1. What is the link between South Korea’s currency market interventions and its growing foreign exchange reserves?
2. What is the annualized cost to the Bank of Korea of maintaining $205.5 billion in reserves? Assume that the government of Korea is issuing bonds that yield about 4% annually while buying dollar assets that yield about 3.25%.
3. Suppose that during the year, the won rose by 8% against the dollar and the Bank of Korea kept 100% of its reserves in dollars. At a current exchange rate of W1,011/$, what would that do to the won cost of maintaining reserves of $205.5 billion?
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 euros and yen?
5. How has the almost universal central bank preference for investing reserve assets in U.S. Treasury bonds affected the cost of financing the U.S. budget deficit?
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—including corporate bonds and mortgage backed securities—to improve returns on its large and growing reserve holdings. At the end of March 2005, South Korea’s foreign reserves were the fourth largest in the world, at $205.5 billion. Currency traders were suspicious that the bank’s decision to invest more money in nontraditional assets was a cover for plans to diversify its reserves out of U.S. dollars and into euros, yen, and other currencies that have held their value better than the sinking dollar. The Bank of Korea’s governor, Park Seung, said in response to these concerns that the bank had no plans to sell dollars because that would lead to a further appreciation of the South Korean won. The bank has been trying to slow the won’s rise against the dollar to protect Korean exporters.