Question 4

What is meant by the Incompatible Trinity? Illustrate your answer with an example of a fixed currency exchange regime and an example of a floating currency exchange regime.

Question 5

When a country's currency depreciates against the currencies of its major trade partners, its trade balance often worsens in the short run before it starts to improve. This leads to a J curve in the trade balance. Illustrate the J curve graphically. Fully label your diagram (note: you are welcome to draw it by hand, take a photo and attach it here). Explain why the J curve happens.

Question 7

You are a U.S.-based treasurer with $1,000,000 to invest. The dollar-euro exchange rate is quoted as $1.50 = 1.00 and the dollar-pound exchange rate is quoted at $2.00 = 1.00. If a bank quotes you a cross rate of 1.00 = 1.25, is there an arbitrage opportunity? If so, how much money would you make? Show all workings.