EXAM 31. Use UIP’s approximation to analyze whether or not the spot foreign exchange market is in...

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EXAM 31. Use UIP’s approximation to analyze whether or not the spot foreign exchange market is in equiliium? If not, explain what market mechanism will ing the market back to an equiliium. (20 pts)2. Use UIP’s approximation to compute the equiliium spot exchange rate. (10 pts) 3. Plot your foreign exchange market equiliium analysis-based results (1) and (2). Explain iefly. Note: you must label the diagram clearly with the figures from this problem. (10 pts)1. Use UIP’s approximation to analyze whether or not the spot foreign exchange market is in equiliium? If not, explain what market mechanism will ing the market back to an equiliium. (10 pts)2. 2. Use UIP’s approximation to compute the equiliium spot exchange rate. (10 pts)3. Plot your foreign exchange market equiliium analysis based results (a) and (b). Explain iefly. Note: you must label the diagram clearly with the figures from this problem. (10 pts)

Komalavalli · Accepted Answer

Problem1
1. Given E$/¥ = $0.0135
F$/¥ = $0.0118 = Ee$/¥
i$ = 2.0%
i¥ = 3.25%
(1+ i¥)* (F$/¥/ E$/¥)
 (1+i$)= 1.02 
(1+i$)= 1 (appx)
(1+ i¥)* (F$/¥/ E$/¥) = 1.0325*(0.0118/0.0135)
(1+ i¥)* (F$/¥/ E$/¥) = 0.90
The market is not in equilibrium, the investor will perceive it to be beneficial to borrow in USD and invest that in Yen, and then reconvert the investment proceeds to USD to make a profit from the difference. The demand US increases this appreciate domestic currency value and result in interest rate increase. This risk is covered with forward rates
2. UIP
(1+i$) =(1+ i¥)* (Ee$/¥)/ E$/¥
(1+i$) = 1.02 
(1+i$)= 1 (appx)
(1+ i¥)* (Ee$/¥)/ E$/¥ =1.0325 *(0.0118/0.0135)
(1+ i¥)* (Ee$/¥)/ E$/¥= 0.90
The market is not in equilibrium, the investor will perceive a fall in expected return , this will shift the return curve downward and the equilibrium will be acheived
3.
Problem 2:
1. Given E$/¥ = $0.0135
F$/¥ = $0.0125 
Ee$/¥= 0.0118
i$ = 2.0%
i¥ = 3.25%
(1+i$) =(1+ i¥)* (Ee$/¥)/ E$/¥
(1+i$)= 1.

EXAM 3 1. Use UIP’s approximation to analyze whether or not the spot foreign exchange market is in equilibrium? If not, explain what market mechanism will bring the market back to an equilibrium. (20...

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