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Economics

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Suggested Answers: Global aspects of finance and labour

Exercise 1

1. Old exchange rate: $US50,000   ="  " $A55, 803.57
   
   0.896
   
   New exchange rate: $US50,000   ="  " $A57, 736.72
   
   0.866
   
   On the payment date Nice-n-Natural Ltd was expecting to pay $A55, 803.57, however the exchange rate depreciated to $A1 = $US0.866, so the actual cost was $A57, 736.72.
   
   
2. Forward contracts on currencies are a common form of derivative security used to reduce the risk and volatility of exchange rate movements. By making a contract on the order date to lock in the existing exchange rate of $US0.896, Nice-n-Natural Ltd could have saved $1933.15. The risk is, of course, that the exchange rate might have appreciated, bringing the cost down.

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Exercise 2

The sub-prime mortgage crisis in the USA created a credit squeeze, since a large number of people were not able to repay their debts. Thus there was less money available to lend out. Since many of these loans had been packaged and sold to investors in the form of CDOs, many financial institutions and investors lost money and there was a global tightening of credit. This reduced the availability of credit around the world as well as investor confidence. This led to a reduction in investment and expenditure, leading to falling output, income and employment as well as continued falling confidence. Sharemarkets around the world lost values and a global financial crisis as well as global recession was the result.

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