1. How does the phenomenon of overshooting contribute to short-term exchange-rate volatility? What policies might governments adopt if they wished to either reduce or control such volatility, short of adopting fixed exchange rates? (6 Pts.)

2.    Assuming market-determined exchange rates, use supply and demand graphs for dollars to analyze the effect on the exchange rate (Euro per dollar) between the US dollar and European Euro under each of the following circumstances: (8 points)
a.    Surveys in US suggests that conservative (pro business) government in US will be replaced by Democratic (pro labor union) government in the next election (to be held three months from now.)
b.    Both the European economy and US economy experience economic growth. However, economic growth is much higher in the U.S.
c. Europe encounters severe inflation, while price stability exists in the U.S.
d.    Two major cities in the US are hit by terrorist bombs.

3. a. Why are investment flows said to depend on real rather than nominal interest-rate differentials between countries? If nominal short-term interest rates were 8 percent in the United States and 6 percent in Canada, with inflation rates of 4 percent in the United States and 1 per cent in Canada, explain in which direction short-term capital would flow and whether the U.S. dollar would appreciate or depreciate relative to the Canadian dollar. How would your answer regarding international capital flows be different if the U.S. and Canadian governments committed themselves to maintaining fixed exchange rates between their two currencies?)
b. Suppose that the spot exchange rate is 1.6 euros per dollar, and that the annual interest rates for 180-day deposits are 4 percent in the United States and 10 percent in Germany. Explain how a U.S. investor would use covered interest arbitrage to hedge against the risk of purchasing a 180-day bill in Germany. Assuming high capital mobility between the United States and Germany, calculate the 180-day forward exchange rate that would be required to eliminate an opportunity for risk-free profits by shifting funds from the United States to Germany. (8points)

4. For each of the following transactions, indicate which account on the U.S. balance of payments statement would he affected, and whether the primary entry would be a credit or a debit. (5 points)
a. U.S. citizens pay $100,000 for Hondas produced in Japan.
b. A Japanese company pays $2 million to build an electronics factory in California.
c. U.S. students studying for a semester in Japan spend $300 at a restaurant in Tokyo.
d. Willamette University students give $500 to support relief efforts in Honduras after Hurricane Mitch.
e. Japanese citizens put $25,000 in U.S. banks to earn higher interest than they could earn in Tokyo banks.
f. A German subsidiary of a U.S. corporation repatriates $600,000 in profits to its headquarters office in Chicago.
g. U.S. citizens purchase $30,000 of 30-year bonds issued by a Mexican telecommunications firm.

5. Explain the potential beneficial and adverse impacts of MNEs on employment in both home and host countries. Why is it often so difficult to estimate accurately such short-term and long-term employment effects?

1. How does the phenomenon of overshooting contribute to short-term...