Part 1

1. If the only thing that causes "shocks" in the economy is when the demand for money changes on its own, should the Federal Reserve continue to focus on the money supply or interest rate targets in order to best stabilize GDP?

2. Discuss the following claims, analyzing each one to determine if it is true, untrue, partially true, or partially false, and providing an in-depth discussion to back up your verdict.

3. "Cheap imports from China come at a hefty cost lost jobs and lower salaries for American workers." [Citation needed]

4. "By keeping the exchange rate between the yuan and the dollar at a low level, the Chinese government can over time sustain an unequal trading relationship with the United States."

5. "If China continues to peg its currency to the dollar at an excessively low value, it may incur a major increase in its price level in the long run," the author states in this quote.

6. "The only way for the United States to close its bilateral trade deficit with China is either for the United States to increase its national savings or for the United States to lower its investment in new plant and equipment."

Part 2

The unpredictability of the value of the euro against the Irish dollar has brought to light the vulnerability of many indigenous Irish enterprises to the risks of both currency and interest.

a) Please provide a brief overview of the many types of interest risk and currency risk that businesses may be subject to.

b) Companies can reduce the amount of exposure they have to currency risk by employing both internal and external hedging strategies. Identify and discuss these various methods of risk management.

Imagine that a bank in Ireland offers a forward contract to an Irish company that has a payment obligation of one million euro to a supplier in the United States that is due in one month's time. Entering into a forward contract for the amount of $1,000,000 at a rate of 1.4353 will result in a fee of 696,718.46. This will fix the exchange rate with total certainty. When compared to the spot rate (the current rate), which is 1.4362, this is priced slightly higher (696,281.85 euros). There is no guarantee that the forward rate will be more expensive than the spot rate. How is it decided what the forward rate will be?

1. Itisnotdeterminedbyestimatingwhatthespotratewillbeinthefuture.
2. Thedifferencebetweenthespotrateandtheforward rateisdueto difference in current interest rates between the two currencies.