Question 4 i. ii. iii. Under the Classical Gold Standard the Price-Specie Mechanism automatically returned a country to balance-of-payments balance. Outline how this adjustment mechanism worked if one country moved into a balance of payments surplus. The Federal Reserve engages in a policy of Quantitative Easing. How is this likely to affect the value of the US Dollar and U.S. interest rates? Explain how the London interbank market establishes the benchmark interest rates of LIBID and LIBOR. Explain what the importance of these rates are and how they are determined. [4 +3+3=10 marks] Question 5 Suppose an Australian importer has to make a 100,000 payment to a German exporter in 60 days. The importer could purchase a European call option to have the euros delivered to him at a specified exchange rate (the strike price) on the due date. Suppose further that the option premium is AUD0.015 per euro and the exercise price is AUD1.50. Discuss the following status/scenarios of this call option for the Australian importer: i. ii. iii. iv. If the Spot rate were to rise to AUD1.55 or fall to AUD1.45 indicate whether the option is in-the-money or out-of-the-money for each scenario and will the importer exercise or let the option lapse and why? What is the cost of this option? What is the break-even spot price for this call option? When is the importer indifferent about exercising or letting the option lapse? Alternative hedging strategies are forwards and futures. How do they differ from options? [2+3+2+3 = 10 marks] Question 6 Following the Corona virus pandemic the Australian dollar (AUD) fell significantly against the USD to USD0.55 cents/AUD. i. ii. One possible action to strengthen the AUD is for the Reserve Bank of Australia (RBA) to intervene in the FE markets and conduct a non-sterilised intervention. Explain what this means, how it is conducted and the impact it would have on the AUD, the money supply, interest rates and export competitiveness? Alternately, the RBA could sterilise the monetary effects of its intervention. Explain what this means, how it is conducted and what are the likely consequences of sterilisation on the money supply and interest rates?