Your answers must be in your own words based on your knowledge in the relevant topics in the course learning.

1. a. Suppose the interest parity condition holds and that the domestic interest rate is greater than the foreign interest rate. What does this imply about the current versus future expected exchange rate? Explain.

b. Suppose the one-year nominal interest rate is 2.0% in the United States and 5.0% in Canada. Should you hold Canadian bonds or U.S. bonds? Explain

c. Suppose the CFO of a German corporation with surplus cash flow has 1 million Euros to invest. Suppose that interest rates on 1-year CD deposits in US banks are 2%, while rates on 1year CD deposits denominated in euros in German banks are currently 4.5%. Suppose further that the CFO expects that the (euro/$) exchange rate will increase from 1euro per $ to 1.1 euros per $ during the coming year. Should the CFO invest in CD's denominated in dollars or in euros? Show your work of estimation to substantiate your response as credible!

The following questions are based on open economy macroeconomic model. The answers must be written in your words along with graphical illustration. Without explaining in your words, the graphical illustration alone will not be credible. Also make sure you use the relevant symbols and notation on each of the lines and axis on the graph(s) to clearly indicate the working mechanism of variables.

2. a. ) Using the ZZ/Y and NX graphs, illustrate graphically and explain what effect a reduction in taxes will have on output, exports, imports, and net exports. Clearly label all curves and clearly label the initial and final equilibria.

b. Using the ZZ/Y and NX graphs, illustrate graphically and explain what effect a reduction in foreign output (Y*) will have on output, exports, imports, and net exports. Clearly label all curves and clearly label the initial and final equilibria.

c. Suppose the national output in the US is below the policy makers' desired level of output and is experiencing a trade deficit. Assume that the policy makers' goals are to achieve the desired level of output (i.e., full employment output) and balanced trade. Given this information, what type of exchange rate and/or fiscal policy can be used to achieve simultaneously these two goals?
d. Using the ZZ/Y and NX graphs, illustrate graphically and explain what effect an increase in government spending will have on output, exports, imports, and net exports. Clearly label all curves and clearly label the initial and final equilibria.
The following questions are based on fixed exchange rate and/or flexible exchange rate regime in an open macroeconomic model. The answers must be written in your words along with graphical illustration. Without explaining in your words, the graphical illustration alone will not be credible. Also make sure you use the relevant symbols and notation on each of the lines and axis on the graph(s) to clearly indicate the working mechanism of variables.

3. a. Suppose the domestic and foreign interest rates are both initially equal to 4%. Now suppose the foreign interest rate rises to 6%. Explain what effect this will have on the exchange rate. Also explain what must occur for the interest parity condition to be restored.

b. Assume the exchange rate is allowed to fluctuate freely. Using the IS-LM-IP model, graphically illustrate and explain what effect an increase in government spending will have on the domestic economy. In your graphs, clearly label all curves and equilibria.

c. Assume the exchange rate is allowed to fluctuate freely. Using the IS-LM-IP model, graphically illustrate and explain what effect expansionary monetary policy will have on the domestic economy. In your graphs, clearly label all curves and equilibria.

d. Assume that policy makers are pursuing a fixed exchange rate regime. Now suppose that the foreign interest rate falls. Discuss what policy makers must do to maintain the pegged exchange rate. Also discuss what effect this will have on domestic output and net exports.

e. Assume the exchange rate is fixed. Using the IS-LM model, graphically illustrate and explain what effect an increase in consumer confidence will have on the domestic economy. In your graphs, clearly label all curves and equilibria.