TECInternationalFinanceHomework2

TECInternationalFinanceHomework2 - 1213962 Manuel Mendoza...

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1213962 Manuel Mendoza Lujambio TEC DE MONTERREY INTERNATIONAL FINANCE HOMEWORK 2 1. Assume the Federal Reserve believes that the dollar should be weakened against the Mexican peso. Explain how, the Fed could use direct and indirect intervention to weaken the dollar's value with respect to the peso. Assume that future inflation in the United States is expected to be low, regardless of the Fed's actions. It will apply talking about direct intervention, a speculating intervention where it intervenes in order to anticipate some results, so it would sell dollars. Or by using indirect intervention, it can reduce the supply of the dollar so the value of the dollar increases, and the devaluation will increase the peso. 2. Exchange Rate Systems. Compare and contrast the fixed, freely floating, and managed float exchange rate systems. What are some advantages and disadvantages of a freely floating exchange rate system versus a fixed exchange rate system? Fixed exchange rate system, some advantages are that it insulate country risk of currency appreciation, also allows firms to engage in direct foreign investment without currency risk. And some disadvantages are that the risk that the government will alter the values of the currency. In the freely floating exchange rate system, the advantages are that the country is more insulated from inflation of other countries, also the country is more insulated from unemployment of other countries, and finally, it doesn’t require the central bank to maintain exchange rates within specific boundaries. The disadvantages are that can adversely affect a country that has high unemployment, and also can adversely affect a country with high inflation. In the managed float exchange rate system, the governments sometimes intervene to prevent their currencies form moving too far in a certain direction, an also manipulate exchange rates to benefit its own country at the expense of others. 3. Locational Arbitrage. Assume the following information: Beal Bank Yardley Bank Bid price of New Zealand dollar $0.401 $0.398 Ask price of New Zealand dollar $0.404 $0.400 Yardley Bank Beal Bank Bid (compra) Ask (venta) Bid Ask .389 $/NZ .400 $/NZ .401 $/NZ .404 $/NZ Given this information, is locational arbitrage possible? If so, explain the steps involved in locational arbitrage, and compute the profit from this arbitrage if you had $1 million to use. What market forces would occur to eliminate any further possibilities of locational arbitrage? Yes, is possible the locational arbitrage. You will need to sell the $1 million dollars to Yardley Bank at a price of 1/.400 NZdollar/dollar, so it would have 2,500,000 New Zealand dollars then you will need buy with those New Zealand dollars in the Beal Bank at a price of .401 dollar/NZdollar and you will have $1,002,500 dollars. And you will have a profit of $2,500 dollars. To force the elimination of locational arbitrage it need to drive prices to adjust in different locations so as to eliminate discrepancies, so the demand of the Yardley Bank’s ask price will force that the ask price increase. The bid price of Beal Bank will decrease, because the large sales.
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