Assignment
A 1) On July 6, 2017, Russia announced that June CPI inflation was 4.4% over the year previous. This was slightly higher than analyst expectations of 4.2%, and was driven by food prices.
a) What effect do you expect that this had on exchange rates?
b) Over what period of time do you expect that this information was incorporated into exchange rates?
c) What happened to the Ruble/Dollar exchange rate over this period? Is this consistent with appreciation or depreciation of the Ruble?
d) Does the observed change in exchange rates line up with your intuition? Answer this for both the direction and magnitude of the change.
2) You observe the exchange rates from the following 4 currencies(US, EU, UK, and Japan):
a. $1.19/€, $1.30/£, $0.0091/¥
b. €0.84/$, €1.09/£, €0.0076/¥
c. £0.77/$, £.91/€, £0.0055/¥
d. ¥110.27/$, ¥130.77/€, ¥183.26/£
Suppose that you incur 2% transaction costs. That is, if you attempt to convert one currency to another, you only get 98% of the quoted rate. So with €1, you can get .98*$1.19 = $1.17 There is an arbitrage opportunity in this market. Find it and describe each transaction you would take to exploit it. If a large amount of money went through this process, this would exert pressure on these exchange rates. For each transaction in your arbitrage strategy, explain how that transaction would impact currency values.
3) The Trilemma refers to the impossibility of maintaining all of the following: a. Stable Exchange Rate b. Independent Monetary Policy c. Free Flow of Capital Assume that the following 3 statements are true: China is currently undergoing an economic transition from an economy based on exports, heavy industry, and construction to one fueled more by domestic demand and services. Many observers believe that this change, while necessary, will be accompanied by slower, less predictable growth. China, to offset slower growth, is likely to ease monetary policy (lower interest rates), which may lead to higher inflation in the medium term. China is continuing capital reforms, allowing Chinese citizens to invest more of their savings abroad.
a) For each of the three statements, explain their effect on the value of the Yuan. b) Explain how these statements are related to The Trilemma. Partially to stabilize their currency vs. the dollar, throughout 2015 and 2016 China sold off roughly $700 billion of foreign reserves, hitting a recent low of just below $3 trillion.
c) Did China's policy of selling reserves combat or exacerbate the pressures on the Yuan from the three factors listed earlier?
d) Despite relatively high pressure on the Yuan, China managed to seemingly solve the Trilemma: Throughout this period, exchange rates were stable while still allowing some capital flexibility and a completely independent monetary policy. How is this possible and why is this not a violation of the premise that all three goals cannot be achieved?