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In March 2022, Moody's Investors Service, one of the Big Three global credit rating agencies, downgraded Russia's long-term government debt from Baa3 to B3, which is junk or non-investment grade status, due to sanctions placed on Russia for its invasion of Ukraine.

Question

1(a) Let the home currency be the Russian ruble (RUB), and the foreign currency be the euro (EUR). Explain how the equilibrium spot exchange rate responds to this announcement using the Adjusted Uncovered Interest Parity Condition and diagrams of the spot exchange rate, estimated currency returns, and actual money holdings.

1(b) Assume the Russian Federation's Central Bank intends to mitigate any currency rate effects caused by this announcement, but due to financial sanctions, it is unable to buy or sell foreign currencies directly on the foreign exchange markets. Show and explain how Russia's central bank could interfere in the money markets to maintain the pre-announcement exchange rate level, using the same diagram above.