Question

Question 2 - Topic: Exchange Rate Determination

The spot bid-offer rates between Australian dollar and pounds (GBP/AUD) is quoted as 0.5144 – 0.5149. Speculator A expects the exchange rate to be 0.5130 – 0.5140, whereas Speculator B expects the exchange rate to be 0.5150 – 0.5155, in two months from the initial quotes.

a) Based on the expectations of the two speculators, which currency will appreciate and which currency will depreciate from the view of Speculator A, and Speculator B? [3 marks]

b) Determine the appropriate strategy between buy-low-sell-high, and short-sell positions on the AUD that each Speculator (A and B) should take given the bid-offer rates at t = 0 and their respective expected rates t = 2 months, to realize a profit. [4 marks]

c) Based on your answers to part (b), calculate the profit in basis points for the different positions taken by Speculator A and B, respectively. [8 marks]

Question 3 - Topic: The Balance of Payments and the Effective Exchange Rates

You are given the following information:

Quantity of imports	300,000 units
Foreign currency price of imports in NZD	$20/unit
Exchange Rate (FJD/NZD)	1.3960

Using the given information:

a) Calculate the foreign currency (NZD) value of imports. [2 marks]

b) Calculate the domestic currency (NZD) value of imports [2 marks]

c) Determine the new quantity of imports if the exchange rate falls to 1.3900, and the elasticity of demand is -0.80. [6 marks]

d) Using the results in part (c), determine the new foreign (NZD) and domestic (FJD) currency value of imports. [5 marks]

Answer 1

2

Spot rate (GBP/AUD) 0.5144 - 0.5149

After two months (As per A) 0.5130- 0.5140

After two months (As per B) 0.5150- 0.5155

i) As per Speculator A , GBP per AUD will decrease in 2 months, So GBP is expected to appreciate and AUD is expected to depreciate.

As per Speculator B , GBP per AUD will increase in 2 months, So GBP is expected to depreciate and AUD is expected to appreciate.

b) As Speculator A believes that AUD will depreciate, he should sell AUD now against GBP and buy AUD after two months against GBP so that he can profit.

As Speculator B believes that AUD will appreciate, she should buy AUD now against GBP and sell AUD after two months against GBP so that she can profit.

c) If speculator A sells 1 AUD , he gets 0.5144 GBP today

With this GBP amount, after two months, he gets 0.5144/0.5140 AUD = 1.000778 AUD

thus profiting by an amount of AUD 0.000778 in 2 months per 1 AUD sold today

If speculator B buys 1 AUD , she has to pay 0.5149 GBP today

With this AUD amount, after two months, she gets 0.5150 GBP

thus profiting by an amount of GBP 0.0001 in 2 months per 1 AUD bought today

.