1) For each of the following six scenarios, say whether the value of the dollar will appreciate, depreciate, or remain the same relative to the Japanese yen. Explain each answer. Assume that exchange rates are free to vary and that other factors are held

constant. (10 MARKS)

1. The growth rate of national income is higher in the United States than in Japan.
2. Inflation is higher in the United States than in Japan.
3. Prices in Japan and the United States are rising at the same rate.
4. Real interest rates are higher in the United States than in Japan.
5. The United States imposes new restrictions on the ability of foreigners to buy American companies and real estate.
6. U.S. wages rise relative to Japanese wages, while American productivity falls behind Japanese productivity

(2) During the currency crisis of September 1992, the Bank of England borrowed DM 33 billion from the Bundesbank when a pound was worth DM 2.78, or $1.912. It sold these DM in the foreign exchange market for pounds in a futile attempt to prevent a devaluation of the pound. It repaid these DM at the post crisis rate of DM 2.50:1. By then, the dollar: pound exchange rate was $1.782:1. (6 MARKS)

1. How much had the pound sterling devalued in the interim against the Deutsche mark? Against the dollar?
2. What was the cost of intervention to the Bank of England in pounds? In dollars?
3. Who won?

(3) On Friday, September 13, 1992, the lira was worth DM 0.0013065. Over the weekend, the lira devalued against the DM to DM 0.0012613. (8 MARKS) a. By how much has the lira devalued against the DM?

2. By how much has the DM appreciated against the lira?
3. Suppose Italy borrowed DM 4 billion, which it sold to prop up the lira. What were the Bank of Italys lira losses on this currency intervention?
4. Suppose Germany spent DM 24 billion in an attempt to defend the lira. What were the Bundesbanks DM losses on this currency intervention?

(4) A foreign exchange dealer in London normally provides quotes for spot, one month, three months, and six months. When you ask over the telephone for current quotations for the Argentine peso (ARS) against the U.S. dollar, you hear: "4.0040 to 200, 120 to

110, 350 to 312, 680 to 620" (8 MARKS)

1. What would it cost you to purchase ARS 15,000,000 forward three months for dollars? When would you make payment?

2. In New York, three-month treasury bills yield 8% per annum. Using offer quotes only (for simplicity), what should be the yield on Argentine three-month bills?

d) Verify your answer to part (c) with a hypothetical investment of $10,000,000 for three months in both countries. Use only offer quotes for simplicity and ignore charges and taxes.

(5) You must make a $1,000,000 domestic payment in New York City in 90 days. The dollars are available now, and you decide to invest them for 90 days. The U.S. 90-day Treasury bill rate is 8.00% per annum. The U.K. 90-day Treasury bill rate is 10.00% per annum. The spot exchange rate is $1.8000 per pound sterling. The 90-day forward

rate is $1.7800 per pound sterling. (8 MARKS)

1. Where should you invest for maximum yield with no risk?

2. Given the stated interest rates, what forward quotation would create an equilibrium situation with no advantage or disadvantage associated with investing in one country or the other? Ignore transactions costs.

3. Would your decision about where to invest change if the U.K. interest rate were 14.00% per annum?
4. Given the stated spot and forward exchange quotations and the U.S. interest rate, what is the equilibrium or break-even U.K. interest rate?