Chapter 2, Question 2

The meaning of defend a fixed exchange rate under gold standard is to fix the values of each
countrys currency in term of gold. The fixed exchange rate occur after the Bretton Woods
Agreement 1944. This agreement is to prevent the high fluctuate of exchange rate that give the
bad effect to the U.S economy as they adopt the flexible exchange rate before. So, the gold is
use as medium of exchange rate of each currency.

After that, the effect to the country money supply is as the money supply must be parallel with
the amount of gold reserve. So the central bank could not expand more their money supply
beyond their gold reserves. Thus, government expenditure and expenses are using the revenue
from the taxation and financial instrument such as the issuance of bond.

Chapter 5, Problem 12

CITIBANK $/ BARCLAYS $/
BID RATE 1.2624 1.2622
ASK RATE 1.2625 1.2623

STRATEGY 1

First, buy Euro at Barclays (at ask rate)

= $1,000,000 X (/$) 1/1.2622 = 792,204.7057

Then, sell Euro to Citibank (at bid rate)

= 792,204.7057 X ($/) 1.2624 = $1,000,079.22

Profit/Loss= $1,000,000-$1,000,079.22= $79.22

So, corporate treasury can do the arbitrage using this quote as they will get profit.

STRATEGY 2

First, buy Euro at Citibank (at ask rate)

= $1,000,000 X (/$) 1/1.2625 = 792,079.2079

Then, sell Euro to Barclays (at bid rate)

= 792,079.2079 X ($/) 1.2622 = $999,762.3762

Profit/Loss = $999,762.3762-$1,000,000 = $ -237.6238

So, corporate treasury cannot do this quote to do the arbitrage as the answer is loss.

Strategy 1 will be choose to do the arbitrage.