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International Finance Questions - Exchange Rates, Arbitrage, and Forecasting

## Question 1: True or False Statements

Question 1: Are the statements below true or false? (0.5 mark for each) Explain the reasons for your answers.

a.It is impossible for a country to run both current account surplus and capital account surplus in the same year.

b.Suppose that the United States is on a bimetallic standard at \$35 to one ounce of gold and \$3 for one ounce of silver. If new silver mines open and flood the market with silver, the two metals will circulate as before in the US since citizens could exchange their gold currency for silver currency at any time.

Question 2: The graph below is the exchange rate of Turkish Lira to US dollar (TRY/USD) between January to September 2018. At the beginning of the year, the exchange rate was 3.7776 lira per dollar. However, on 13th August Turkish Lira jumped to 6.9025 lira per dollar, a historic high against the dollar.

a.Was it an appreciation or depreciation of Turkish Lira (TRY) in 2018? Calculate the percentage change of TRY value when the exchange rate went from 3.776 to 6.9025.

b.What were the main reasons for the dramatic change of TRY in 2018?

c.What did the Turkish central bank do to try to stabilize their current value? Do you think their measures were successful in the long run and why? Explain the reasons for your answer.

Question 3: Assume you are a trader in foreign currencies and you look for arbitrage. From the quote screen on your computer terminal, you observe the exchange rate quotations below

Bank Quotations Rate

Citi Bank  : \$1.8501/£

UBS    : \$1.3325/€

Barclays Bank  : €1.3469/£

Show how you can make a triangular arbitrage profit by trading at these prices. (Ignore the ask-bid spread for this question)   Assume you have £5,000 with which to conduct the arbitrage. (Please note that your answers are worth zero mark if they do not include currency symbols £, \$, €)

a. Explain what a triangular arbitrage is. What is a condition that will give rise to a triangular arbitrage opportunity?

b. What €/£ price will eliminate triangular arbitrage?

c.How can you make a triangular arbitrage profit by trading at these prices?  What is the profit? Explain and discuss your calculations.

Question 4: A fund manager uses the concepts of purchasing power parity (PPP) and the International Fisher Effect (IFE) to forecast spot exchange rates. He gathers the financial information as follows:

A year ago, the spot rate between pound and dollar is \$1.70/£. In the past year, US inflation is 2% and UK inflation is 3.5%. The current spot rate is \$1.57/£.

(Please note that your answers are worth zero mark if they do not include currency symbols \$, £)

a. What is relative PPP? Calculate the current pound spot rate in dollar that would have been forecast by PPP.

b. Does the PPP hold in this case? What could be the fundamental reasons for that?

c. What is IFE? If the expected US one-year interest rate is 0.25%, expected UK one-year interest rate is 0.5%, use IFE to predict the expected pound spot rate in dollar one year from now.