Question 1 Which of the following statements is correct? Choose only one. a) The higher the interest rate of a country relative to other countries, the weaker will be its home currency, holding all else equal. b) If the spot rate of the British pound (GBP) changes from $1.50 to $1.35, the percentage depreciation of the GBP with respect to the U.S. dollar is equal to 11.11%. c) The value of the Canadian dollar against the U.S. dollar is likely to fluctuate more widely than the value of the euro against the U.S. dollar. d) If Japanese government relaxes its controls on imports by Japanese companies, other things being equal, the supply of Japanese yen for sale should increase, resulting in a decline in the value of yen. e) None of the above Answer:

Question 2 Complete the statements below with correct choices from the underlined. a) Assume U.S. interest rates are expected to fall relative to British interest rates. Other things being equal, as a result of this expectation, the supply of British pounds for sale should (i) increase/decrease, and the value of British pounds should (ii) increase/decrease. Answer: (i) ; (ii) b) Assume that the U.S. inflation rate becomes high relative to Canadian inflation. Other things being equal, the U.S. demand for Canadian dollars should (i) increase/decrease, and the equilibrium value of the Canadian dollar should (ii) increase/decrease. Answer: (i) ; (ii)

Question 3 Country A has large capital flows with the U.S although it has no trade with the U.S. The current interest rate is 3% in both Country A and the U.S. The inflation rate of Country A is 6%, whereas the U.S. inflation rate is 5%. The interest rate of Country A is expected to decline to 2% during the next year, whereas the U.S. interest rate will rise to 4% during the next year. Complete the following statement with correct choices from the underlined: As a result of these expectations, the currency of Country A should (i) appreciate/depreciate against the U.S. dollar because money flows to where interest rates are (ii) higher/lower. Answer: (i) ; (ii)

Question 4 Assume that the U.S. investors invest heavily in government and corporate securities of Country K. In addition, residents of Country K invest heavily in the U.S. Approximately $10 billion worth of investment transactions occur between these two countries each year. The value of trade transactions per year is $8 billion. These patterns are expected to continue in the future. Suppose you are required to forecast the value of Country K's currency (the "krank") with respect to the dollar. Complete the statements below with correct choices from the underlined.

a) Assume the U.S. inflation has suddenly increased substantially, while Country K's inflation remains low. As a result of this, the supply schedule for the krank will shift

to the (i) right/left, and there will be (ii) upward/downward pressure on the value of the krank. Answer: (i) ; (ii)

b) Assume the U.S. income level increased substantially, while Country K's income level has remained unchanged. As a result of this, the demand schedule for the krank will shift to the (i) right/left, and the krank will (ii) appreciate/depreciate with respect to the U.S. dollar. Answer: (i) ; (ii)

Question 5 ABC Corp. expects that the British pound (GBP) will depreciate from $1.70 to $1.68 in one year. It has no money to invest but can borrow money to invest. A bank allows the company to borrow either 1 million dollars at 6% or 1 million pounds at 5% for one year. The company can invest in a USD-denominated risk-free deposit at a rate of 5% for one year or a GBP-denominated risk-free deposit at a rate of 4% for one year. Suppose ABC Corp. is going to pursue a strategy to capitalize on the expected depreciation of GBP. Determine the expected gain or loss, in the U.S. dollars. Answer (show the steps/calculation toward your answer):

Question 6 Suppose Trust Bank expects Mexican peso (MXP) to appreciate from its current spot rate of $0.15 to $0.17 in one month. The interbank lending and borrowing rates are as follows: Lending rate Borrowing rate MXP 8.5% 8.7% USD 8.0% 8.3% Trust Bank has a borrowing capacity of either $10 million or MXP 70 million in the interbank market, depending on which currency it wants to borrow.

If Trust Bank capitalized on its expectation, what would its profit from such a trading strategy be?