Due the sanctions imposed on Russia for its invasion on Ukraine, Moodys Investors Service, one of the Big Three global credit rating agencies, downgraded Russias long-term government debt from Baa3 to B3, which is junk or non-investment grade statusin March 2022.

a. (8 Points) Let the Russian ruble (RUB) be the domestic currency and the euro (EUR) be the foreign currency. Use the Adjusted Uncovered Interest Parity Condition along with diagrams showing the spot exchange rate, expected currency returns, and real money holdings to explain how the equilibrium spot exchange rate responds to this announcement.

b. (6 Points) Suppose the Central Bank of the Russian Federation wants to counteract any exchange rate effects resulting form this announcement but cannot buy or sell foreign currencies in the foreign exchange markets directly due to financial sanctions. Using the same diagram above, show and explain how Russias central bank could intervene in the money markets to maintain the pre-announcement exchange rate level.

c. (6 Points) Suppose the Central Bank of the Russian Federation is able to circumvent all financial sanctions. Explain how they can counteract exchange rate effects resulting from this credit downgrade and also keep their money supply unchanged