Chapter 3

Question 1

It’s the statistical record of a country’s international transactions over a certain period oftime presented in the form of double-entry bookkeeping.

Answer 1

Balance of payments.

Question 2

What can the Balance of payments be used about?

Answer 2

1. Providing detailed information about the demand and supply of a country
2. A country’s balance-of-payment data may signal its potential as a business partner for the rest of the world.
3. Balance-of-payments data can be used to evaluate the performance of the coun- try in international economic competition.

Question 3

Examples of international transactions.

Answer 3

• Import and export of goods and services

- Cross-border investments in businesses, bank accounts, bonds, stocks, and real estate.

Question 4

Since the balance of payments is recorded over a certain period of time (i.e., a quarter or a year), it has the same time dimension as…

Answer 4

The National income accounting.

Question 5

Any transaction that results in a receipt from foreigners will be recorded as a…

Answer 5

Credit, with a positive sign.

Question 6

These entries arise from purchases of foreign goods and services, goodwill, financial claims, and real assets.

Answer 6

Debits.

Question 7

A country’s international transactions can be grouped into the following three main types:

Answer 7

1. The current account.
2. The capital account.
3. The official reserve account.

Question 8

It includes the export and import of goods and services.

Answer 8

The current account.

Question 9

It includes all purchases and sales of assets such as stocks, bonds, bank accounts, real estate, and businesses.

Answer 9

The capital account.

Question 10

It covers all purchases and sales of international reserve assets such as·dollars, foreign exchanges, gold, and special drawing rights (SDRs).

Answer 10

The official reserve account.

Question 11

It represents a reduction in the country’s net foreign wealth.

Answer 11

A current account deficit.

Question 12

A country with a current account surplus acquires IOUs from foreigners, thereby increasing its…

Answer 12

Net foreign wealth.

Question 13

The current account is divided into four finer categories:

Answer 13

• Merchandise trade
• Services
• Factor income, and
• Unilateral transfers.

Question 14

It represents exports and imports of tangible goods, such as oil, wheat, clothes, automobiles, computers, and so on.

Answer 14

Merchandise trade.

Question 15

It represents the net merchandise export.

Answer 15

The trade balance.

Question 16

The second category of the current account, include payments and receipts for legal, consulting, and engineering services, royalties for patents and intellectual properties, insurance premiums, shipping fees, and tourist expenditures.

Answer 16

Services.

Question 17

These trades in services are sometimes called…

Answer 17

Invisible trade.

Question 18

The third category of the current account, consists largely of payments and receipts of interest, dividends, and other income on foreign investments that were previously made.

Answer 18

Factor income.

Question 19

The fourth category of the current account, involve “unrequited” payments.

Answer 19

Unilateral transfers.

Question 20

Examples of unilateral transfers.

Answer 20

Examples include foreign aid, reparations, official and private grants, and gifts. Unlike other accounts in the balance ofpayments, unilateral transfers have only one-directional flows, without offsetting flows.

Question 21

Examples of factor income.

Answer 21

If U.S. investors receive interest on their holdings of foreign bonds, for instance, it will be recorded as a credit in the balance of payments. On the other hand, interest payments by U.S. borrowers to foreign creditors will be recorded as debits.

Question 22

Examples of services/invisible trade.

Answer 22

For example, X-ray pictures taken at a local hospital in the United States may be transmitted overnight via the Internet to an IT outsourcing center in India. Then, doctors there would examine the digital images and data and e-mail their diagnosis back to the U.S. hospital for a fee. In this case, the U.S. effectively imported medical service from India.

Question 23

What happens when a country’s currency depreciates against the currencies of major trading partners?

Answer 23

The country’s exports tend to rise and imports fall, improving the trade balance.

Question 24

Explain the J-curve effect.

Answer 24

Following a depreciation, the trade balance may at first deteriorate for a while. Eventually, however, the trade balance will tend to improve over time.

Question 25

In how many percent of the cases did Sebastian Edwards confirmed the existence of the J-curve effect, after examining cases of devaluations from the 1960s through the 1980s?

Answer 25

In 40% of the cases.

Question 26

It measures the difference between U.S. sales of assets (exports) to foreigners and U.S. purchases foreign assets (imports).

Answer 26

The capital account balance.

Question 27

U.S. sales (or exports) of assets are recorded as credits, as they result in…

Answer 27

Capital inflow.

Question 28

U.S. purchases (imports) of foreign assets are recorded as debits, as they lead to…

Answer 28

Capital outflow.

Question 29

In the absence of the government’s reserve transactions, the current account balance must be…

Answer 29

Equal to the capital account balance but with the opposite sign. When nothing is excluded, a country’s balance of payments must necessarily balance.

Question 30

Mention the three categories of the capital account:

Answer 30

• Direct investment
• Portfolio investment, and
• Other investment.

Question 31

It occurs when the investor acquires a measure of control of the foreign business. In the U.S. balance of payments, acquisition of 10 percent or more of the voting shares of a business is considered giving a measure of control to the investor.

Answer 31

Direct investment.

Question 32

Provide an example of foreign direct investment (FDI).

Answer 32

When Honda, a Japanese automobile manufacturer, built an assembly factory in Ohio.

Question 33

The second category of the capital account, mostly represents sales and purchases of foreign financial assets such as stocks and bonds that do not involve a transfer of control.

Answer 33

Portfolio investment.

Question 34

Why have International portfolio investments have boomed in recent years?

Answer 34

Partly, due to the general relaxation of capital controls and regulations in many countries, and partly due to investors’ desire to diversify risk globally.

Question 35

What do portfolio investment comprise?

Answer 35

Equity securities and debt securities.

Question 36

Type of securities that include corporate shares.

Answer 36

Equity securities.

Question 37

What do debt securities include?

Answer 37

(1) Bonds and notes.
(2) Money market instruments.
(3) Financial derivatives like options.

Question 38

Why do Investors diversify their portfolio investments?

Answer 38

To reduce risk.

Question 39

It includes transactions in currency, bank deposits, trade credits, and so forth. These investments are quite- sensitive to.both changes in relative interest rates between countries and the anticipated change in the exchange rate.

Answer 39

Other investments.

Question 40

How can statistical discrepancy happen?

Answer 40

Recordings of payments and receipts arising from international transactions are done at different times and places, possibly using different methods.

Question 41

What do we obtain when we compute the cumulative balance of payments including the current account, capital account, and the statistical discrepancies?

Answer 41

Overall balance or official settlement balance.

Question 42

Why is the overall balance significant?

Answer 42

Because it indicates a country’s international payment gap that must be accommodated with the government’s official reserve transactions.
It is also indicative of the pressure that a country’s currency faces for depreciation or appreciation.

Question 43

What should the central bank of the country do when a country must make a net payment to foreigners because of a balance-of- payments deficit?

Answer 43

It should either run down its official reserve assets or borrow anew from foreign central banks.

Question 44

Name examples of official reserve assets.

Answer 44

Gold, foreign exchanges, and SDRs.

Question 45

It includes transactions undertaken by the authorities

to finance the overall balance and intervene in foreign exchange markets.

Answer 45

The official reserve account.

Question 46

After 1945, however, international reserve assets comprise…

Answer 46

1. Gold.
2. Foreign exchanges.
3. Special drawing rights (SDRs).
4. Reserve positions in the International Monetary Fund (IMF).

Question 47

When the balance-of-payments accounts are recorded correctly, the combined balance of the current account, the capital account, and the reserves account must be…

Answer 47

zero.

Question 48

State the equation of balance-of-payments identity (BOPI).

Answer 48

BCA+BKA+BRA= 0

Where:

BCA = balance on the current account.
BKA = balance on the capital account.
BRA = balance on the reserves account.

Question 49

What would be the equation with the pure flexible exchange rate regime?

Answer 49

BCA = -BKA.

Question 50

What is a dirty floating exchange rate system?

Answer 50

A dirty float is an exchange rate regime in which the country’s central bank occasionally intervenes to change the direction or the pace of change of the country’s currency value.

Question 51

It was originated in Europe during the period of absolute monarchies, holds that precious metals like gold and silver are the key components of national wealth, and that a continuing trade surplus should be a major policy goal as it ensures a continuing inflow of precious metals and thus continuous increases in national wealth.

Answer 51

Mercantilism.

Question 52

How can a country can run a balance-of-payments surplus or deficit?

Answer 52

By increasing or decreasing its official reserves.