1. 3 pts) Trade Restriction Effects on Exchange Rates. Assume that the Japanese government relaxes its controls on imports by Japanese companies. Other things being equal, how should this affect the (a) U.S. demand for Japanese yen, (b) supply of yen for sale, and (c) equilibrium value of the yen?

2. (8 pts) Speculation. Blue Demon Bank expects that the Mexican peso will depreciate against the dollar from its direct spot rate of $0.048 to $0.042 in 30 days. The following interbank lending and borrowing nominal annualized rates exist:

Lending Rate Borrowing Rate

U.S. dollar 1.0% per yr 1.2% per yr

Mexican peso 5.2% per yr 5.6% per yr

Assume that Blue Demon Bank has a borrowing capacity of either $10 million or 200 million pesos in the interbank market, depending on which currency it wants to borrow.

1. How could Blue Demon Bank attempt to capitalize on its expectations without using deposited funds? Estimate the profits that could be generated from this strategy.

2. Assume all the preceding information with this exception: Blue Demon Bank expects the peso to appreciate from its present spot rate of $0.048 to $0.053 in 90 days. How could it attempt to capitalize on its expectations without using deposited funds? Estimate the profits that could be generated from this strategy.