Problem 11.

One day, market participants realize that the Japanese yen will be substantially weaker in a years time, because Japans central bank will cut interest rates in the future. However, Japans interest rates remain unchanged today.

Using the exchange rate model we have discussed in class, discuss what effect, if any, this change in expectations would have on the Japanese yen. What impact would you expect this to have on Japans current account?

Problem 13.

Your company has a factory in Atlantis. You live in Salt Lake, where you are in charge of liaising with the Atlantis subsidiary. News articles suggest that Atlantis is headed for a crisis.

Unfortunately, Atlantis has stopped publishing a full set of balance of payments statistics, so one night you decide to use the available information to piece together a story.

You find that Atlantis has published the following data points for 2016:

Current account balance USD - 100bn

Financial account balance n.a.

Official reserve transactions n.a.

All other financial transactions USD 50bn

Capital account USD 0

Statistical discrepancy USD -100bn

a. Is Atlantis gaining or losing foreign exchange reserves? Please use the available data to explain your answer.

b. Atlantiss website states that We believe that market forces should determine our exchange rate. Thus, we allow our exchange rate to float. Do you believe this statement? State why or why not.

Problem 14.

You start a new job at XYZ bank, and your boss assigns you to search for covered interest rate arbitrage opportunities in the New Zealand dollar (NZD) forward market. However, she says, this isnt the classroom. You need to recognize that XYZ bank faces different borrowing and lending rates for NZD funds.

XYZ bank faces the following interest rates.

Transaction One-year interest rate

Borrowing USD 1%

Lending USD also 1%

Borrowing NZD 5%

Lending NZD 2%

The spot exchange rate is 0.65 USD per NZD. For both of the one-year forward rates below:

Assess whether a covered interest rate arbitrage opportunity exists for XYZ bank. If the answer is no, please verbally explain why not.

If the answer is yes, please describe the arbitrage trade, and calculate the maximum profits you would earn in one years time if you could borrow at most NZD 1million or USD 650,000.

a. You observe a one-year forward rate of 0.66 USD per NZD.

b. You observe a one-year forward rate of 0.60 USD per NZD.