1. Midterm Exam
EC Fall

2. Question 1 (a) BOP<0  outflow of gold  MS
BOP>0  inflow of gold  MS
(b) President Nixon closed the gold window (1971)
(c) UK, Denmark and Sweden

3. Question 1 (cont’d)
(d)
(1) Argentine, Hong Kong, Estonia, Lithuania, Ecuador, Panama,…
(2) UK, Switzerland, Japan,…
(3) Chile, Malaysia,…

4. Question 1. (cont’d)
(e) The country with a currency board still has its currency, while the dollarized country does not.
Currency boards: Argentine, Hong Kong
Dollarization: Ecuador, Panama

5. Question 2
(a) Since F$/SF,180 = > E$/SF = .6049, the the 6-month forward SF is at a premium.

6. Question 2 (cont’d) (b) (i) (the return on domestic borrowing)
(ii) (the return on covered foreign lending)
= (1/E$/SF) x (1 + iSF/2 ) X F$/SF,180
= (.6098/.6049) x =

7. Question 2 (cont’d)
(b)
(iii) There is an arbitrage profit opportunity, i.e. you can make positive profits at no cost and with no risk.
Borrow $1 from a US bank and convert it into SF Deposit this amount with a Swiss bank, which will earn SF six months from today. Sell this amount of SF forward at SF per dollar, which amounts to $ Subtracting $1.025, the amount you have to pay back, you end up with $ per each dollar you borrow.

8. Question 2 (cont’d) (c) 1.025 = (.6098/.6049) x (1 + iSF/2 ) = 1.0168
1 + iSF/2 = x (.6049/.6098) =
So, iSF should be 3.4 %.

9. Question 3
(a) The German firm could borrow in the US$ CP market and swap its dollar obligation into DM, that is by buying US$ forward to match its future CP payments (principal plus interest) and selling US$ spot.

10. Question 3 (cont’d)
(b) The German firm can secure the rate: 1 + iDM/4 = (S/F) x (1 + i$/4).
Or, 1 + iDM/4 = (0.60/0.58) x ( /4),
which implies that
iDM is 22.07%.