midterm_soln - International Financial Management Midterm...

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International Financial Management Midterm Exam Solution March 31, 2008 Prof Jaewon Choi Time: 1 Hour 15 Min Name: _______________________________________ Good luck!
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Part I True/False. Circle T if the statement is true and F if it is false. (+2 for each correct, 0 for omitted, -1 for each wrong) 1. T F In the Bretton Woods system, countries pegged their currency to the. British pound sterling (US Dollar ) 2. T F Under the floating (fixed) rate system, the Federal Reserve actively purchases and sells currency to maintain foreign exchange rates. 3. T F If exchange rates are fluctuating randomly, that may discourage international trade and make it hard to achieve national policy autonomy 4. T F Bid-Ask spreads are usually higher after the market makers see some large trades 5. T F Suppose Mexico decides to stabilize its currency by maintaining a peg to the US dollar at the current exchange rate (10.932 pesos/$) for the next year. The Mexican interest rate is 7% whereas the US interest rate is 5%. This will cause a decrease (increase) in Mexican government dollar reserves. 6. T F When the US yield curve is flat and the Indian yield curve is upward sloping, the dollar will appreciate and rupee will depreciate. 7. T F It is possible to run both capital and current account deficits if a country depletes its reserves of foreign currency and/or gold. . 8. T F In the monetary approach, the increase in interest rates causes lowered demand for money and increased price levels. The inflation causes US goods to become less competitive and by purchasing power parity, the spot rate therefore decreases (increases) 9. T F According to uncovered interest rate parity, if one year interest rates are higher in the UK than in the US, the pound will appreciate (depreciate) over the year 10. T F As the volatility of the underlying asset increases, both put and call options become more expensive.
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Part II Short answer. Make sure to show any intermediate calculations and avoid roundoff error by keeping at least 4 decimal places. For conceptual questions, explain your logic briefly. You should not need to write lengthy essays. 1. Suppose that the Fed lowers the interest rate in US due to the high risk of recession whereas the European Central Bank keeps the current interest rate. (15 pts) a) Given that the market does not expect a change in the future exchange rate, what is the impact of the rate cut on the current spot exchange rate ($/€)? Explain your reasoning. (5 pts) The uncovered interest rate parity provides the relations between expected future exchange rate, current exchange rate and the interest rates. Given that the expected future exchange rate is the same, the rate
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This test prep was uploaded on 04/20/2008 for the course UNKNOWN 15.0030.0 taught by Professor Jaewonchoi during the Spring '08 term at SUNY Albany.

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midterm_soln - International Financial Management Midterm...

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