Economics 356 Section 002

Prof Gordon Munro

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Time: 50 minutes

First Mid-Term Examination Febtuary26,2l07

AnsweranyTWO questions. not attsmpt answer Do to morethantwo questions. two The questionsthat you answerwill be given equalweight. 1 Spotmarketsfor foreign ctmenciesin a particular country canbe subjectto different foreign cxchange regimes. The two most importantonesare:i) fixed foreign rate late exchange regims; ii) lieely floating(or flexible)exchange and regimes.Distinguish clearly between two rcgimes the

Canit be argued thetems "Balance Palments that of Surplus', ,,Balance and ofpa),rnents Deficit"haveno realmcaning, ifthe countryin question operating is undera fixed foreign exchange regime?Wh/ Explain. iate It is arguedthat, in Canada the presenttime, we areoperatingon an imperfectfloating at exchange regime,oflen rcfrredto as a "managedfloat,,. What is meantby the term mte 'lnanaged float", andwhatevidencc ifany, we havcthatsuchan exchange do, mte regime in exists Canada? Explain. 2. (a) Oneathaction economists to ofthe Interest ParityTheoryofthe determination of equilibrium rates the spotmarketliesin thefaotthatearlier exchange in theodes ofspot marketexchange determination rate predictedthat spotexchange rates,under flexible exchange regimes, rate wouldstable overtime. Suchspotmteshave, fact,provenat in periodto be very volatile. The Can.$ - US $ spotrate,sinceSeptember various 2006,is oneexample. How canthe InterestParity Theory explain suchvolatility? Discuss. O) The Purchasing PowerParity (PPP)Theory andthe lnterestpaxityTheory appear, the on surface,to be radically different. After all, oneis a long run, while the otheris a short run, theory. Thereis, nonetheless, key linkage betweenthe PPPTheory and Interest a Parity Theory. Explaio the natue of the linkage. jn Ifthere is, at anygiventime,a "spotrate"for U.S.dollars beingquoted Canada, e.g. Toronto, thereis, at thesame time,a "spotrate"for Canadian dollars beingquoted the in ,,spot UnitedStates, New York. Wlat does meanto saythattwo aforementioned e.g. it mtes" are "consistent",or "inconsistent",with one another?Normally, the two spotrates showa highdegree of"consistency''. Whatforces comeinto playto eliminate any exchange thatmight arise?What,if an),thing 'lnconsistency" does question the of of ntes haveto do with theLaw ofOne.price?Explain. "consistency'' foreignexchange

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I.

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2.

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3.

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r T( r

-r

,,

Ee"$lur$,p+l

E ec$/us$,p+1

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