EXAM 3 1. Use UIP’s approximation to analyze whether or not the spot foreign exchange market is in equilibrium? If not, explain what market mechanism will bring the market back to an equilibrium. (20...

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EXAM 3 1. Use UIP’s approximation to analyze whether or not the spot foreign exchange market is in equilibrium? If not, explain what market mechanism will bring the market back to an equilibrium. (20 pts) 2. Use UIP’s approximation to compute the equilibrium spot exchange rate. (10 pts) 3. Plot your foreign exchange market equilibrium analysis-based results (1) and (2). Explain briefly. Note: you must label the diagram clearly with the figures from this problem. (10 pts) 1. Use UIP’s approximation to analyze whether or not the spot foreign exchange market is in equilibrium? If not, explain what market mechanism will bring the market back to an equilibrium. (10 pts) 2. 2. Use UIP’s approximation to compute the equilibrium spot exchange rate. (10 pts) 3. Plot your foreign exchange market equilibrium analysis based results (a) and (b). Explain briefly. Note: you must label the diagram clearly with the figures from this problem. (10 pts)
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Answered 1 days AfterMar 30, 2021

Answer To: EXAM 3 1. Use UIP’s approximation to analyze whether or not the spot foreign exchange market is in...

Komalavalli answered on Mar 31 2021
135 Votes
Problem1
1. Given E$/¥ = $0.0135
F$/¥ = $0.0118 = Ee$/¥
i$ = 2.0%
i¥ = 3.25%
(1+ i¥)* (F$/¥/ E$/¥)
(1+i$)= 1.02
(1+i$)= 1 (appx)
(1+ i¥)* (F$/¥/ E$/¥) = 1.0325*(0.0118/0.0135)
(1+ i¥)* (F$/¥/ E$/¥) = 0.90
The market is not in equilibrium, the investor will perceive it to be beneficial to borrow in USD and invest that in Yen, and then reconvert the investment proceeds to USD to make a profit from the difference. The demand US increases this appreciate domestic currency value and result in interest rate increase. This risk is covered with forward rates
2. UIP
(1+i$) =(1+ i¥)* (Ee$/¥)/ E$/¥
(1+i$) = 1.02
(1+i$)= 1 (appx)
(1+ i¥)* (Ee$/¥)/ E$/¥ =1.0325 *(0.0118/0.0135)
(1+ i¥)* (Ee$/¥)/ E$/¥= 0.90
The market is not in equilibrium, the investor will perceive a fall in expected return , this will shift the return curve downward and the equilibrium will be acheived
3.
Problem 2:
1. Given E$/¥ = $0.0135
F$/¥ = $0.0125
Ee$/¥= 0.0118
i$ = 2.0%
i¥ = 3.25%
(1+i$) =(1+ i¥)* (Ee$/¥)/ E$/¥
(1+i$)=...
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