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FIN 535 Week 4 Homework

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FIN 535 Week 4 Homework 3 Direct Intervention. How can a central bank use direct intervention to change the value of a currency? Explain why a central bank may desire to smooth exchange rate movements of its currency. 5. Intervention Effects. Assume there is concern that the United States may experience a recession. How should the Federal Reserve influence the dollar to prevent a recession? How might U.S. exporters react to this policy (favorably or unfavorably)? What about U.S. importing firms? 10. Intervention Effects on Bond Prices. U.S. bond prices are normally inversely related to U.S. inflation. If the Fed planned to use intervention to weaken the dollar, how might bond prices be affected? 15. Indirect Intervention. During the Asian crisis (see Appendix 6 at the end of this chapter), some Asian central banks raised their interest rates to prevent their currencies from weakening. Yet, the currencies weakened anyway. Offer your opinion as to why the central banks’ efforts at indirect intervention did not work. Chapter 7 5. Covered Interest Arbitrage. Explain the concept of covered interest arbitrage and the scenario necessary for it to be plausible. 10. Inflation Effects on the Forward Rate. Why do you think currencies of countries with high inflation rates tend to have forward discounts? 14. Changes in Forward Premiums. Assume that the Japanese yen’s forward rate currently exhibits a premium of 6 percent and that interest rate parity exists. If U.S. interest rates decrease, how must this premium change to maintain interest rate parity? Why might we expect the premium to change? 22. Covered Interest Arbitrage in Both Directions. The following information is available: You have $500,000 to invest The current spot rate of the Moroccan dirham is $.110. The 60-day forward rate of the Moroccan dirham is $.108. The 60-day interest rate in the U.S. is 1 percent. The 60-day interest rate in Morocco is 2 percent. a. What is the yield to a U.S. investor who conducts covered interest arbitrage? Did covered interest arbitrage work for the investor in this case? b. Would covered interest arbitrage be possible for a Moroccan investor in this case?

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