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Chapter 7

Question 1

What is meant by Uncovered Interest Rate Parity (UIP)? Assume that the spot dollar pound exchange rate is $1.90/£1, the one year UK interest rate is 4% and the one year US interest rate is 7%. What is the expected dollar per pound exchange rate in one year’s time according to UIP?

Question 2

Discuss the “flexible price monetary model of exchange rate determination and the impact of the following variables on the exchange rate according to that model (i) a rise in the domestic money supply (ii) a rise in foreign income (iii) a fall in the expected rate of domestic inflation.

Question 3

Discuss the impact of a one off increase in the domestic money supply using the Dornbusch model of exchange rate overshooting.

Question 4

Discuss the key differences between the flexible price monetary model and the Frankel real interest rate model in both the short and the long run.