EF4331: International Finance and Banking - Reverse Repurchase - Finance Assignment Help

Assignment Task:

Reverse Repurchase Agreements 

On 3 February 2020, China’s central bank, the People’s Bank of China (PBOC), conducted the largest single-day reverse repo operation in it is his- tory. The PBOC injected a total of 173.81 billion USD into the money markets through reverse bond repurchase agreements, which is the purchase of bonds with the agreement to sell them at a higher price at a specific future date. Use a diagram showing the exchange rate, the expected currency returns, and money holdings to describe the short-term and long-term effects (i.e., flexible prices) of this monetary policy action from the perspective of the United States. That is, let USD be the domestic currency and CNY be the foreign currency.

Export Demand Shock
 
Whether the coronavirus outbreak will have a permanent impact on the Chinese economy is an actively debated topic among politicians, business leaders, and economists. On one hand, several major U.S. companies have already closed factories and retail locations because of the outbreak. As a result, supply chains for products from cars to smartphones are disrupted. On the other hand, President Xi Jinping continuously stresses that the impact on China’s economy will only be temporary. 

1. Use a diagram showing the exchange rate, expected currency returns and money holdings to analyze the short-term and long-term effects (i.e., flexible prices) of a temporary decrease in demand for Chinese exports on the nominal Chinese interest rate and the nominal spot exchange rate. Let the Chinese Yuan (CNY) be the domestic currency. 
2. Are your conclusions different if the decrease in demand for Chinese exports is permanent? Explain your answer. 
 
Interest Rate Arbitrag
 
You observe that the GBP/USD spot exchange rate (i.e., the price of 1 Pound Sterling in terms of U.S. Dollars) is 1.2881 and the 3-month GBP/USD forward exchange rate is quoted at 1.2895. 
1. Does an arbitrage opportunity exist given that the 3-month deposit rates in the U.S. and U.K. are 1.65% and 1.70% per annum, respectively? 
2. If so, outline an arbitrage strategy and explain step-by-step why your strategy yields risk-free profits. 

Purchasing Power Parity

1. Define the Law of One Price (LOOP), the Absolute Purchasing Power Parity (Abs. PPP), and the Relative Purchasing Power Parity (Rel. PPP). 
2. Prove mathematically that the LOOP implies the Abs. PPP and the Rel. PPP. 
3. (5 Points) Discuss how the LOOP, Abs. PPP, and Rel. PPP can fail. 
 
Currency Valuation in the Long-term 

In February 2019, the Thai Baht exchange rate with Euro (EUR/THB) was 35.462. From February 2019 to February 2020, Thailand’s inflation rate is 1.05%, and the Euro Area’s inflation rate is 1.4%. 
1. Suppose the EUR/THB exchange rate in February 2020 is 34.169. Is the Thai Baht overvalued, undervalued, or fairly valued if the Relative Purchasing Power Parity holds? Explain your answer. 
2. What if instead Thailand’s and the Euro Area’s inflation rates were 1.4% and 1.05%, respectively (i.e., inflation rates are switched)? Explain your answer. 
 
National Income Accounts 

Suppose Hong Kong’s Gross National Product (GNP) is 100 billion USD, total consumption (C) is 70 billion USD, domestic investments (I) is 40 billion USD, total government spending (G) is 20 billion USD, and exports (EX) is 20 billion USD. 
1. What is the value of Hong Kong’s imports (IM)? 
2. What is Hong Kong’s savings rate (i.e., total savings divided by GNP)? 
3. What would the government, private, and total savings rate be if the government introduced taxes (T) of 10 billion USD while the other variables remain unchanged? 

True or False
 
Determine if the following statements are TRUE or FALSE. Explain your answers. 
1. “A decrease in money supply always increases nominal interest rates and appreciates the domestic currency.” 
2. “According to the overshooting theory, nominal exchange rates are volatile because the money supply fluctuates randomly.” 
3. “Under the Gold Standard, importing goods and services will lead to gold exports and exporting goods and services will lead to gold imports.” 
4. “If central banks abide by the ‘Rules of the Game’, they expedite the Price-Specie Flow Mechanism by offsetting the effects of gold inflow and outflow arising from international trade.” 
5. “Under the Bretton Woods System, the U.S. could set its monetary policy at will. In other words, other countries must adjust their monetary conditions.”

 
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