Good Essay On Output Yield

International Finance

Question one
a. Exchange rate-pass-through is sometime incomplete due to a number of factors in the industrialized countries. Its completion depends on the duration of the depreciation, demand conditions and the price adjustment costs. First, homogenous must be sold at the same price irrespective of the market they are sold in a competitive market in order to complete ERPT to occur. In this type of market, there no barriers to trade and transport cost is insignificant. Secondly, complete ERPT will only be complete if marginal trade cost is constant. If it is not constant, import prices will fall with the appreciation of the local currency. In Canada and US, the magnitude of ERPT is low since consumer prices have not been affected much by the depreciation of the Canadian and US dollar in the last few years.
b. The degree of ERPT has declined in many industrialized countries in the recent past due to a number of factors. First, abolition of custom duties and restructuring of the retail market has greatly contributed to this decline. For instance, free trade between US and Canada has reduced the effects of their currency depreciation on the retail prices. Secondly, increased export of manufactured goods especially to the Asian countries have reduced the effect of ERPT.

Question two

a. shadow banking is a term that is used to refer to a collection of financial intermediaries that are non- bank that offers services that are similar to those that were offered by traditional commercial banks. It comprises of diverse set of markets and institutions that conduct traditional banking services in a collective way. They perform their functions outside regulated depository system in order to operate effectively. Some of the components of this system include ABCP conduits, mutual funds for money market, repos, securitization vehicles, mortgage companies and investment banks.
b. Shadow banking provides market players with alternative liquidity and funding means that promote real economy. Other benefits include growing efficiency, differentiation, variety, additional funds as well as reduction of risks.
On the other hand, shadow banking is associated with many systematic risks that result to huge losses that outweigh their benefits to the economy. It is not insured nor holds any guarantees from monetary institutions or state officials. Rarely will shadow banking provide adequate information on risks associated with them to the customers. In addition, they are affected by economic circumstances, psychological features, human errors or the stability of the company.

Question three

Euro central bank implemented the policy of quantitative easing after realizing the standard monetary policy were not very effective in dealing the prevailing economic circumstances in the euro zone. The strategy of buying 60 billion Euros per month is intended to address the problem of deflation that is currently facing many European countries leading to economic crises. Through this policy, the bank would lower short-term interest rates for national and commercial banks to almost zero level. As result, the inflation rate would fall to the desirable target.

Interest rate

€/$US
E

The rate of interest decline to almost zero as the output for euro increases. The strength of the euro against US dollar increase as the interest approaches zero.

Question four

Canada has a floating exchange system, hence it currency will adjust to the lowering oil prices. On the other hand, Saudi Arabia has a fixed exchange system and its currency may not change with decreasing oil prices.

Exchange rate

Saudi Arabia Canada
Saudi Arabia will respond to the lowering oil prices by fixing their inflation rate at another point different from the previous one.
r old level

New level

c. a floating exchange rate will enable the government of Canada to automatically adjust to changes in the global oil prices. Secondly, it will not require large amount of foreign currency reserve since it can adjust to changes in other foreign currencies. Finally, it minimizes crises that may result to changes in economic conditions.

Question five

GDP-linked bonds will help the country to reduce problems related to debt crisis through lowering debt-to- GDP ratio. It makes s the economy less prone to sudden jumps that are common in many unstable economies. The amount paid out to GDP-linked bond depends on the prevailing economic conditions. In favorable economic conditions, the government will pay more to creditors and pay less interest rate if the opposite occur. Therefore, during slump, the government will be able stabilize its economy through paying low interest rates and reduced borrowing since there will be no need to issue new bonds. However, the economy may face endless vicious cycle during boom that comes from high interest rates and much borrowing. During this period, the government will pay more to creditors due to high interest rates forcing it to issue more GDP-linked bonds in order to pay debts. Issuing new bonds will come with additional costs, hence exposing the economy to more financial crisis. In addition, GDP-linked bonds normally transfer their risks to the lender unlike conventional bonds where issuer bears all the risks associated with them. Therefore, if the economy does not flourish the way government expected, lenders of the bonds will be forced to bear the loss.