Suppose that the US Economy adopts a fixed exchange rate regime against the British Pound: BP-$1.3 If the market exchange rate is at BP-$1.2 (see picture below) E 1.3 32 1.2 E DE 3 There is an excess supply of British Pounds on the market, and the Fed needs to purchase Pounds in exchange for US dollars, which means to increase its reserves of British Pounds There is an excess demand of British Pounds on the market, and the Fed needs to purchase Pounds in exchange for US dollars, which means to increase its reserves of British Pounds There is an excess supply of British Pounds on the market, and the Fed needs to purchase Dollars in exchange for British Pounds, which means to decrease its reserves of British Pounds There is an excess demand of British Pounds on the market, and the Fed needs to purchase Dollars in exchange for British Pounds, which means to decrease its reserves of British Pounds

Suppose that the US Economy adopts a fixed exchange rate regime against the British Pound: BP-$1.3 If the market exchange rate is at BP-$1.2 (see picture below) E 1.3 32 1.2 E DE 3 There is an excess supply of British Pounds on the market, and the Fed needs to purchase Pounds in exchange for US dollars, which means to increase its reserves of British Pounds There is an excess demand of British Pounds on the market, and the Fed needs to purchase Pounds in exchange for US dollars, which means to increase its reserves of British Pounds There is an excess supply of British Pounds on the market, and the Fed needs to purchase Dollars in exchange for British Pounds, which means to decrease its reserves of British Pounds There is an excess demand of British Pounds on the market, and the Fed needs to purchase Dollars in exchange for British Pounds, which means to decrease its reserves of British Pounds

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Let's suppose you have $1 million to invest. You are considering to invest in UK first, then convert the British Pound back to US$ in the future. You know following information: Annual Interest rate on investment in US: 2% Annual Interest rate on investment in UK: 1% Investment period: 1 year Current exchange rate: 1.52 $/BP Forward exchange rate which you can apply when converting BP to US$: 1.53 $/BP What will be profit or loss if you apply the covered-interest arbitrage? (step by step answer please)