Question 1

According to the Law of One Price in a globalized financial market, what is the expected relationship between the real interest rate in Canada and the rest of the world, assuming perfect capital mobility and no barriers to trade?

Accepted Answer

The real interest rate in Canada will equal the world real interest rate.

Question 2

If Canada has an excess supply of financial capital at the equilibrium world interest rate, what is the likely outcome for Canada’s capital flows?

Accepted Answer

Canada will experience a capital outflow, investing in foreign assets.

Question 3

Which of the following best describes the effect of an increase in Canadian investment demand, holding the world interest rate constant?

Accepted Answer

Canada’s demand for financial capital will increase, leading to a capital inflow.

Question 4

Suppose the Canadian saving supply curve shifts right due to a domestic shock. What is the most likely impact on Canada’s current account balance, assuming the world interest rate remains unchanged?

Accepted Answer

Canada’s current account surplus will increase.

Question 5

In the context of globalized financial markets, which assumption is necessary to ensure the Law of One Price holds for financial capital?

Accepted Answer

Financial capital is highly mobile and there is free trade internationally.

Question 6

Given the following equations for investment demand and saving supply in Canada: $$I = 100 - 5r$$ and $$S = 60 + 3r$$, where $$r is $$the real interest rate, and the world interest rate is $$r^* = 5$$, what is the net capital flow for Canada?

Accepted Answer

$$I - S = (100 - 25) - (60 + 15) = 75 - 75 = 0$$, so there is no net capital flow.

Question 7

If the world interest rate increases, what is the expected effect on Canada’s investment and saving, assuming upward-sloping saving supply and downward-sloping investment demand?

Accepted Answer

Investment in Canada will decrease and saving will increase.

Question 8

Which of the following scenarios would result in a current account deficit for Canada?

Accepted Answer

Canada’s investment demand exceeds its saving supply at the world interest rate.

Question 9

Suppose Canada experiences a domestic shock that increases the demand for investment. What is the most likely effect on the equilibrium quantity of financial capital and the current account?

Accepted Answer

The equilibrium quantity of financial capital will increase and the current account deficit will rise.

Question 10

If Canada’s saving supply curve shifts left due to a decrease in household savings, what is the likely impact on Canada’s capital flows and current account balance?

Accepted Answer

Canada will experience increased capital inflows and a larger current account deficit.

Question 11

Which of the following best explains why the world interest rate is used to determine equilibrium in Canada’s financial capital market under globalization?

Accepted Answer

Because financial capital is highly mobile and arbitrage ensures rates equalize globally.

Question 12

If the Canadian government implements policies that restrict international capital mobility, what is the most likely effect on the Law of One Price for financial capital?

Accepted Answer

The Law of One Price will be weakened or may not hold.

Question 13

Consider the following scenario: Canada’s investment demand curve is $$I = 120 - 4r$$ and its saving supply curve is $$S = 80 + 2r. If $$the world interest rate is $$r^* = 10$$, calculate Canada’s net capital flow.

Accepted Answer

$$I - S = (120 - 40) - (80 + 20) = 80 - 100 = -20$$, so there is a capital outflow of 20.

Question 14

Which of the following is NOT an assumption required for the Law of One Price to hold in globalized financial markets?

Accepted Answer

There are significant barriers to international capital flows.

Question 15

If Canada’s investment demand equals its saving supply at the world interest rate, what is the implication for Canada’s current account?

Accepted Answer

Canada will have a balanced current account (neither deficit nor surplus).

Question 16

Suppose a domestic shock causes Canadian households to increase their savings. What is the most likely effect on the supply curve for financial capital and the equilibrium interest rate in Canada?

Accepted Answer

The supply curve will shift right and the equilibrium interest rate will fall.

Question 17

Which of the following best describes the role of international financial flows in balancing investment-saving imbalances within a country?

Accepted Answer

They allow countries to maintain investment levels above domestic saving by borrowing from abroad.

Question 18

If Canada’s saving supply exceeds its investment demand at the world interest rate, what is the most likely outcome?

Accepted Answer

Canada will experience a capital outflow and a current account surplus.

Investment and Saving in Globalized Financial Markets

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