International Finance
Transcript: Introduction What is the annualized cost to the Bank of Korea of maintaining $205.5 billion in reserves? Assume that the government of Korea is issuing bonds that yield about 4% annually while buying dollar assets that yield about 3.25%. 1) Government of Korea issue bonds that yield 4% : Amount to be paid: $205.5 billion X (1+0.04) = $213.72 billion 2) Government of Korea buys dollar assets: Amount generated: $205.5 billion X (1+0.0325) = $212.17875 billion Profit = Revenue - cost = $212.17875 bil - $213.72 bil = -$1.54125 billion question 4 what are some pros and cons of the bank of korea diversifying its investment holdings out of dollars and into other currencies, such as euro and yen? pros a) greater exchange market stability b) reduction of volatility c) growth of the export d) reduction cost of maintaining large reserve cons a) trigger violent exchange market adjustment b) adjustment in the currency composition of reserve holdings are not smooth Question 5... How has the almost universal central bank preference for investing reserve assets in US Treasury Bonds affected the cost of financing the US budget deficit? 4 When money supply increases, this will lower the interest rate. 1. Before appreciation: $212.2b x W1011 = W214,536b Question 1 In April 2005, the Bank of Korea, South Korea’s central bank, was reviewing its investment policy.It was looking at a range of higher-yielding investment options. Solution -To hold down the value of the won, South Korea's Central Bank will buy dollar and sell won. - Extra supply of won, will drag down the won value and extra demand of dollar will push the dollar value - Consequently it will increase foreign reserves Suppose that during the year the won rose by 8% against the dollar and that the Bank of Korea kept 100% of its reserves in dollars. At a current exchange rate of W1,011/$, what would that do to the won cost of maintaining reserves of $205.5 billion? GROUP MEMBER: Group 6 8 Second Solution: New Cost Currency traders were suspicious that the Bank’s decision to invest more money in nontraditional asset was a cover for plans to diversify its reserves out of US dollars and into euros, yen and other currencies. 2. US paid 3.25%, thus: (1.0325 x $205.5b = $212.2b) 3 These are the problems that has caused the lowering of cost of financing the U.S. budget deficit. 6 2 Spread = 3.25% - 4% = -0.75% Annual cost = $205.5 billion X -0.0075 = - $1.54125 billion 2. After appreciation: W198,622.9b Growing cost of maintaining large reserves stems from the bank of Korea’s policy of sterilizing its currency market interventions. What is the link between South Korea’s currency market interventions and its growing foreign exchange reserves? Historically, the bank of Korea, has focused on safe, short-term investments. First solution : 5 However, this policy is changing as foreign exchange reserves pile up, exceeding the amount needed for policy reasons. Question 3 3. If Won appreciate 8%, thus: new exchange rate = (1/1.08 x W1,011 = w936.1/$) thus: reserves = ($212.2b x W936.1 = W198,622.9b) Megat's It has been selling government bonds and buying Treasury bonds and other dollar denominated assets. 1. Borrow W207,760.5b ($205.5b x w1,011) Payment to investors = ($205.5 x W1,011 x 1.04 = W216,070.9) The Bank of Korea Reassesses Its Reserve Policy 7 1 3. new cost = (W216,070.9b-W214,536b) + (W214,536b -W198,622.9b) = W1,534.9b + W15,913.1b = W17,448b Question 2 NOR NAZIRAH MOHAMED 1015724 ANI ARISHAH MOHD ZIN 1013542 MEGAT TARIQ MEGAT NASIR 0813483 NOORHAZLINA MOHAMED FAROUK 0829692 BENAZIR MOHAMED NAZIR 0835916 End of March 2005, South Korea’s foreign reserves were the fourth largest in the world, at $205.5 billion. The Bank of Korea has been suffering valuation losses as the dollar continues to fall against the won.