Assignment 3
Q. 1 A U.S. investor is planning to do some speculation in the foreign exchange market. a) Suppose the investor chooses to buy a pound futures contract for ￡62,500 and the futures contract price is 2 USD per pound. Currently the value of the contract is $125,000 and the maturity date of the contract is the third Wednesday in June 2017. (1) If the future’s price on May 1st, 2017 is 2.02 USD per pound, calculate the profit/loss of liquidating this contract on that date. (2) If the future’s price on May 1st, 2017 is 1.98 USD per pound, calculate the profit/loss of liquidating this contract on that date. (3) Compare the benefits and costs for speculators of trading in the futures market to those of a) the forward market and b) option markets. b) Suppose the investor chooses to buy a pound call option contract for ￡62,500 and the option contract strike price is 2 USD per pound. The option premium/price is $1500. The maturity date of the contract is the third Wednesday in June 2017. (1) If the spot market rate on May 1st, 2017 is 2.02 USD per pound, do you think the investor should exercise the option? Note whether the option is in the money, out of the money or at the money. Calculate the payoff from exercising. Explain why the investor might NOT exercise the option at this date. Can you infer anything about the approximate time value of the option? (2) If the spot market rate on May 1st, 2017 is 1.98 USD per pound, do you think the investor should exercise the option? Note whether the option is in the money, out of the money, or at the money. Calculate the payoff from exercising. Explain why the investor might NOT exercise the option at this time. Can you infer anything about the approximate time value of the option? (3) Suppose the intrinsic value of the option is negative on May 1st. What ranges of spot exchange rates are associated with a negative intrinsic value? What factors would cause an investor to purchase a contract with negative intrinsic value. c) Depict the expiration value profiles of the future and the option in diagrams for a spot price of
2.02 and 1.98 in each case. Q.3 c) Suppose that you observe forward rates are biased predictors of future spot rates. How would you account for this? Use algebra and/or a simple model to illustrate your argument. d) An MBA student who has just completed a finance course states that “a forward contract and a portfolio consisting of a call and a put with both options having the forward rate as their strike price are equivalent”. Do you agree? Why or why not? e) How would you interpret a finding that the 90 day forward rate for a currency exhibited a premium relative to the current spot rate that was larger than the premium associated with the 30 day forward rate? How would you expect this to be reflected in international interest differentials
for assets of differing maturities? f) Suppose the nominal interest rate is 4% and the expected inflation rate according to all consumer surveys is 1%. What is the real (“ex­ante”) interest rate? What do real interest rates reflect and under what circumstances might we expect them to be equal across countries? What is your intuition for this last result? QUESTION 4. The Forward Rate Puzzle Suppose that the spot exchange rate of a foreign currency follows the following process, where t denotes year t: ￡￡+1 = ￡￡￡ + ￡￡￡−1 + ￡ ￡+1 where ￡￡ is a normally distributed error with zero mean and constant finite variance, and α and ￡ are constant parameters with values between zero and one. a) What is the rational forecast of ￡￡+1? Show your workings. b) What is the annual forecast error for the rational forecast? Show your workings. c) What is the mean/expected annual forecast error for the rational forecast? Show your workings. d) If speculators do not demand risk premiums in the forward market, and form rational forecasts, what should be the one year (360 day) ahead forward price for this currency? Explain. e) If speculators do not demand risk premiums in the forward market, and form rational forecasts, what should be the annualized/standardized forward premium for this currency
Assignment 4
QUESTION 1 – Monetary Models of Exchange Rate Determination Suppose that a monetary
model describes the long-run behavior of the nominal exchange rate well, but fails to describe
the short-run behavior; specifically, in the short run large deviations from purchasing power
parity are observed due to nominal rigidities in goods’ prices and overshooting of the nominal
exchange rate in response to monetary shocks occurs as a result. a) What are the three key
modeling assumptions used to derive the monetary model of exchange rates? What is the only
one of these modeling assumptions which is different in the Dornbusch over-shooting model? b)
Write down an equation that reflects the nominal exchange rate solution provided by the
monetary model i.e. expresses the nominal exchange rate as a function of monetary and real
fundamentals and expectations of the future exchange rate and explain each term. c) Use
diagrams and words to describe the impact of a (relative) home money supply shock for i) the
nominal exchange rate ii) the home interest rate, and iii) the home price level in the short run
(according to the Dornbusch overshooting model) and in the long run (according to the monetary
model). Explain carefully why the differences in prediction arise in each case. d) What do each
of these two models imply about the ability of monetary policy to influence interest rates and
aggregate demand/output in an open economy?
QUESTION 2 – Long Run Exchange Rate Determination and PPP a) Write down the expression
for a country’s real exchange rate in terms of the nominal exchange rate and aggregate price
levels, defining your notation carefully. What does a country’s real exchange rate measure? b)
What does purchasing power parity theory state that the value of a country’s real exchange rate
should be? Under what conditions would you expect purchasing power parity to be a valid
description of a country’s real exchange rate? c) Now derive an equivalent expression for a
country’s real exchange rate, in terms of the real exchange rate of traded goods and the relative
price of traded to all goods (or traded to non-traded goods). Define your notation carefully. What
does each of these two components of the real exchange rate reflect, in words? Empirically, do
we know which is more important for real exchange rates? d) Suppose there is an increase in
domestic demand for non-traded goods relative to traded goods. How would you expect this to affect the country’s real exchange rate and why? e) Suppose the home country imposes a
permanent tariff on imported goods from abroad. How do you think this would affect its real
exchange rate in the long-run? (Think of the border adjustment that is being currently discussed).
QUESTION 3 – Fixed Exchange Rates During the 1990s, Argentina established a fixed (1:1)
exchange rate peg of its currency against the $US. The peg also involved full convertibility of its
currency with the $US: the central bank could only print an additional peso if it accumulated an
additional dollar in its foreign exchange reserves. The peg was abandoned in an exchange rate,
banking and debt crisis in 2001-2002.
a) Explain the implications of this exchange rate regime for the efficacy of monetary and fiscal
policy. Why was the Argentine government willing to sacrifice its ability to use independent
monetary policy in order to peg the exchange rate?
b) Show that purchasing power parity implies that fixed exchange rates can eliminate inflation.
c) Discuss the fact that exchange rate crises tend to be associated with banking and public debt
crises and default. Reference the balance sheet effects of exchange rate crises in particular.

SuperTutor

(15)

Status NEW Posted 03 May 2017 03:05 AM My Price 20.00

-----------

Attachments

file 1493783265-Solutions file.docx preview (56 words )

S-----------olu-----------tio-----------ns -----------fil-----------e -----------Hel-----------lo -----------Sir-----------/Ma-----------dam----------- T-----------han-----------k y-----------ou -----------for----------- yo-----------ur -----------int-----------ere-----------st -----------and----------- bu-----------yin-----------g m-----------y p-----------ost-----------ed -----------sol-----------uti-----------on.----------- Pl-----------eas-----------e p-----------ing----------- me----------- on----------- ch-----------at -----------I a-----------m o-----------nli-----------ne -----------or -----------inb-----------ox -----------me -----------a m-----------ess-----------age----------- I -----------wil-----------l b-----------e q-----------uic-----------kly----------- on-----------lin-----------e a-----------nd -----------giv-----------e y-----------ou -----------exa-----------ct -----------fil-----------e a-----------nd -----------the----------- sa-----------me -----------fil-----------e i-----------s a-----------lso----------- se-----------nt -----------to -----------you-----------r e-----------mai-----------l t-----------hat----------- is----------- re-----------gis-----------ter-----------ed -----------on�-----------�th-----------is -----------web-----------sit-----------e. ----------- H-----------YPE-----------RLI-----------NK -----------&qu-----------ot;-----------htt-----------p:/-----------/wo-----------rkb-----------ank-----------247-----------.co-----------m/&-----------quo-----------t; -----------\t -----------&qu-----------ot;-----------_bl-----------ank-----------&qu-----------ot;----------- -----------Tha-----------nk -----------you----------- -----------

Not Rated(0)

• Buy Answer