4. Interest Rate Parity

a. Discuss the interest rate parity and illustrate it in graph using U.S. (home) and Canadian (foreign) interest rates. Choose one point on the line, one point below the line, and one point above the line to discuss specific examples. For each point discuss which countrys investors will invest in the other country and what market forces these actions will cause to bring rates back to parity.

b. Assume the following information:

Spot rate of Canadian dollar = $0.80; 1 year the U.S. interest rate= 7% and 1-year Canadian interest rate = 4%. According to the IRP what should the 1-year forward rate of Canadian dollar be?

Is there an arbitrage opportunity if 1-year forward rate of Canadian Dollar currently is $0.75? What form of arbitrage is it and will American investors invest in Canada or Canadian investors invest in the U.S.?

5. Central Bank Intervention

a) Discuss how the Central bank of Azerbaijan can intervene directly to strengthen the value of Azerbaijani manat. Discuss both sterilized and unsterilized interventions. Why would the Central Bank need to sterilize its intervention?

b) Discuss how the Central bank of Azerbaijan can intervene indirectly to strengthen the value of Azerbaijani manat. What are the possible adverse effects from this type of intervention?

c) Discuss how recent actions (post-financial crisis period) taken by FED have impacted the economy and currency exchange rate of the US dollar? What type of intervention was it?