Download Name ______ last 4 PSU ID

1. (5 points) You are a Japanese citizen and want to profit by using a forward
contract since your expectations of the spot rate 30 days hence is different than
the current 30 day forward rate. In particular, the 30 day forward rate is 90 yen/$
and you expect the spot rate, 30 days hence, to be 100 yen/$. Assuming your
expectations are correct, explain exactly how you could use the forward market to
make a profit. Assume you have 900 yen to invest. Be sure to identify the profit in
yen and your return in terms of the percent of your original investment.
2. (5 points) Suppose the world is made up of four countries: The US, England, and
Japan and China. The trade weights, that is, the percent of trade that the US
conducts with each country is below:
England
Japan
China
20%
30%
50%
Suppose that the $ US appreciates by 10% against the Japanese Yen, depreciates
by 10% against the English pound, and depreciates by 2% against the Chinese
Yuan. Calculate the percent change in the effective exchange rate.
3. (5 points) Suppose you are a US importer of gypsum from Canada. You have a
contract with a US firm to sell them 10 tons of gypsum 30 days from now. You
want to use the forward market to avoid exchange rate risk and guarantee yourself
a profit. The Canadian Dollar (CD) price of gypsum per ton is 5000 CD. The 30
day forward rate is 1.25 CD/$ and the contract with the US firm is that you are
selling the gypsum is for $ 4500 per ton. Calculate your profit, per ton, in terms
of US dollars.
4. (15 points total) You are in the market for a new car and you have your eyes on a
Mercedes Benz (MB). The (identical) car is available in Europe and the US and
we assume away all transactions costs and transportation costs. Suppose that the
MB costs $120,000 in the US and the current spot rate is 1.3 $/euro. Please
answer the following questions:
a. (5 points) What is the euro price of the MB in Europe consistent with the
law of one price (LOOP)?
b. (5 points) If the MB was selling for 95,000 euro, explain how you could
make a profit since this pair of prices is not consistent with the LOOP. Be
sure to state profit in terms euros and $ US of buying one MB low and
selling one MB high.
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c. (5 points) Now explain how arbitrage would work in terms of influencing
the US dollar price and the euro price to be consistent with the law of one
price. Please explain in detail - referring to your answer in part b).
5. (30 points total)Suppose I own a French winery and that I am selling wine to the
US in 90 days for a price of $ 100,000. The current spot price is $ 1.3 / €. We are
going to use the option market to hedge against unfavorable exchange rate
movements.
a. (5 points) Considering this transaction only, what do we mean by
'unfavorable' exchange rate movements?
b. (5 points) Suppose it costs me € 70,000 to produce and transport the wine,
if the exchange rate in 90 days is the same as the current spot ($1.3/€),
what is my profit in terms of euros?
Suppose that there are options available that give me the option to
exchange $ for € at an exchange rate of $1.4 per €. Suppose these options
collectively cost you € 5000. We are going to consider two separate
scenarios:
Scenario #1: In 90 days, the spot exchange rate is $ 1.2/€.
Scenario #2: In 90 days, the spot exchange rate is $ 1.5/€.
Reminder: The options give you the right, not the obligation to exchange
your $100,000 at $1.4 per €.
c. (5 points) Given Scenario #1, what is your total profit / loss from selling
the wine?
d. (5 points) Given Scenario #2, what is your profit / loss from selling the
wine?
e. (5 points) Compare your answer in d) to your profit / loss if you, instead of
hedging with options, went 'naked' as in not hedging at all (taking you
chances in the spot market). Was it better to hedge or go naked? Assume
Scenario #2.
f. (5 points) How would your answer change in e) above if the spot rate was
1.6 $/€ (90 days from now) instead of the $ 1.5/€ as in scenario #2.
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Correct 1.
Suppose that you are a US citizen and that you go on vacation in Canada every
year. The current US $ / Canadian dollar (CD) exchange rate is 90 cents per CD.
If you expect that the US $ / CD exchange rate is going to rise to parity - that is,
you expect the US $ / CD exchange rate to be 1, then you should use your US $
now to buy CD before the exchange rate changes.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): True
Incorrect 2.
According to the real world application regarding the Swiss National Bank
(SNB), in order to keep the franc from appreciating, the SNB bought francs with
euros.
A) True
B) False
Points Earned: 0.0/2.0
Correct Answer(s): False
Correct 3.
According to the real world application regarding the Swiss National Bank
(SNB), we learned that the Swiss exports account for approximately 50% of their
GDP.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): True
Correct 4.
Russia defaulted on its international debt in 1995.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): False
Correct 5.
Whenever the current account (CA) is negative, that implies that the country is
'spending beyond it's means.'
A) True
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B) False
Points Earned: 2.0/2.0
Correct Answer(s): True
Incorrect 6.
In 2008, China's current account surplus was larger than the US current account
deficit.
A) True
B) False
Points Earned: 0.0/2.0
Correct Answer(s): False
Incorrect 7.
External wealth in the US grew to over a negative $ 2 trillion in the early 2000's.
A) True
B) False
Points Earned: 0.0/2.0
Correct Answer(s): True
Incorrect 8.
In this lesson, we learned that emerging markets are more financially open than
advanced countries.
A) True
B) False
Points Earned: 0.0/2.0
Correct Answer(s): False
Correct 9.
According to the index of economic freedom from 2013, Argentina is becoming
more free.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): False
Incorrect 10.
There are more countries that have a floating exchange relative to the countries
that have a fixed exchange rate regime.
A) True
B) False
Points Earned: 0.0/2.0
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Correct Answer(s):
False
Correct 11.
The higher the institutional quality, the higher the per capita income and the lower
the volatility of the growth rate of the economy.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): True
Correct 12.
Most advanced countries have a fixed exchange rate regime.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): False
Correct 13.
Ecuador completed dollarization in the year 2000.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): True
Correct 14.
During the latter part of the 1990s, Argentina pegged their currency, the peso, one
to one - that is one peso equals one US dollar.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): True
Correct 15.
The three biggest over the counter foreign exchange markets are in London, New
York, and Tokyo.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): True
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Incorrect 16.
Suppose the yen / $ exchange rate is 80 yen / $ and the yen / € exchange rate is
110 yen / €, then the $ / € exchange rate is 1.375.
A) True
B) False
Points Earned: 0.0/2.0
Correct Answer(s): True
Incorrect 17.
According to the chart depicting the volume of foreign exchange transactions,
trading in the spot market eclipsed $ 1 trillion in 2004.
A) True
B) False
Points Earned: 0.0/2.0
Correct Answer(s): False
Correct 18.
During the Great Recession the Federal Reserve conducted a substantial amount
of foreign exchange swaps with the European Central Bank (ECB). Foreign
exchange swaps utilize a combination of forward contracts and option contracts.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): False
Incorrect 19.
When the Federal Reserve conducted the foreign exchange swaps with the ECB
during the Great Recession, they exposed themselves to significant exchange rate
risk.
A) True
B) False
Points Earned: 0.0/2.0
Correct Answer(s): False
Correct 20.
Capital controls are more common in developing countries as compared to
advanced countries. One example we used were the capital controls that exist in
Argentina.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): True
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1.
(10 points) Suppose that one year interest rates in the US are 0.01 (1%)
and .03 (3%) in Europe. The current spot rate is $1.35/€, calculate the forward
rate consistent with covered interest rate parity. Explain your answer.
2.
Suppose that one year interest rates in the US are 0% and that one year
interest rates in Europe are 4%. The current $/€ exchange rate is 1.2. Suppose
that you have $100 to invest.
a.
(10 points) Use the uncovered interest rate parity (UIP) condition (the
approximation) and solve for the expected exchange rate, one year hence, that is
consistent with UIP. Show that with this particular exchange rate, the returns in
'like' currencies are approximately the same.
b.
(10 points) Explain the intuition underlying your results.
3.
Suppose you have $1000 that serves as margin for a $9000 one year loan
where the interest rate is 1%. You invest the total = $10,000 in Europe where the
exchange rate is $1.25 $/€. The one year interest rate in Europe is 4%.
a.
(10 points) According to UIP, what is the expected exchange rate one year
from now?
Consider the following two scenarios:
Scenario #1: The $/€ exchange rate remains constant over the holding period = 1
year
Scenario #2: The exchange rate after one year is 1.3 $/€
b.
(10 points) Assuming scenario #1, what is your profit / loss and your rate
of return in $ when you close your position?
c.
(10 points) Assuming scenario #2, what is your profit / loss and your rate
of return in $ when you close your position?
4.
Suppose that you have the following information:
The inflation rate in the US is 2% and -2% in Japan (deflation in Japan)
The real exchange rate ($/yen) is appreciating by 2%.
a.
(10 points) What is the implied change in the nominal exchange rate
($/yen)? Please show work. Explain the intuition of your result.
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b.
(10 points) Suppose that Bank of Japan (BOJ) successfully rids the
economy of deflation so that the new rate of inflation is 2%, same as the US.
Assuming all else constant, what is the implication on the nominal exchange rate?
Explain the intuition of your result.
Correct 1.
Covered interest rate parity is more likely to hold in a world where countries
impose significant capital controls.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): False
Correct 2.
In terms of the terminology regarding the carry trade, the cost of carry is the rate
of interest in the high interest rate country.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): False
Correct 3.
UIP, strictly speaking, implies that the carry trade strategy of borrowing in the
low interest rate country and investing in the high interest rate country will result
in zero profits.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): True
Correct 4.
If good X costs $150 in the US and €100 in Europe and the current exchange rate
is 1.3$/€ , then according to PPP, the $ is undervalued.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): False
Correct 5.
The existence of trade barriers is one reason that APPP does not hold.
A) True
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B) False
Points Earned: 2.0/2.0
Correct Answer(s): True
Correct 6.
According to the Balassa-Samuelson Model, one reason APPP does not hold in
the data is due to the existence of non-tradable goods and services.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): True
Correct 7.
According to the Balassa-Samuelson Model, non-tradable services are cheaper in
developing countries relative to developed countries.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): True
Correct 8.
According to relative PPP, if inflation is higher in Europe than it is in the US, the
Euro should appreciate so that the law of one price holds.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): False
Correct 9.
Suppose APPP holds so that the real exchange rate =1. According to relative
purchasing power parity, if prices are rising in Japan and remaining constant in
the US, then the US $ will appreciate against the Japanese yen.
A) True
B) False
Points Earned: 2.0/2.0
Correct Answer(s): True
Correct 10.
One reason that we see deviations from PPP in the data is due to 'sticky' prices.
A) True
B) False
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Points Earned: 2.0/2.0
Correct Answer(s): True
1.
(75 points total) Monetary Approach to the Exchange Rate. For the
following questions imagine a world in which the assumptions of the monetary
approach to the exchange rate hold at all times. There are two countries the U.S.
and Mexico (treat Mexico as the home country). Suppose that the real interest rate
is 2%. In Mexico, the expected money supply growth rate is 8 percent and the
expected real GDP growth rate is 2 percent. In the United States the expected
money supply growth rate is 4 percent and the expected real GDP growth rate is 1
percent.
a.
(5 points) What is the nominal interest rate in Mexico? In the United
States?
b.
(5 points) What is the expected change in the exchange rate in Mexican
terms Epeso/$?
Suppose at time T, the money supply in Mexico increases by 50% unexpectedly.
Nothing else changes (including expectations for the future). Please answer the
following questions:
c.
(5 points) What happens to the Mexican interest rate at time T? Explain
your answer.
d.
(5 points) What happens to the exchange rate written in Mexican terms at
time T?
e.
(20 points) Draw 4 times series diagrams as we did in the lesson (all
referring to Mexican economic variables) with the log of the Mexican money
supply on the top left, real money balances and nominal interest rates on the top
right, the log of the price level on bottom left, and the log of the exchange rate:
Mexican pesos per $ on bottom right. Please show exactly what happens to these
time series variables at time T using real numbers when possible. Please label
graph completely (levels, growth rates, etc)
Now suppose instead (go back to the original conditions) that the expected rate of
growth of the Mexican real GDP increases from 2 percent to 4 percent at time T.
Nothing else changes (including the levels of all other variables).
f.
(5 points) What happens to the Mexican interest rate at time T? (Give
numbers)
g.
(5 points) What happens to the level of the exchange rate written in
Mexican terms at time T?
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h.
(5 points) What happens to the rate of depreciation/appreciation of the
Mexican peso, whichever applies?
i.
(20 points) Just like you did in part e), draw 4 times series diagrams as we
did in the lesson (all referring to Mexican economic variables) with the log of the
Mexican money supply on the top left, real money balances and nominal interest
rates on the top right, the log of the price level on bottom left, and the log of the
exchange rate: Mexican pesos per $ on bottom right. Please show exactly what
happens to these time series variables at time T using real numbers when possible.
Please label graph completely (levels, growth rates, etc)
2.
(15 points total) Given Europe and the US and assuming that relative PPP
and UIP holds, you are given the following information: The nominal interest
rate in the US is 1% and 2% in Europe. The inflation rate in Europe is 2%.
a.
(5 points) What is the inflation rate in the US?
b.
(5 points) What is the rate of appreciation/depreciation, whichever applies,
of the $ relative to the €?
c.
(5 points) What is the real interest rate in both countries?
3.
(15 points total) You are the central banker for a country (Turkey) that is
considering the adoption of a new nominal anchor. When you take the position as
chairperson, the inflation rate is 4% and your position as the central bank
chairperson requires that you achieve a 2.5% inflation target within the next year.
The economy’s growth in real output is currently 3%. The world real interest rate
is currently 1.5%. The currency used in your country is the lira. Assume prices are
flexible.
a.
(5 points) What is the growth rate of the money supply in this economy? If
you choose to adopt a money supply target, what is the money supply growth rate
that will achieve your inflation target?
b.
(5 points) Suppose the inflation rate in the United States is currently 2%
and you adopt an exchange rate target relative to the U.S. dollar. Calculate the
percent appreciation/depreciation in the lira needed for you to achieve your
inflation target. Will the lira appreciate or depreciate relative to the U.S. dollar?
c.
(5 points) Your final option is to achieve your inflation target using
interest rate policy. Using the Fisher equation, calculate the current nominal
interest rate in your country. What nominal interest rate will allow you to achieve
the inflation target?
1.
Consider a world in which prices are sticky in the short-run and perfectly
flexible in the long-run. APPP may not hold in the short run but does hold in the
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long-run. The world has two countries, the U.S. and Japan. Both countries are
initially in a long-run equilibrium with fixed money supplies.
a.
(20 points) Suppose at time T, real GDP in the United States falls
permanently. Draw two diagrams with the money market diagram for the US on
the left and the expected return in $/ exchange rate ($/yen) diagram on the right.
Label the short-run (impact) effect as point(s) B and the long-run effects as
point(s) C.
b.
(10 points) What is the immediate effect of the shock in the United States
on the U.S. interest rate and the exchange rate ($/yen)? Give two reasons why the
exchange rate changes the way it does.
c.
(15 points). How do nominal interest rates, prices, and the exchange rate
evolve over time? Please use a separate time series diagram for each variable.
d.
(5 points) Did the exchange rate "overshoot?" If so, identify the
overshooting in your diagram.
2.
Suppose instead, real GDP in the United States falls temporarily instead.
Contrast the immediate effect of the temporary shock on interest rates and the
exchange rate compared to the permanent shock.
a.
(20 points) Draw two diagrams with the money market diagram for the US
on the left and the expected return in $/ exchange rate ($/yen) diagram on the
right. Label the impact effect, when the shock is temporary, as point B and the
impact effect when the shock is permanent as point C.
b.
(5 points) Why are these impact effects on the exchange rate different?
Explain.
c.
(5 points) Assuming again that the shock to real GDP in the US was
temporary, what would happen to the nominal interest rate in the US and the
exchange rate in the long-run. Explain.
3.
Denmark pegs their currency, the krone, to the euro.
a.
(10 points) Draw two diagrams, side by side with the money market
diagram for Denmark on the left and the expected return in krone / exchange rate
diagram on the right hand side. Label the initial equilibrium point A. Denmark
suffers from an adverse productivity shock and goes in a recession. Show how
your two diagrams are affected by the recession in Denmark. Assume that the
peg is credible.
b.
(10 points) Suppose Denmark prefers to fight the recession via countercyclical monetary policy by increasing the money supply in hopes of lowering
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interest rates in Denmark. Explain what would happen...i.e., would they be
successful or not? Be sure to mention capital flows and use the term(s) 'capital
flight' and/or 'hot money,' whichever applies.
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