business

Topics: Foreign exchange market, Central bank, Exchange rate Pages: 1 (428 words) Published: November 5, 2014

TUTORIAL 5
QUESTION 1
Compare and contrast the fixed, freely floating, and managed float exchange rate systems. ANSWER:
Under a fixed exchange rate system, the governments attempted to maintain exchange rates within 1% of the initially set value (slightly widening the bands in 1971). Under a freely floating system, government intervention would be non-existent. Under a managed float system, governments will allow exchange rates move according to market forces; however, they will intervene when they believe it is necessary. QUESTION 2

How can a central bank use direct intervention to change the value of a currency? Explain with example. Explain why a central bank may desire to smooth exchange rate movements of its currency. ANSWER:

Central banks can use their currency reserves to buy up a specific currency in the foreign exchange market in order to place upward pressure on that currency. Central banks can also attempt to force currency depreciation by flooding the market with that specific currency (selling that currency in the foreign exchange market in exchange for other currencies). Abrupt movements in a currency’s value may cause more volatile business cycles, and may cause more concern in financial markets (and therefore more volatility in these markets). Central bank intervention used to smooth exchange rate movements may stabilize the economy and financial markets. QUESTION 3

How can a central bank use indirect intervention to change the value of a currency? Explain with example.ANSWER: To increase the value of its home currency, a central bank could attempt to increase interest rates, thereby attracting a foreign demand for the home currency to buy high-yield securities. To decrease the value of its home currency, a central bank could attempt to lower interest rates in order to reduce demand for the home currency by foreign investors. QUESTION 4

What are some advantages and disadvantages of a freely floating exchange rate system versus a...
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