Provide solutions to the. following questions.

1.Exchange Rate Overshooting

Use the foreign exchange and money market diagrams to answer the following questions about the relationship between the Indian rupee (INR) and the Chinese yuan (CNY). Let the exchange rate be defined as rupees per yuan EINR/CNY. Suppose there is a fall in the Indian nominal money supply. Make the usual assumptions: UIP holds, PPP holds in the long run, prices are sticky in the short run,

a.Assume first that the fall in money supply is temporary (so that the nominal money supply is put back at its original level in the long run). Illustrate the effects of this in a pair of graphs, one for the Indian money market and one for the foreign exchange market. Label the initial equilibrium as point A, the short-run equilibrium point B, and your long-run equilibrium point C.

b.Now assume instead that the fall in money supply is permanent. Illustrate this in a pair of graphs, one for the Indian money market and one for the foreign exchange market. Label the initial equilibrium as point A, the short-run equilibrium point B and your long-run equilibrium point C.

c.For the case you just analyzed above (permanent shock), plot a graph for each of the following variables over time showing the initial equilibrium, short run equilibrium, and the long run equilibrium: India's nominal money supply, India's interest rate, India's price level, India's real money supply, and the exchange rate EINR/CNY.

d.Does the theory of "exchange rate overshooting" apply to the case in part (a) above? How about to

the case in parts (b) and (c)? Explain the economic reason the two cases are different.

Show that (inx-p)- [4] 12no- A general insurance company writes claims, whose amounts have a lognormal distribution, with mean 300 and standard deviation 400. The insurance company purchases excess of loss reinsurance with retention 500 per claim. (ii) Calculate the average expected claim size payable by the insurance company. [6] Next year, claim inflation is 10%, but the retention amount remains the same. (iii) Explain whether the average expected claim size payable by the insurance company next year would increase by 10%. [2] ['Total 12] Consider the following time series model: Y, = 1+0.6Y,_1+0.167,-2+ 5, where & is a white noise process with variance of. Determine whether Y, is stationary and identify it as an ARMA(p,q) process. [3] (ii) Calculate E(F). [2] (iii) Calculate for the first four lags: the autocorrelation values P1. P2- P3. P, and the partial autocorrelation values V1, Vy, (;, W4. 171 [Total 12]Show that (inx-p)- [4] 12no- A general insurance company writes claims, whose amounts have a lognormal distribution, with mean 300 and standard deviation 400. The insurance company purchases excess of loss reinsurance with retention 500 per claim. (ii) Calculate the average expected claim size payable by the insurance company. [6] Next year, claim inflation is 10%, but the retention amount remains the same. (iii) Explain whether the average expected claim size payable by the insurance company next year would increase by 10%. [2] ['Total 12] Consider the following time series model: Y, = 1+0.6Y,_1+0.167,-2+ 5, where & is a white noise process with variance of. Determine whether Y, is stationary and identify it as an ARMA(p,q) process. [3] (ii) Calculate E(F). [2] (iii) Calculate for the first four lags: the autocorrelation values P1. P2- P3. P, and the partial autocorrelation values V1, Vy, (;, W4. 171 [Total 12]Furthermore, "The Question" is expected to reduce sales of other Reebok shoes, and the life of the shoe is expected to be only 6 years. Reebok's CFO, Kenneth Watchmaker, had compiled the following information surrounding "The Question" project: 1. The life of the project is 6 years. 2. The retail price of the shoe is estimated to be in the $130-$150 range; Reebok's wholesale selling price will be $100.00 3. The athletic shoe market is projected to reach $18 billion during Year 1 and is growing at a rate of 3% per year. The market share projections for Reebok's "The Question" are: Year 1, 1.70%; Year 2, 1.75%; Year 3, 1.60%; Year 4, 1.45%; Year 5, 1.35%; and Year 6, 1.25%. 4. In order to produce the shoe, Reebok will need to build a factory in New Delhi, India. This will require an immediate outlay of $150 million, which will be depreciated on a 39 year MACRS basis. The depreciation percentages for the first six years, respectively, are: 2.6%, 5%, 4.7%, 4.5%, 4.3%, and 4.0%. Reebok analysts estimate that the building will be sold for $102.35 million at the project's termination. Note that this "salvage value" is not taken into consideration when computing the annual depreciation charges here. 5. Reebok must also immediately purchase equipment costing $15 million. Freight and installation of the equipment will cost $5 million. The equipment and freight/installation costs will be depreciated on a 5-year MACRS basis. The depreciation percentages for the six years, respectively, are: 20%, 32%, 19%, 12%, 11%, and 6%. It is believed that the equipment can be sold for $3 million at the project's termination. 6. In order to manufacture "The Question," two of Reebok's working capital accounts are expected to increase immediately. The inventory balance is expected to increase by $60 million and the accounts payable account is expected to increase by $15 million. These balances will be maintained until the final year of the project, at which time they will be recovered. 7. Sales of "The Question" are expected to reduce sales of other Reebok basketball sneakers. Specifically, Reebok's other sneaker sales are expected to decrease by $170 million during each year of the project. Assume these lost sales have the same margins as The Question. 8. Variable costs of producing the shoe are expected to be 31% of the shoe's sales. Including salvage value in depreciation computations is done for financial reporting purposes. Here, we are concerned with the cash flow impacts of taxes; for fax purposes, it is not necessary for firms to incorporate salvage valuc. 2