Hong Kong maintains a credible peg with the US dollar. The currency for Hong Kong is the Hong Kong dollar denoted HK$. Capital flows freely across the two countries. Please answer the following questions:

a) (10 points) Suppose the Federal Reserve in the US conducts expansionary monetary policy so that interest rates in the US fall. Show what would happen in the Hong Kong money market. Start at an initial point A and then show what happens and label as point B. Please label your graph completely.

b) (10 points) Explain your results in your graph above by using a T account / Balance Sheet for the central bank of Hong Kong. In your answer you should use the term endogenous and the terms capital flight / hot money, which ever applies. Be sure to explain what happens to the money supply and why.

c) (5 points) What could Hong Kong do if they wanted to prevent any change in their interest rates - that is, if they wanted to keep their interest rates at their original level?