Pia Takchi

20171398

ECN431 – Exam 2

1) FWD= $1.08/ ϵ x (1+0.03/ 1+0.01) = $1.101/ ϵ

CD ϵ = i ϵ x (e expected/ e) – i$

= 1.012 x ($1.101/ ϵ / $1.08/ ϵ -1.02

= 0.011677

=1.1677%

Speculators will make a profit of 1.1677% in each dollar invested.

2) A) CA= 4228-18939+16796-14867+2456+3198-6639+772=$ -12995

FA= 1551+1757+7387= $10695

Change in reserves = CA + FA = -12995 + 10695= $-2300

B) The central bank is decreasing its official reserves, since the change is negative so
reserves are depleted.

3) A) The supply of $ will increase in Lebanon, since Lebanese living abroad will import $
into Lebanon and then convert it to L.L.

B) CD (L.L) = 1.08 x (1/ L.L 2000/$ / 1/ L.L1515/$) - 1.03 = -2.119. Reserves will
decrease since the exchange rate is expected to depreciate.

C) Implied rate= L.L2.9/Syr x Syr518/$= L.L1502.2/$.

L.L1502.2/$ < L.L1515/$.  Thus, Lebanese will increase the supply of $ since there is an
arbitrage profit when converting using the actual rate of L.L1515/$.
4) In an attempt to maintain a stable exchange rate over the last 30 years, the Lebanese
government had to keep the USD equal to 1,500LBP, which would lead it eventually to
have a high supply of USD. In order to do so, the Lebanese Central Bank governor Riad
Salameh increased the interest rate on the Lebanese pound so that investors would
exchange their foreign currencies (mainly USD) to LBP to benefit from the high interest
rates. Doing so, the governor increased the supply of USD in Lebanon (shift from S to S’).
Although this seems like a good strategy, when the governor did this move, he made all
investors put their money in the banks instead of investing them in Lebanese companies,
which made the manufacturing sector in Lebanon even worse than it was before. When the
American government claimed that Lebanon is a corrupt country, investors got scared and
took back their money, exchanging it to USD again. Thus, the supply of USD decreased
(shift from S’ to S’’) and the crisis in Lebanon began, while the exchange rate between the
USD and the LBP is still rising to this day.