Reference no: EM131198831

Question 1) Suppose the CFO of an American corporation with surplus cash flow had $50 million to invest last March 20, 2015 and the corporation did not believe it would need to utilize these funds to retool or expand production capacity for 1 year. Suppose further that the interest rate on 1year CD deposits in US banks was 1%, while the rate on 1 year CD deposits in England (denominated in British Pounds) was 2% at the time. Suppose further that the exchange rate at that time was $1.55 per British pound

A) Suppose that now a year later the exchange rate is $1.42 per British pound. What rate of return did the CFO earn on the investment in the British CD? (Note: a specific numeric answer is required for full credit.)

B) What must the CFO have expected about the value of the British pound in $ today to believe in March, 2015 that investment in 1year British CD's would be more profitable than investment in US CD's.

Question 2) Between February 2008 and Summer 2009 the Fed supplemented its open market operations with a greatly expanded program of direct lending (both overnight and short term 28 and 84 day loans) to commercial banks, investment banks, brokerage and primary dealer units of bank holding companies. It also agreed to accept a wider range of short term securities (instead of accepting only T-Bills) as collateral on these loans and even initiated a program to buy commercial paper from money market funds.

Explain why the Fed created all these extraordinary direct lending facilities instead of simply relying on traditional open market purchases of Treasury securities from commercial banks.

Question 3) As conditions in short term financial markets improved by summer of 2009 the Fed closed down its lending under these programs. However, throughout the next 4 years the Fed increased substantially its purchases of longer term mortgage backed securities and Treasury notes from banks in a series of 3 "Quantitative Easing" (QE) Programs. This infusion of reserves led to a situation where in the aggregate commercial banks in the US accumulated substantial excess reserves. Even today although the volume of bank lending has grown, there is still a large volume of excess reserves.

A) The Fed has decided that it is time to start raising the Federal funds rate and other money market rates back to more normal levels. It increased its Fed funds target range by ¼% (25 basis points) in December and signaled in its FOMC meeting last week that it expected two more 25 basis points increase in the range in the rest of 2016. If both lenders' & borrowers' confidence level in the profitability of Investment in residential and commercial construction plus new technologies starts to rise much more strongly in the next 12 months than in the last few years, what potential problems will the backlog of banks' excess reserve deposits that has resulted from 3 rounds of Quantitative Easing create?

B) What relatively untested policy tools will help the Fed deal with this problem? Explain.

(Hint: you may wish to look at www.federalreserve.gov then click monetary policy...then Policy Normalization: Principles and Plans)

Question 4) In January of this year US equity markets were rattled by signs of a slowdown in growth of the Chinese economy and other emerging markets, collapsing prices of oil and stagnation in most of the Euro zone countries...In response, central banks outside the US have adopted policies which reduce interest rates in their economies. In Japan, Switzerland and in the Euro zone yields on short term treasury bills and on medium term treasury notes are less than 0. However, continued strong growth in employment in the US together with signs of recovery in residential housing and consumer confidence have prompted a rally in US equities in the last five weeks and led the Fed to conclude that the economy is strong enough to withstand two 25 basis point increases in the Federal funds target range this year.

A) What is the likely impact on the Exchange rate of the $ versus other currencies if the Fed follows through with its plans to raise its Federal Funds Rate target 50 total basis points over the rest of 2016 year? Explain your answer.

B) Given the current condition of the US economy, do you think US policy makers would prefer to see the $ rise in value, decline in value or stay at its current value? Discuss the advantages and disadvantages to the US economy at this time of a stronger vs. a weaker $. Frame your answer in terms of the current Aggregate Demand and Aggregate Supply situation of the US economy.

Question 5) Look at the quote below from the statement released by the Federal Reserve on Wednesday, March 16, following its most recent open market committee meeting. ( The entire statement is at: www.federalreserve.gov then click Monetary Policy...then

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate.

In the section I have underlined, the Fed highlights the incoming information over the rest of the year that it considers most important in determining how far and how fast to raise its federal funds rate target. Discuss why and how each of the factors it mentions, including signs of market expectations of inflation, are relevant to decisions about the timing of increases in the federal funds rate.

Question 6) Each year since winning control of the House of Representatives in the 2010 election, Tea Party Republicans have argued that we need to immediately initiate sharp reductions in marginal tax rates (particularly on tax rates in the upper income brackets) together with reductions in government spending and entitlement programs in order to rapidly move towards a balanced budget. (However, Republicans have never actually produced a budget proposal in which tax revenues would match government spending plus entitlement transfers. Plans proposed by current republican candidates for President independent analysts estimate would drain anywhere from 6.5 to 9.5 Trillion $ in Treasury revenues over the next 10 years.)

A) What is the argument against attempting to balance the Federal Government budget rapidly at the present time via either deep cuts in Federal Government spending or sharp increases in federal income tax rates?

B) Does the argument used in part A imply that budget deficits don't matter in the long run? If not, why might the impact of large deficits predicted in the long run under current tax and spending programs (let alone deficits that would result from current republican tax cut proposals) be different than the impact of deficits in recent years? Explain.