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INTERNATIONAL FINANCE

2019/20

SECTION A

Question 1

Explain shortly the difference between covered and uncovered interest rate parity. Give an example (in a numerical or narrative way) for both cases for an investor who wants to invest 100 pounds (£) to buy a riskless asset either in a country A or B. Please limit your answer up to 300 words.

Question 2

Given the following data:

UKEUR(S) is the nominal exchange rate of pound (£) per one euro (€).EURCPI(P*) is the consumer price index for the foreign country while UKCPI(P) is the consumer price index for the domestic country.

a) Assuming that UK is the home country, complete the real exchange rate in column 5.

b) Assuming that 1991 is the base year, complete the real exchange rate with respect to 1991 in column 6.

SECTION B

Question 3

Describe what happens if there is money supply under floating exchange rates using the monetary model. Where appropriate, use the relevant diagrams in your answer.

Question 4

Using the Dornbusch model, explain what happens if authorities increase the money supply from M1 to M2 (M2= 1.25 ˟ M1). How adjustment (initial equilibrium) is achieved in the long run?