Suppose a common basket of goods costs is GHS53 in Ghana, N4500 in Nigeria and K$1200 in Kenya. The actual spot exchange rates for the Nigerian naira (N) and the Kenyan shilling (K$) are respectively N80/GHS and K$25/GHS.

Given the information above and assuming that the law of one price holds:

i. Is naira under-valued or over-valued against the cedi (GHS)?

ii. Is Kenyan shilling under-valued or over-valued against the cedi (GHS)?

iii. One can often observe a gap between actual exchange rates and those predicted by the law of one price. Briefly discuss possible reasons that contribute to the persistency of the exchange rate gap

(15 marks) Part B

The graph below shows the cedi/$ exchange rates over the period, 16th October 2017 to 1st

December 2017.

The Bank of Ghana believes the current trend is largely due to speculation and is considering intervening in the foreign market to stop the depreciation of the cedi. Clearly illustrate how the Bank of Ghana could use sterilized intervention to prevent further depreciation of the cedi?

(10 marks)