1. Please answer each of the following questions.
(a) In March of 2020, the Bank of Canada set the deposit rate equal to the target
for the overnight rate, which was 25 basis points below the bank rate. Using a
supply and demand diagram for the market for settlement balances, show how this
policy change can partially solve the zero lower bound problem. Why can it not
fully solve the zero lower bound problem?
(b) Show the e ect of a large-scale asset purchase on the market for settlement
balances using a supply and demand diagram, when the central bank is at the zero
lower bound. Normally, large increases in the money supply are thought to lead
to high rates of in
ation as the newly created money makes its way to the broader
economy through the banking sector. Explain using your gure why this may not
be the case.
(c) In the spring of 2022, the Bank of Canada began raising interest rates. Because
of policies undertaken during the COVID period, the size of the Bank's balance
sheet is much larger than usual. Explain why this has forced the Bank of Canada
to keep the target for the overnight rate at the deposit rate. Use a supply and
demand diagram to support your answer.
2. The textbook lists ve elements that characterize an in
ation targeting strategy. Go to
the Reserve Bank of Australia webpage. Report on any evidence you nd for each of these
elements.
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3. The le oilprices.xlsx contains monthly data on the price of oil and the CPI. Use this
data to answer the following questions. For the purpose of this questions, suppose that oil
is always bought and sold in real terms, so you can use the values from part (a) directly in
the remaining questions.
(a) Calculate the real oil price by dividing the price of oil by the CPI in each period.
What is the average real oil price over the sample period?
(b) Suppose you entered into a forward contract obligating you to buy one barrel
of oil at a price equal to the average real price of oil that you calculated in part (a).
Calculate the pro t on this forward contract in each month. What is the average
pro t earned on this forward contract?
(c) Now suppose you purchased a call option with a strike price equal to the average
price of oil over the previous 12 months and a premium of $5. Calculate the pro t
on this call option in each month. What is the average pro t earned on this call
option.
(d) Plot the two pro t series you calculated in parts (b) and (c), with time on the
horizontal axis and pro t on the vertical axis. On average, would you have earned
more pro t from the forward contract or the call option? Comment on periods
where this is not the case.
(e) Now suppose that in January 2022 you enter into a futures contract agreeing
to purchase one barrel of oil for $30 in January 2022. If the margin requirement
is $10 and the contract is marked to market each month, calculate how much you
would have in your margin account for each month between January and October
2022.
(f) Now consider a call option with a strike price of $30 and a premium of $5.
For what values of the oil price will the option be executed? For what values of
the price of oil will the option have a positive pro t? Explain why the option will
sometimes be executed even though the pro t is negative.
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(g) Draw a graph of the pro t functions for the contracts from parts (e) and (f).
You should have the asset price on the horizontal axis and pro t on the vertical
axis. Be sure to label your gure.