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Unformatted text preview: Department of Economics University of California, Berkeley Fall 2008 econ 182 Solutions to Problem Set 3 1 True, False, Uncertain An increase in money supply is always associated with an increase in nominal interest rate because of higher expected inflation. Explain your answer in a few sentences. False. In short run, an increase in the level of money supply reduces the nominal interest rate since prices are fixed. 2 Interest Rate Parity The exchange rate spread and 3-month interest rate spread of US and Japan are shown in table 1. Median Bid Median Ask Yen/Dollar exchange 92 93 Borrowing rate Lending rate US 2% 0.5% Japan 1.4% 0.2% Table 1: Exchange rate and Interest rate (a) What is the implied the bid-ask spread on the dollar/yen 3-month forward rate, as- suming no risk-premium? We can derive the range of forward rates by eliminating arbitrage opportunities. First, we consider shorting dollars and longing yens to see how much one can earn with this strategy. The cost of shorting one dollar is- (1 + 2%) , and the benefit of longing yens with 1 dollar is...
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This note was uploaded on 02/07/2010 for the course ECON 182 taught by Professor Kasa during the Spring '08 term at Berkeley.
- Spring '08