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e. The world real interest rate is r* - 3%. The country of Riskistan can borrow at this rate and invest 1000 units of real output in a project where the extra payoff in all future periods is SO (we assume no depreciation). What is MPK? Should they undertake the investment project? Explain. MPK Should they invest? Explanation: 2 f. In the last question, suppose investors learn of political instability in Fiskistan and demand a risk premium of +5%. Now Riskistan can only borrow at a real interest rate of r = 89. Should they still do the project? Should they invest? Explanation: There are two states of the world. In state 1. Home has output and income of 60, and Foreign has 40. In state 2, Home has output and income of 40 and Foreign has 60. There is no net international borrowing or lending If all income is capital income, what is the best risk-sharing outcome possible? State 1 consumption/income levels: Home Foreign State 2 consumption/income levels: Home Foreign Portfolios Home owns % home and % foreign capital h. When a country's real exchange rate appreciates its trade balance should Circle one: Increase / Decrease i. Under a floating exchange rate regime, after a temporary home monetary expansion, in the short run, the home country's (circle answer in each case) Nominal interest rate is... Higher / Lower / Unchanged Nominal exchange rate is... Depreciated / Appreciated / Unchanged Level of output is.. Higher / Lower / Unchanged e. The world real interest rate is r* - 3%. The country of Riskistan can borrow at this rate and invest 1000 units of real output in a project where the extra payoff in all future periods is SO (we assume no depreciation). What is MPK? Should they undertake the investment project? Explain. MPK Should they invest? Explanation: 2 f. In the last question, suppose investors learn of political instability in Fiskistan and demand a risk premium of +5%. Now Riskistan can only borrow at a real interest rate of r = 89. Should they still do the project? Should they invest? Explanation: There are two states of the world. In state 1. Home has output and income of 60, and Foreign has 40. In state 2, Home has output and income of 40 and Foreign has 60. There is no net international borrowing or lending If all income is capital income, what is the best risk-sharing outcome possible? State 1 consumption/income levels: Home Foreign State 2 consumption/income levels: Home Foreign Portfolios Home owns % home and % foreign capital h. When a country's real exchange rate appreciates its trade balance should Circle one: Increase / Decrease i. Under a floating exchange rate regime, after a temporary home monetary expansion, in the short run, the home country's (circle answer in each case) Nominal interest rate is... Higher / Lower / Unchanged Nominal exchange rate is... Depreciated / Appreciated / Unchanged Level of output is.. Higher / Lower / Unchanged

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