Mary Andrews and Drew McClure are economists for Gasden Econometrics. Gasden provides economic consulting and forecasting services for governments, corporations and small businesses. Andrews and McClure are currently consulting for the developing country of Wakulla, which is considering imposing new regulations on its businesses.Due to increases in industrial production in the country, the demand for electricity has increased. Unfortunately the cost of electricity has increased as well, and the Wakullian government is considering regulating the electrical utility industry by limiting the amount producers can charge. The price limits would be established so that the utilities can set their own prices as long as they do not earn a return on invested capital that is higher than the average Wakullian business.The Wakullian government has also proposed stiffer environmental regulations on its firms because the level of air quality has declined in its largest cities. Andrews advises that this regulation is likely to increase production costs that will burden smaller businesses more than larger businesses, and thus can adversely affect competition within an industry. The higher production cost from the environmental regulation will ultimately be borne by consumers, she asserts.One of the concerns of the Wakullian government is that previous regulation of the economy has been ineffective. For example, when the automobile industry was required to increase the fuel efficiency of passenger vehicles, they increased the weight of some vehicles so more could be classified as trucks, instead of passenger vehicles. The trucks were not subject to the regulation and as a result, fuel efficiency actually declined in the country due to the heavier weight of trucks.McClure comments that the regulation should have been written so that the regulation would be more effective.McClure gives another example of an ineffective regulation from the automobile industry. When airbags were required in automobiles, consumers started wearing their seat belt less often and driving at higher speeds because the airbags gave them a feeling of greater safety. Consequently, driving fatalities and injuries did not decline as much as expected.Some regulation, Andrews states, is limited in effectiveness when the regulators are chosen from the industry that is regulated. For example, Andrews states that, due to the level of scientific knowledge needed, many regulatory bodies for the pharmaceutical industry are dominated by former drug company executives and scientists. She states that, according to the share-the-gains, share-the-pains theory, regulatory decisions tend to favor the drug industry because of the close relationship between the industry and the regulator.McClure adds that another example of regulatory ineffectiveness is when telephone companies go before their regulatory bodies to ask for rate increases. He states that according to the capture hypothesis, telephone companies will have greater economic resources and more at stake than individual consumers. As a result, the regulatory decisions tend to favor the telephone industry.The Wakullian government is considering some of the country's industries. To illustrate the potential costs and benefits of deregulation to the Wakullian government, Andrews and McClure compose a matrix of the potential consequences of deregulation. In the matrix, three scenarios of possible economic consequences are presented in Exhibit 1.Regarding the statements made by Andrews and McClure on regulation in the drug industry and the telephone industry, are both statements correct?
Answer(s): B
Andrew's statement is incorrect. Although the effect Andrews describes exists, it is most consistent with the capture hypothesis, not the share-the-gains, share-the-pains theory. In the share-the-gains, share-the-pains theory, the pains and gains of regulation would be shared equally between the industry and consumer. According to Andrews, the regulatory decisions favor the drug industry. In the capture hypothesis, this can be due to the fact that the regulatory bodies tend to have members who used to work in the industry.McClure's statement is correct. The capture hypothesis also states that regulatory decisions will favor industry because the industry has greater economic resources and incentives than consumers. This is the case here with the telephone industry. (Study Session 4, LOS 15.c)
Mary Andrews and Drew McClure are economists for Gasden Econometrics. Gasden provides economic consulting and forecasting services for governments, corporations and small businesses. Andrews and McClure are currently consulting for the developing country of Wakulla, which is considering imposing new regulations on its businesses.Due to increases in industrial production in the country, the demand for electricity has increased. Unfortunately the cost of electricity has increased as well, and the Wakullian government is considering regulating the electrical utility industry by limiting the amount producers can charge. The price limits would be established so that the utilities can set their own prices as long as they do not earn a return on invested capital that is higher than the average Wakullian business.The Wakullian government has also proposed stiffer environmental regulations on its firms because the level of air quality has declined in its largest cities. Andrews advises that this regulation is likely to increase production costs that will burden smaller businesses more than larger businesses, and thus can adversely affect competition within an industry. The higher production cost from the environmental regulation will ultimately be borne by consumers, she asserts.One of the concerns of the Wakullian government is that previous regulation of the economy has been ineffective. For example, when the automobile industry was required to increase the fuel efficiency of passenger vehicles, they increased the weight of some vehicles so more could be classified as trucks, instead of passenger vehicles. The trucks were not subject to the regulation and as a result, fuel efficiency actually declined in the country due to the heavier weight of trucks.McClure comments that the regulation should have been written so that the regulation would be more effective.McClure gives another example of an ineffective regulation from the automobile industry. When airbags were required in automobiles, consumers started wearing their seat belt less often and driving at higher speeds because the airbags gave them a feeling of greater safety. Consequently, driving fatalities and injuries did not decline as much as expected.Some regulation, Andrews states, is limited in effectiveness when the regulators are chosen from the industry that is regulated. For example, Andrews states that, due to the level of scientific knowledge needed, many regulatory bodies for the pharmaceutical industry are dominated by former drug company executives and scientists. She states that, according to the share-the-gains, share-the-pains theory, regulatory decisions tend to favor the drug industry because of the close relationship between the industry and the regulator.McClure adds that another example of regulatory ineffectiveness is when telephone companies go before their regulatory bodies to ask for rate increases. He states that according to the capture hypothesis, telephone companies will have greater economic resources and more at stake than individual consumers. As a result, the regulatory decisions tend to favor the telephone industry.The Wakullian government is considering some of the country's industries. To illustrate the potential costs and benefits of deregulation to the Wakullian government, Andrews and McClure compose a matrix of the potential consequences of deregulation. In the matrix, three scenarios of possible economic consequences are presented in Exhibit 1.Which of the following scenarios proposed by Andrews and McClure is the most likely result from deregulation?
Answer(s): C
Scenario C is the most likely scenario resulting from deregulation. As a result of deregulation, in the short run:• High cost producers may exit the industry due to lower profits. The quality of goods and services may decline.• Prices may rise.• Unions become less powerful and employees may be laid off. As a result of deregulation, in the long run:• Industries will become more competitive as barriers to entry fall.• Prices should fall.(Study Session 4, LOS 15.c)
Jill Surratt, CFA, and Elizabeth Castillo, CFA, are analysts for Summit Consulting. Summit provides investment advice to hedge funds and actively managed investment funds throughout the United States and Canada.Surratt and Castillo have a client, Tom Carr, who is interested in increasing his returns from foreign currency positions. Carr currently has a position in Japanese yen (¥) that he wishes to convert to Taiwanese dollars (NTS) because he thinks the Taiwanese currency will appreciate in the near term. He docs not have a quote for yen in terms of the NTS, but has received quotes for both currencies in terms of the U.S. dollar The quotes are $0.008852-56 for the yen and $0.02874-6 for the Taiwanese dollar. He would like to purchase NTS10 million.Discussing these quotes, Surratt notes that the bid-ask spread is affected by many factors. She states that if an economic crisis were expected in the Asian markets, then the bid-ask spread of the currency quotes should widen. Castillo states that if a dealer wished to unload an excess inventor}' of yen, the typical response would be to lower her ask for the yen, thereby narrowing the bid-ask spread.In regards to changes in currency values, Surratt states that if the U.S. Federal Reserve unexpectedly restricts the growth of the money supply and foreign interest rates remain constant, then the U.S. interest rate differential should increase, thereby increasing the value of the dollar. She states that this change may occur without a change in the quantity of dollars traded. Surratt also mentions that in addition to monetary policy having an impact on exchange rates, governments sometimes intervene directly into the foreign currency markets. She states that if a country was defending its currency value, it would buy up its currency for as long as needed in the foreign currency markets.In addition to using monetary policy, Summit Consulting uses anticipated changes in fiscal policy to forecast exchange rates and the balance of payments for a country. Castillo states that if the U.S. Congress were to unexpectedly reduce the budget deficit, then this should have a positive impact on the value of the dollar in the short-run because foreigners would have more confidence in the U.S. economy. Castillo adds that this change would result in changes in the balance of payments components, with the trade deficit and the capital account surplus decreasing.Another of Summit's clients is Jack Ponder. Ponder would like to investigate the possibility of using covered interest arbitrage to earn risk free profits over the next three months, assuming initial capital of $1 million. He asks Surratt to gather information on the inflation rates, interest rates, spot rates, and forward rates for the U.S. dollar and the Swiss franc (SF). Surratt has also used technical analysis to obtain a projection of the future spot rate for the two countries' currencies. The information is presented below:Spot rate $0.85 /SFThree month forward rate (as of today) for SF $0.80 / SF Expected spot rate three months from now $0.60/SF Three month inflation rate in Switzerland (annualized) 2.0% Three month inflation rate in the US (annualized) 6.0%Three month interest rate for SF (annualized) 12.0%Three month interest rate for U.S. dollars (annualized) 18.0%At a training session for new employees, Surratt and Castillo lecture on international trade and finance issues. To illustrate the concept of comparative advantage, Castillo uses two countries, Country A and Country B. Both produce computers and food but have different opportunity costs for producing them. A's opportunity cost of producing another pallet of computers is two bushels of food. B*s opportunity cost of producing another pallet of computers is five bushels of food. The table below provides the output from each country before international trade takes place;What is the yen cost to Carr of buying NTS10 million?
A foreign currency dealer buys currency at a low (bid) price and resells it at a high (ask) price in order to make a profit. The easiest way to interpret a currency quote is to put the currency in which you want to transact in the denominator. The quotes are $0.008852-56/¥ and $0.02874-6/NT$. So the dealer will buy yen for $0.008852 and resell it at $0.008856. The dealer will buy NTS for $0.02874 and resell it at $0.02876.Carr will be selling yen at the dealers bid and buying NT$ at the dealer's ask. To determine the yen cost of buying the NT$, we set up the currency quotes so U.S.$ and NTS cancel and we are left with ¥.NTS 10,000,000 x $0.02876/NT$ x V/S0.008852 = ¥32,489,833. (Study Session 4, LOS 18.c)
Jill Surratt, CFA, and Elizabeth Castillo, CFA, are analysts for Summit Consulting. Summit provides investment advice to hedge funds and actively managed investment funds throughout the United States and Canada.Surratt and Castillo have a client, Tom Carr, who is interested in increasing his returns from foreign currency positions. Carr currently has a position in Japanese yen (¥) that he wishes to convert to Taiwanese dollars (NTS) because he thinks the Taiwanese currency will appreciate in the near term. He docs not have a quote for yen in terms of the NTS, but has received quotes for both currencies in terms of the U.S. dollar The quotes are $0.008852-56 for the yen and $0.02874-6 for the Taiwanese dollar. He would like to purchase NTS10 million.Discussing these quotes, Surratt notes that the bid-ask spread is affected by many factors. She states that if an economic crisis were expected in the Asian markets, then the bid-ask spread of the currency quotes should widen. Castillo states that if a dealer wished to unload an excess inventor}' of yen, the typical response would be to lower her ask for the yen, thereby narrowing the bid-ask spread.In regards to changes in currency values, Surratt states that if the U.S. Federal Reserve unexpectedly restricts the growth of the money supply and foreign interest rates remain constant, then the U.S. interest rate differential should increase, thereby increasing the value of the dollar. She states that this change may occur without a change in the quantity of dollars traded. Surratt also mentions that in addition to monetary policy having an impact on exchange rates, governments sometimes intervene directly into the foreign currency markets. She states that if a country was defending its currency value, it would buy up its currency for as long as needed in the foreign currency markets.In addition to using monetary policy, Summit Consulting uses anticipated changes in fiscal policy to forecast exchange rates and the balance of payments for a country. Castillo states that if the U.S. Congress were to unexpectedly reduce the budget deficit, then this should have a positive impact on the value of the dollar in the short-run because foreigners would have more confidence in the U.S. economy. Castillo adds that this change would result in changes in the balance of payments components, with the trade deficit and the capital account surplus decreasing.Another of Summit's clients is Jack Ponder. Ponder would like to investigate the possibility of using covered interest arbitrage to earn risk free profits over the next three months, assuming initial capital of $1 million. He asks Surratt to gather information on the inflation rates, interest rates, spot rates, and forward rates for the U.S. dollar and the Swiss franc (SF). Surratt has also used technical analysis to obtain a projection of the future spot rate for the two countries' currencies. The information is presented below:Spot rate $0.85 /SFThree month forward rate (as of today) for SF $0.80 / SF Expected spot rate three months from now $0.60/SF Three month inflation rate in Switzerland (annualized) 2.0% Three month inflation rate in the US (annualized) 6.0%Three month interest rate for SF (annualized) 12.0%Three month interest rate for U.S. dollars (annualized) 18.0%At a training session for new employees, Surratt and Castillo lecture on international trade and finance issues. To illustrate the concept of comparative advantage, Castillo uses two countries, Country A and Country B. Both produce computers and food but have different opportunity costs for producing them. A's opportunity cost of producing another pallet of computers is two bushels of food. B*s opportunity cost of producing another pallet of computers is five bushels of food. The table below provides the output from each country before international trade takes place;Are Surratt and Castillo correct with regard to their statements concerning the currency bid-ask spreads?
Answer(s): A
Surratt is correct. Market conditions affect currency spreads such that the bid-ask spread on foreign currency quotations increases as exchange rate volatility (uncertainty) increases. In this example, an economic crisis in the Asian markets would create uncertainty, thereby impacting the $/¥ and $/NT$ exchange rates and increasing the bid-ask spread.Castillo is incorrect. Bank and other currency dealer positions are not considered to directly impact the size of foreign currency spreads. If a dealer wants to reduce her holdings, she will usually adjust the mid-point of the spread rather than the spread itself.In this example, it is true that the dealer would likely reduce her yen ask (selling price) if she wanted to unload an excess inventory of yen. However, the dealer would also probably reduce her bid (buying price) so that she did not buy any additional yen. The result would be that the spread would remain relatively unchanged. (Study Session 4, LOS 18.b)
Jill Surratt, CFA, and Elizabeth Castillo, CFA, are analysts for Summit Consulting. Summit provides investment advice to hedge funds and actively managed investment funds throughout the United States and Canada.Surratt and Castillo have a client, Tom Carr, who is interested in increasing his returns from foreign currency positions. Carr currently has a position in Japanese yen (¥) that he wishes to convert to Taiwanese dollars (NTS) because he thinks the Taiwanese currency will appreciate in the near term. He docs not have a quote for yen in terms of the NTS, but has received quotes for both currencies in terms of the U.S. dollar The quotes are $0.008852-56 for the yen and $0.02874-6 for the Taiwanese dollar. He would like to purchase NTS10 million.Discussing these quotes, Surratt notes that the bid-ask spread is affected by many factors. She states that if an economic crisis were expected in the Asian markets, then the bid-ask spread of the currency quotes should widen. Castillo states that if a dealer wished to unload an excess inventor}' of yen, the typical response would be to lower her ask for the yen, thereby narrowing the bid-ask spread.In regards to changes in currency values, Surratt states that if the U.S. Federal Reserve unexpectedly restricts the growth of the money supply and foreign interest rates remain constant, then the U.S. interest rate differential should increase, thereby increasing the value of the dollar. She states that this change may occur without a change in the quantity of dollars traded. Surratt also mentions that in addition to monetary policy having an impact on exchange rates, governments sometimes intervene directly into the foreign currency markets. She states that if a country was defending its currency value, it would buy up its currency for as long as needed in the foreign currency markets.In addition to using monetary policy, Summit Consulting uses anticipated changes in fiscal policy to forecast exchange rates and the balance of payments for a country. Castillo states that if the U.S. Congress were to unexpectedly reduce the budget deficit, then this should have a positive impact on the value of the dollar in the short-run because foreigners would have more confidence in the U.S. economy. Castillo adds that this change would result in changes in the balance of payments components, with the trade deficit and the capital account surplus decreasing.Another of Summit's clients is Jack Ponder. Ponder would like to investigate the possibility of using covered interest arbitrage to earn risk free profits over the next three months, assuming initial capital of $1 million. He asks Surratt to gather information on the inflation rates, interest rates, spot rates, and forward rates for the U.S. dollar and the Swiss franc (SF). Surratt has also used technical analysis to obtain a projection of the future spot rate for the two countries' currencies. The information is presented below:Spot rate $0.85 /SFThree month forward rate (as of today) for SF $0.80 / SF Expected spot rate three months from now $0.60/SF Three month inflation rate in Switzerland (annualized) 2.0% Three month inflation rate in the US (annualized) 6.0%Three month interest rate for SF (annualized) 12.0%Three month interest rate for U.S. dollars (annualized) 18.0%At a training session for new employees, Surratt and Castillo lecture on international trade and finance issues. To illustrate the concept of comparative advantage, Castillo uses two countries, Country A and Country B. Both produce computers and food but have different opportunity costs for producing them. A's opportunity cost of producing another pallet of computers is two bushels of food. B*s opportunity cost of producing another pallet of computers is five bushels of food. The table below provides the output from each country before international trade takes place;Evaluate Surratt's statements concerning changes in currency values. Surratt is:
Surratt is correct regarding the effecrs of an unexpected restriction of the U.S. monetary supply. If the central bank unexpectedly restricts the growth of the money supply, then interest rates will increase. If foreign interest rates are constant, the U.S. interest rate differential will increase, causing its currency value to increase. Furthermore, this change can occur without a change in quantity of currency traded. This is because the supply of dollars is decreasing (the supply curve shifts up and to the left) and the demand for dollars is increasing (the demand curve shifts up and to the right), resulting in a higher exchange rate with quantity unchanged. As a result, the volatility of currency values can be quite high, even if trading volume is unchanged.Surratt is incorrect regarding intervention in the foreign currency market by governments. It is true that governments sometimes intervene directly into the foreign currency markets and that to defend its currency value the government would buy up its currency. However, it cannot defend its currency indefinitely. The reason is that governments will need another currency to buy up their own and their supply of other currencies is not unlimited. (Study Session 4, LOS 17.b,c,f)
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