Explain How the International Trade Flows Should Initially Adjust in Response to the Changes in Inflation (Holding Exchange Rates Constant).

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Assignment #1: The International Financial Environment.

Explain how the international trade flows should initially adjust in response to the changes in inflation (holding exchange rates constant). Explain how the international capital flows should adjust in response to the changes in interest rates (holding exchange rates constant).

International trade flows are the exchange of goods and services for money between different countries. It is referred to as sales which cross juridical borders. Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price levels rises, each unit of currency buys fewer goods and services. Exchange rates between two currencies specify how
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Because the interest rates are expected to decline, I would assume the capital flows will decrease to the UK. Since the US interest rates are expected to rise, capital flows to the US will increase. However, the inflation rates implies that the US purchase more British goods and will sells less goods to the UK due to the changes in prices in the two countries. Since Mesa believes that capital flows are more important, they believe the pound will depreciate in the future. Mesa believes international capital flows shift in response to changing interest rate differentials. Is there any reason why the changing interest rate differentials in this example will not necessarily cause international capital flows to change significantly? Explain.

Because there is upward pressure on the pound some investors may anticipate an appreciation. This may discourage British investors from attempting to capitalize on US higher interest rates. If the uncertainty about future exchange rates discourages British capital flows to US, there would be no reason to anticipate the pound to depreciate.

Based on your answer to question 2, how would Mesa’s cash flows be affected by the expected exchange rate movements? Explain.

Mesa’s cash flows would be negatively affected because the pounds received by Mesa would convert to a smaller amount of dollars if the pound weakened.

Based on your answer to question 4, should Mesa consider hedging its
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