9 Credit Rating Downgrade (10 Points)

On 20 April 2020, Fitch Ratings Inc. downgraded Hong Kong as an issuer

of long-term, foreign currency debt because the city is facing a "second

major shock" from the coronavirus after prolonged social unrest last year.

Fitch Ratings is an American credit rating agency and is one of the "Big

Three credit rating agencies". Hong Kong therefore has bonds that bear

greater risk than investments in other countries than before.

a. (1 Points) State the Adjusted Uncovered Interest Parity Condition.

b. (5 Points) Use diagrams showing the spot exchange rate, expected

currency returns, and real money holdings to explain how the Hong

Kong Monetary Authority (HKMA) might intervene in money markets in order to maintain the exchange rate that may have been affected by this credit downgrade.

c. (4 Points) Are there limitations to your proposed strategy? Explain

your answer.