Questions and Answers Assignment

Questions and Answers Assignment

Would you characterize the U.S. dollar as a freely floating or dirty float system? What characteristics support your answer?

The US dollar is a freely floating system since pure exchange occurs as the value of the currency is determined by pure supply and demand of money in the market (Gerlach, & Smets, 2000). Unlike the dirty float, the US dollar exchange rate is not determined by government rules or laws.

What is direct central bank intervention in the currency markets? Provide an example of this from the last 50 years.

Direct central bank interventions in the currency market involve foreign exchange transactions conducted by the Fed to influence the exchange rate. The interventions are aimed at building their reserves or for the banking sector in the economy (Di Giorgio, 2014). An example of direct intervention was when the Japanese Yen was very strong against the dollar, the bank of Japan depreciated the Yen making a positive gain for USD/JPY.

Assume that Canada suddenly experiences high inflation. How might this affect the value of the Canadian dollar according to the purchasing power parity (PPP) theory?

This will lead to reduced ability of the Canadian dollar to buy a similar basket of goods with another currency such as the US dollar at the prevailing exchange rate (Gerlach, & Smets, 2000). Thus, the Canadian dollar needs to be depreciated to reflect the same price level as the US dollar.

Australia’s central bank decides to increase the value of the Australian dollar against the Japanese yen. How might it use direct intervention to do this?

This can be achieved by increasing the quantity of Australian central bank reserves by purchasing more Australian dollars reducing the quantity available in the market for exchange against the Japanese Yen (Di Giorgio, 2014). This will make the Australian dollar appreciate against the yen.

Assume the following information: i. Mexican one-year interest rate = 15 percent ii. U.S. one-year interest rate = 11 percent iii. If interest rate parity exists, what would be the forward premium or discount on the Mexican peso’s forward rate? Would covered interest arbitrage be more profitable to U.S. investors than investing at home? Explain.

Forward Premium = Mexican Interest rate/US Interest rate = (1.15/1.11) % = 1.03 %. It will be more profitable for an investor to invest in Mexico than at home.

Create a balance sheet for a typical bank, showing its main liabilities (sources of funds) and assets (uses of funds). 

ABC BANK INC. LIMITED

CONSOLIDATED BALANCE SHEET

Bank Assets

Cash and Cash equivalents                                          xxxx

Market Securities                                                          xxxx

Inventories                                                                      xxxx

Property & Equipment                                                 xxxx

Good Will                                                                        xxxx

                                                                                          Xxxx

LESS: Bank Liabilities

Accounts Payable                                            xxxx

Unearned Revenue                                         xxxx

Longterm debt                                                 xxxx    xxxx

Share Holders Equity                                                  xxxx

The Federal Reserve has increasingly favored the use of Repurchase Agreements as part of its open market operations. Briefly describe these and why the Fed or banks prefer to use them.

The Federal Reserve favors the use of Repurchase Agreements as a tool to regulate liquidity, money supply, and inflation (Gerlach, & Smets, 2000). Repurchase agreements are a form of collateral sold by Federal reserves at certain interest to investors with the option of buyback.

Banks engage in proprietary trading as part of their operations. Briefly speculate on why they now must adhere to more stringent trading activity as a result of the 2008-09 financial crises.

This is because the Office of the Controller of currency has enacted policies and laws that prohibit banks from engaging in predatory lending activities engineered by the non-bank lender’s partnership (Di Giorgio, 2014). The rule seeks to look at the person getting huge economic benefit from the money loaned and gives punitive action that supersedes the action of the court as the non-bank lenders used the system to evade state laws.

Briefly describe two off-balance-sheet activities and why banks favor the use of these.

A loan commitment as off-balance sheet activity is an agreement in writing between the borrower and bank that gives terms and conditions the bank will use to finance a loan (Gerlach, & Smets, 2000). The item assures the bank of recovery of the loan since it gives the funding limit and expiration date. Letter of credit as off-balance activity gives conditional commitment to the banks to pay drafts drawn in line with the terms of the document. The bank uses them since they are considered as demand on deposits.

If you were the CEO of a US bank, would you consider establishing a foreign branch? What might be a concern related to doing so?

Establishing a foreign branch will be essential to serving underserved markets through encouraging the use of Eurodollar a facility that encourages deposit in foreign countries in US dollars. This will generate money for the bank since the lending rates are not under the control of Federal funds for more than two weeks (Gerlach, & Smets, 2000).

References

Di Giorgio, G. (2014). Monetary policy challenges: how central banks changed their modus operandi. Eurasian Economic Review, 4(1), 25-43.

Gerlach, S., & Smets, F. (2000). MCIs and monetary policy. European Economic Review, 44(9), 1677-1700.