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Eco 365 Sumerl 2020 Exam
Eco 365 Sumerl 2020 Exam
University of Toronto
Faculty of Arts and Science
Eco365 International Monetary Economics
August 2020 Final Examination
There are 4 pages in the exam
Submit a pdf file of the answers to utmeco365s@gmail.com by
Wednesday, August 19 at 3:00pm EST
Aids: Non-programmable calculator
Part A: Multiple Choice. 15 marks. Each question is worth 3
marks.
1. Random Walk exchange rates imply
a. deviations from PPP can be permanent.
b. deviations from PPP may only be corrected by offsetting random
shocks
c. both (a) and (b).
2. Suppose S0 = 1.32, i = 0.062, i∗ = 0.073 then E0 S1 equals
a. 1.4328
b. 1.3065
c. 1.6893
3. Suppose domestic consumption rises and there are restrictions on hold-
ing foreign assets then with a floating exchange rate, in the long run the
Fleming-Mundell model predicts
a. a rise in Y and a fall in X − M .
b. depreciation of the domestic currency, a rise in Y and a rise in X − M .
c. jumps in the domestic interest rate and a rise in X − M .
4. Purchasing power parity is more likely to hold when
a. exchange rates are a random walk.
b. countries are geographically close.
c. countries have different consumption patterns.
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5. Suppose foreign consumption rises then with a fixed exchange rate the
supply-demand model of exchange rates predicts
a. a rise in domestic central bank reserves of foreign currency and rise in
domestic net exports.
b. a fall in domestic central bank reserves of foreign currency and a fall
in domestic net exports.
c. a fall in the domestic money supply.
Part B: Numerical Problems. 20 marks
(5) 1. Consider the following direct quotes: 95.83 yen per CAD, 1.04 CAD
per USD and 98.56 yen per USD. Calculate the cross rate between CAD and
USD using the yen as an intermediate currency. Is there an opportunity for
triangular arbitrage?
(5) 2. The Canadian dollar-Euro exchange rate (Canadian dollar price of
euros) is currently 1.26. In 4 months time the exchange rate will be either
1.28 or 1.24. A European call option on euros expiring in 4 months has strike
price K = 1.25 CAD per euro. The risk free rate in Canada is 2 percent per
annum and the European risk free rate is 1 percent per annum. Solve for the
option price in the one step binomial model.
3. Suppose the Canadian dollar-Euro spot rate is S0 = 1.38 CAD per
euro. The one year dollar-Euro forward rate is F0,1 = 1.39 CAD per euro.
The one year interest rate in the Canada is 2 percent; in Europe the one year
interest rate is 1.8 percent.
(5) a. Suppose an investor has 500,000 Canadian dollars to invest then
converts it to euros at the spot rate, invests the resulting capital at the
European interest rate for one year and converts the proceeds back to CAD
at the forward rate. Determine returns from this trade.
(5) b. Suppose the investor buys one year Canadian Treasury securities
with the 500,000 instead. Determine whether this strategy or the one in
(a) generates greater profit. Based on this calculation explain in a sentence
whether this forward rate is the equilibrium rate.
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