Question 1

Which of the following is the value of a country's external wealth at the end of 2016 if its external wealth was $1 billion at the end of 2015 and its trade balance was $500 million in 2016? Assume the world interest rate is 10% per annum.

Accepted Answer

The formula for a country's external wealth is:
external wealth = net foreign assets + present value of future current account surpluses
We know that the trade balance for 2016 was $500 million, which means there was a current account surplus of $500 million. Since the world interest rate is 10%, we can calculate the present value of this future current account surplus:
PV = 500 / (1 + 0.1) = $454.55 million
Therefore, the net foreign assets at the end of 2016 would be:
$1 billion + $454.55 million = $1.45455 billion
Rounding to the nearest hundred million gives us $1.5 billion, which is option B.

Question 2

Which of the following is NOT an assumption belonging to the long-run budget constraint model?

Accepted Answer

The long-run budget constraint model assumes that the economy can borrow or lend unlimited amounts at the world real interest rate, that prices are perfectly flexible, and that the economy is a price taker, small, and open. However, it does not assume that the government has a balanced budget. In fact, the model allows for government borrowing and lending, which can affect the economy's external debt and lead to changes in the current account balance.

Question 3

The notion that a country must live within its means, thus determining the amount a country can borrow, is known as the:

Accepted Answer

The long-run budget constraint refers to the idea that a country must live within its means and cannot continually borrow beyond its capacity to repay. This constraint reflects the notion that a country's ability to borrow is limited by its ability to generate income and repay its debts over time.

Question 4

Continually rolling the interest on a loan over into the principal is called:

Accepted Answer

This practice is known as a Ponzi game, where the borrower pays interest or repays the principal on a loan by taking out more debt, rather than from their own income or other revenue sources.

Question 5

Suppose that a country has external wealth of $1 billion in 2014. What is the future value of this external wealth at the end of 2016, assuming a world interest rate of 10% per annum and no additions or subtractions to external wealth from trade balance surpluses or deficits during the period?

Accepted Answer

Using the future value formula FV = PV*(1+r)^n, where PV is the present value, r is the interest rate, and n is the number of periods, we can calculate the future value of the external wealth. In this case, PV = $1 billion, r = 0.10, and n = 2 (since we are calculating the future value at the end of 2016, which is two years after 2014). Plugging in these values, we get:
FV = $1 billion * (1 + 0.10)^2
FV = $1.21 billion
Therefore, the best choice is C.

Question 6

International borrowing and lending involve changes in:

Accepted Answer

International borrowing and lending directly affect the levels of external wealth, as they involve the transfer of financial resources between countries, impacting a nation's net foreign assets.

Question 7

A nation's use of international capital markets enables it to do all of the following, EXCEPT:

Accepted Answer

A nation's use of international capital markets can enable it to do all of the options listed except for providing for a higher level of national defense because international capital markets do not directly fund national defense efforts.

Question 8

A country has $50 million of debt at the rate of 10%. It does not make any payments in year 1 and manages to renegotiate the interest rate to 5% at the end of year 1. The interest payment in year 2 for this country would be:

Accepted Answer

At the end of year 1, the debt grows to $55 million due to the 10% interest. In year 2, with the renegotiated 5% interest rate, the interest payment is 5% of $55 million, which is $2.75 million.

Question 9

When disaster strikes a country and destroys infrastructure and businesses, it is likely that:

Accepted Answer

When a disaster strikes a country and destroys infrastructure and businesses, savings are likely to decline as individuals have to use their savings to meet their immediate needs. This causes a decrease in the supply of savings and an increase in demand for foreign goods, leading to a decrease in the current account balance and causing it to move into a deficit. Investment is also likely to decline as businesses may not have the resources to rebuild or expand.

Question 10

When a disaster destroys a family's home, the family can make use of all the following solutions, EXCEPT:

Accepted Answer

Taking over the next undamaged property in the vicinity may not be a feasible solution for most families as it may not be available or affordable. The other solutions of accepting gifts or donations from friends, charitable organizations, and applying for a loan or seeking insurance payouts are more feasible and commonly used solutions in such situations.

Question 11

A nation's net income from interest is:

Accepted Answer

Net income from interest for a nation is calculated as the world interest rate times its external wealth, which includes both assets and liabilities.

Question 12

If a country has a $100 million debt and the interest rate on the debt is 5% and the debt is serviced each year, this would result in:

Accepted Answer

An interest rate of 5% on a $100 million debt results in an interest payment of $5 million annually. If only the interest is serviced, the principal amount of the debt remains unchanged.

Question 13

If a nation has a balanced current account and its net external wealth is positive:

Accepted Answer

A balanced current account means that the country's exports and imports are equal, indicating no deficit or surplus. A positive net external wealth means that the country's assets abroad are greater than its liabilities to foreigners. This makes the country a net creditor, with payment flows being positive as it is receiving more from its investments abroad than it owes to foreigners.

Question 14

There is a limit to a nation's ability to use international financial markets to supplement domestic consumption or investment. Why?

Accepted Answer

As a nation takes on more external debt, the level of debt service (interest and principal payments) required to service that debt will increase. At some point, the nation may not be able to generate enough income from exports or other sources to meet its debt service obligations. This can lead to default and/or a loss of investor confidence, making it more difficult for the nation to borrow in the future. Therefore, there is a limit to a nation's ability to use international financial markets to supplement domestic consumption or investment.

Question 15

In theory, financially open economies can:

Accepted Answer

In financially open economies, access to the international financial markets can help stabilize investment and consumption levels by facilitating capital inflows and outflows. However, manipulating trade accounts to avoid imbalances is not a sustainable solution and avoiding all economic shocks or downturns is impossible. While lowering the unemployment rate is possible, controlling inflation through monetary policy can also be challenging in financially open economies.

Question 16

If a country has $100 million of debt, the interest rate on the debt is 10%, and the country does not make any payments on the debt, then at the end of year 3, the debt amount would be:

Accepted Answer

If the country does not make any payments on the debt, the interest will accrue over time. 
At the end of year 1, the debt amount would be $110 million (original debt amount of $100 million + 10% interest). 
At the end of year 2, the debt amount would be $121 million [(original debt amount + 10% interest for year 1) + 10% interest for year 2].
At the end of year 3, the debt amount would be $133.1 million [($121 million + 10% interest for year 2) + 10% interest for year 3]. 
Therefore, the correct answer is C.

Question 17

For the three years after a severe economic shock such as that caused by a hurricane, typically:

Accepted Answer

After a severe economic shock such as a hurricane, investment often rises as the affected areas require rebuilding efforts. However, saving tends to fall due to the increased consumption needed for reconstruction. This increase in consumption can lead to a rise in current account deficit, which is then financed by financial inflows. Creditors may become impatient for debtors to begin payback, but this is not a typical outcome for the three years following an economic shock. Additionally, it is not stated that domestic financial markets are able to handle the situation without a decrease in consumption.

Question 18

Which of the following is the value of a country's external wealth at the end of 2016 if its external wealth was -$1 billion at the end of 2015 and its trade balance was $500 million in 2016? Assume the world interest rate is 10% per annum.

Accepted Answer

The external wealth at the end of 2016 is calculated by adjusting the initial external wealth for the trade balance and the interest on the initial wealth. Starting with -$1 billion, add the trade balance of $500 million, and then account for 10% interest on the initial -$1 billion, which is -$100 million. Thus, the final external wealth is -$1 billion + $500 million - $100 million = -$0.6 billion.

Question 19

The change in external wealth from period N - 1 to N is equal to:

Accepted Answer

The change in external wealth is determined by the trade balance (deficit or surplus) plus interest (earned or paid) on external debt or wealth. Therefore, option B is the correct answer. Options A, C and D are not correct as they do not include interest payments or external debt/wealth in their calculation of the change in external wealth.

Question 20

In a two-period case, a country's present value of _____ from year 1 should be equal to the present value of _______.

Accepted Answer

In a two-period case, the country's present value of wealth from year 1 should be equal to the present value of trade balances for the next two years. This is because wealth is a measure of a country's overall economic well-being, which is influenced by its trade balance. As such, the two are closely related and can be used as a proxy for each other in this context. The other options do not accurately reflect this relationship or the time frame being considered.

Quiz 17: Balance of Payments I: the Gains From Financial Globalization