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international finance course about exchange rates, 3 questions 1) [25 points] Suppose we observe the following information for France, Canada and the United States. France
international finance course about exchange rates, 3 questions
1) [25 points] Suppose we observe the following information for France, Canada and the United States. France Canada U.S. S(1990) S(1991) $0.198/FF $0.867/C$ $0.179/FF $0.741/C$ CPI (1990) 100 100 100 CPI (1991) 114.3 117.4 121.0 a. Calculate the 1991 real exchange rate for the US$ with respect to FF using 1990 as the base year ( French goods per US goods). b. Repeat Question a. with the Canadian dollar c. How would you interpret these findings and what in the most likely implication on the balances of trade of these countries during subsequent years? 2) [25 points] As a foreign exchange trade at Deutsche Bank, a dealer from Citibank would like a yen quote on Australian dollars. The current spot market rates are 101.3785/U.S.$ and A$1.2924-44/U.S$. a. Why are the bid-ask spreads quoted in the interbank spot market? What is their purpose and how do they behave during period with no major news versus periods with a lot of news? b. What bid and ask yen cross rates would you quote on spot Australian dollars? c. If you quote 78.85-90/A$, how the dealer of Citibank can take advantage of your quote by making money without taking risk? Calculate the potential profit that the dealer from Citibank if he/she starts with US$10M. 3) [25 point] Suppose the US interest rate and the UK interest rates are the same, 5% per year. a. What is the relationship between the current equilibrium US$/ exchange rate and its expected future level? b. Suppose the expected future US$/ exchange rate level, 1.52 US$/, remains constant as Britain's interest rate rises to 10% per year. If the US interest rate also remains constant, what is the new equilibrium US$/ exchange rate? [Use information from the UIP section of Chapter 3] c. Assume that the FED announces (as it did in 1979) that it would play a less active role in limiting the fluctuations in the dollar interest rate. After this new policy was put in effect, the dollar's exchange rate against the Pound becomes more volatile. Does our analysis of the interest rate parity suggest any connection between the two events? [Note that this question is independent from the other questions a, b of this problem]Step by Step Solution
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