Microsoft Word - Assignment.doc 1 1. Briefly answer the following three questions: a. What are the two properties of an exchange rate crisis? b. What are two of the leading explanations for exchange...

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Microsoft Word - Assignment.doc 1 1. Briefly answer the following three questions: a. What are the two properties of an exchange rate crisis? b. What are two of the leading explanations for exchange rate crises? c. Why should we be concerned with exchange rate crises? 2. Use an on-line source for exchange rates to find the spot rates for the following three currencies: U.S. dollar per British pound (E$,₤), U.S. dollar per Japanese yen (E$,¥), and Japanese yen per British pound sterling (E¥,₤). a. Report these three spot exchange rates. b. If there is no arbitrage opportunity, the spot exchange rates for these three currencies should satisfy the following equilibrium condition: E$,₤ = E$,¥×E¥,₤. Do the spot exchange rates that you retrieved from the on-line source satisfy this condition? Explain your answer. 3. You are a financial advisor to a U.S. corporation that expects to receive a payment of 40 million Japanese yen in 180 days for goods exported to Japan. The current spot exchange rate is 110.57 yen per U.S. dollar (E¥,$). You are concerned that the U.S. dollar is going to appreciate against the yen over the next six months. a. Assuming the exchange rate remains unchanged, how much does your firm expect to receive in U.S. dollars in 180 days? b. How much would your firm receive (in U.S. dollars) if the dollar appreciates to 112 yen per U.S. dollar (E¥,$ = 112)? c. Describe how you could use a forward exchange rate contract to hedge against the risk of losses associated with the potential appreciation of the U.S. dollar. 4. Suppose Switzerland has a real output growth rate of 3% and growth rate of nominal money supply of 8% per year. Use the monetary model of the long-run real exchange rates to answer the following questions. a. What is Switzerland’s rate of inflation rate in this case? b. Describe how the Swiss Central Bank could use monetary policy to achieve a long-run inflation rate equal to 2% in the long-run. 5. You are given the following information. The current spot exchange rate is U.S. $1.33 per pound sterling. A basket of goods that costs $100 in the U.S. costs $120 in the United Kingdom (U.K.). For the following year, the Federal Reserve Bank of the United States is expected to keep the U.S. inflation rate at 2% and the Bank of England is predicted to keep the U.K. inflation rate at 3%. a. What is the expected inflation differential between the U.S. and U.K. for the coming year? b. What is the real exchange rate qUS,UK between the U.S. and the U.K.? c. How much is the U.S. dollar overvalued/undervalued with respect to the pound sterling? d. Assuming the speed of convergence to absolute purchasing power parity is 15% per year, what do you predict the real exchange rate between the U.S. and the U.K. will equal in one year’s time? 2 e. What is the expected rate of nominal depreciation between the U.S. dollar and the pound sterling (ΔE$,₤,t/E$,₤,t)?