Consider the following supply-demand framework for the USD/£

 

 

A) Given that the UK has flexible exchange rates, can you discuss two examples of real-world factors that could cause the demand for British pounds to move from D to Dˊ, that from the initial equilibrium exchange to a new exchange rate of $1.80? 

 

B) By what percent has the pound gone up or down against the USD (must show your workings)?

 

C) Suppose on Monday 8^th May 2023 the USD was worth $1.75/£. The three-month forward rate for the USD is $1.85/£. Calculate the USD forward premium or discount in percentage terms (must show your workings). Explain what these quotes indicate for the future value of the USD and/or the British pounds. 

 

D) Suppose over the last five years the volatility of $/£ increased rapidly. What is likely to happen to its ($/£) bid-ask spread? In an environment of such extreme volatility, what does the central bank (e.g., Bank of England) usually do if the value of domestic currency is very high or very low?

Transcribed Image Text:

Dollar price per pound (exchange rate) $1.90 $1.80 S D = S D D S Dollar price per pound (exchange rate) $1.90 $1.80 S D = S D D S