Question

5. Suppose the current spot exchange rate is $1.17 to €1. The dollar is expected to appreciate to $1.11 to €1 during the next year. (Assume inflation and risk etc. are the same between the Eurozone and the U.S.)

(a) What is the expected currency appreciation gain for the dollar? (Give this as a percentage and round to the nearest 0.1%.)

(b) Suppose the interest rate on 1-year corporate bonds in the U.S. is 4%. What is the expected total return for Eurozone investors who buy dollar bonds now? (Give this as a percentage, round to the nearest 0.1%, and use our total return approximation.)

6. Suppose a country wants to fix the exchange rate of its domestic currency higher than what markets alone would bring about.

(a) Suppose the central bank officially sets the higher-than-market exchange rate for the domestic currency, but otherwise undertakes no action. Which would result, a surplus of the currency or a shortage of the currency?

(b) Suppose the central bank does undertake an action to achieve its desired fixed exchange rate. Which would the central bank do, buy the domestic currency or sell the domestic currency?

(c) Which does the country have, a reserve transaction outflow or a reserve transaction inflow?

(d) Which does the country have, a narrow Balance of Payments deficit or a narrow balance of Payments surplus?

Answer 1