3) Consider an open economy and use the IS/TR model together with uncovered interest paritycondition (UIP) to answer the following questions:(a) Discuss and illustrate how globalization (NX) and interdependence of financial markets (UIP) canaffect the propagation of international shocks.(b) Discuss and illustrate with the IS/TR and UIP graphs the effects on the domestic economy of anincrease in the interest rate by a big foreign economy, affecting the level of the international interestrate. Assume that the domestic economy is adopting perfect capital mobility and a flexibleexchange rate regime.(c) Why might a rise in international interest rates lead to hyperinflation in some highly-indebtedcountries?(d) A risk neutral investor in London has two investment opportunities. They can invest in one year UKgovernment bonds with an annual nominal interest rate of 5%. Or they can invest in one year USgovernment bonds with an annual nominal interest rate of 2.5%. Currently the spot exchange rate is1.2 US dollar/UK pound (i.e., the price of one UK pound= 1.2 US dollars) and the one year expectedexchange rate is 1.12 US dollar/UK pound. Should the investor hold their money in UK or USgovernment bonds? (In replying to the question, use the exact and not the approximate version ofthe relevant interest rate formula, and show your work).

Globalization refers to the method of accelerated interconnectedness and interdependence among…

Answered: domestic economy

Business

Economics

domestic economy

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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