Instructions
1. Explain the following:
a) What constitutes deficit or surplus items in balance of payments. Is it inherently good or bad to run a current account deficit? Why? Explain.
b) Carefully explain how can foreign exchanged risk be covered in foreign exchange markets: who can use these markets? Why does hedging not usually happen in spot market? Explain.
c) What is the difference between a speculator and foreign exchange arbitrager? Explain: how does speculation happen in foreign exchange markets? What is stabilizing and destabilizing speculation?
2. Explain the following:
a) What is covered and uncovered interest arbitrage? How is interest arbitrage covered in forward market? Carefully explain how interest arbitrage leads to interest parity.
b) Carefully explain how is the nation’s demand curve for foreign exchange derived? What determines its elasticity? Use diagrams.
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