐

Here, t stands for the period and let us say that t=1 is the present. Now let’s compare the two
options.

Option 1: (1,1)

𝑈(1,1) = 1 + 1 = 𝟐

Option 2: (0.5, 1.5)

𝑈(0.5,1.5) = 0.5 + 1.5 = 𝟐

Since both options result in the same utility, agent 2 is indifferent to any options.
Question 6

(a)

The question assumes that 𝑢(𝑐) = ln(𝑐).

We know that:

𝐶𝐴1 = 𝑇𝐵1 + 𝑟0 𝐵0 = 𝑌1 − 𝐶1 + 𝑟 ∗ 𝐵0 = 1 − 𝐶1

∵ 𝑌1 = 1, 𝐵0 = 0

𝐶𝐴2 = 𝑇𝐵2 + 𝑟0 𝐵1 = 𝑌2 − 𝐶2 + 𝑟 ∗ 𝐵1 = 1.2 − 𝐶2

∵ 𝑌2 = 1.2, 𝐵1 = 0

All we need is to solve for 𝐶1 𝑎𝑛𝑑 𝐶2. Let’s start by plugging in the given information.

𝐶1 = 1 + 0.99(1.2) − 0.99𝐶2 = 2.188 − 0.99𝐶2

max 𝑢(𝑐1 ) + 𝛽𝑢(𝑐2 ) = max ln(2.188 − 0.99𝐶2 ) + 0.99 ln(𝐶2 )

𝐶1 ,𝐶2 𝑐2

= max ln((2.188 − 0.99𝐶2 ) × 𝐶20.99 ) = max ln(2.188𝐶20.99 − 0.99𝐶21.99)

𝑐2 𝑐2

To solve maximization problem, we find the derivative and put it as 0.

𝑑 2.16612𝐶2−0.01 − 1.9701𝐶20.99
ln(2.188𝐶20.99 − 0.99𝐶21.99 ) =
𝑑𝑥 2.188𝐶20.99 − 0.99𝐶21.99

𝐶20.99 (2.16612𝐶2−1 − 1.9701) 2.16612𝐶2−1 − 1.9701

= = =0
𝐶20.99 (2.188 − 0.99𝐶2 ) 2.188 − 0.99𝐶2

Since the numerator must be 0 to maximize, we get the following:

𝑪𝟐 = 𝟏. 𝟎𝟗𝟗𝟓

𝑪𝟏 = 𝟏. 𝟎𝟗𝟗𝟓

 This means that we perfectly smooth our consumption throughout the period.

Therefore, CAs are:

𝑪𝑨𝟏 = 𝟎. 𝟎𝟗𝟗𝟓

𝑪𝑨𝟐 = 𝟎. 𝟏𝟎𝟎𝟓
(b)

The question assumes that 𝑢(𝑐) = 𝑐.

max 𝑢(𝑐1 ) + 𝛽𝑢(𝑐2 ) = 𝐶1 + 0.99𝐶2

𝑐1 ,𝑐2

Also, by putting in the given numbers into the equation, we get the following.

𝐶1 = 2.188 − 0.99𝐶2

By combining the two, we get:

max 𝑢(𝑐1 ) + 𝛽𝑢(𝑐2 ) = 2.188

𝑐1 ,𝑐2

This implies that the maximum utility we can get from consumption is 2.188.

Also, when we consider the maximization problem, 𝐶2 is discounted by 0.01 compared to 𝐶1.

Therefore, we reach

𝑪𝟏 = 𝟐. 𝟏𝟖𝟖, 𝑪𝟐 = 𝟎

 This means that we consume all in t=1 and do not save in t=2.

When we solve for CAs, we get as follows:

𝑪𝑨𝟏 = −𝟏. 𝟏𝟖𝟖

𝑪𝑨𝟐 = 𝟏. 𝟐