Short Answer: Answer the following questions in 2 or 3 brief written paragraphs.

1. Briefly explain the "pros" and "cons" of a government policy of "managing"the country's foreign exchange rate as compared to a policy of letting the exchange rate "free float" according to prevailing market forces.

2. Using the simple model of supply and demand for foreign exchange (eg.$US) that we studied from Chapter 14 of the course textbook, illustrate theeffects on the foreign exchange market of an increase in the relative productivityof the foreign country. Briefly describe the implications of such a change forthe domestic country's balance of payments, and domestic monetary policy,assuming a fixed exchange-rate regime.

3. "The current account measures the gap between a country's current productionand its current use of resources". Explain this statement and how itrelates to the effects of government budget deficits on a country's current account.

4. Using an example explain what is meant by "exchange rate risk". Briefly discuss two ways that you can "hedge" against such risk.