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Question 1: Are the statements below true or false? Explain the reasons for your answers. a. A country which decides to join a Monetary Union expects an increased ability to stabilize or stimulate its output, and an increased ability to keep inflation low compared with its initial ability under flexible exchange rates. (2.5 marks) b. Suppose that the United States is on a gold standard and the US authorities have committed to exchange an ounce of gold for $35. Suppose that France is on gold standard too and French authorities have committed to exchange an ounce of gold for 60 French Francs. If the exchange rate between French Francs (FF) and US Dollars ($) is FF2/$1, would there be arbitrage opportunities? Is the exchange rate of FF2/$1 correct or not? (2.5 marks) Question 2: The graph below is the exchange rate of Japanese Yen to US dollar (¥/$) between August and November 2010. On 15th Sept, Yen moved from 83 to 85.7 yen per dollar due to the Japanese authorities’ intervention in the foreign exchange markets to weaken the value of the yen against the dollar, a day after the yen hit a 15-year high against the dollar. a. Explain how did the Japanese central bank intervene and influence the exchange rate between Yen and Dollar in the foreign exchange markets? (1.5 marks) b. What was the government’s justification for their intervention? (2 marks) c. Did the intervention succeed? Explain the reasons for your answer. (4 marks) Question 3: Based on the table for the rates published in the US below, find the €/£ cross bid and ask rates and fill in the table. You need to show the steps how you get your answers. (Numbers should be rounded to 4 decimal places. Please note that your answers will be worthy zero mark if they do not include currency symbols $, £ and €) (3 marks) USD Bank Quotations Direct American Terms Indirect European Terms Bid Ask Bid Ask Between £ and $ 1.5924 1.5929 .6278 .6280 Between € and $ 1.3509 1.3514 .7400 .7402 Between £ and € ? ? ? ? Question 4: Assume you are a trader in foreign currencies and you look for arbitrage. From the quote screen on your computer terminal, you observe the exchange rate quotations below. (Numbers should be rounded to 4 decimal places. Please note that your answers will be worthy zero mark if they do not include currency symbols, £, $, €.) Bank Quotations Rate Citi Bank : $1.8403/£ UBS : $1.3225/€ Barclays Bank : €1.3647/£ a. Explain what a triangular arbitrage is. What is a condition that will give rise to a triangular arbitrage opportunity? (1.5 marks) b. What €/£ price will eliminate triangular arbitrage? (1 mark) c. How you can make a triangular arbitrage profit by trading at these prices? What is the profit? Explain and discuss your calculations. (4 marks) Question 5: A fund manager uses the concepts of purchasing power parity (PPP) and the International Fisher Effect (IFE) to forecast spot exchange rates. He gathers the financial information as follows: A year ago, the spot rate between pound and dollar was $1.60/£. In the past year, US inflation was 3.5% and UK inflation was 4.5%. The current spot rate is $1.576/£. (Numbers should be rounded to 4 decimal places. Please note that your answers will be worthy zero mark if they do not include currency symbols $, £) a. What is relative PPP? Calculate the current pound spot rate in dollar that would have been forecast by PPP. (2 marks) b. Does the PPP hold in this case? What could be the reasons for that? (3 marks) c. What is IFE? If the expected US one-year interest rate is 0.5%, expected UK one-year interest rate is 0.75%, use IFE to predict the expected pound spot rate in dollar one year from now. (3 marks)