Question: Question 2 (30 points) Answer the following questions. Each part of the question is not related to each other. a) The (home) country has a

Question 2 (30 points) Answer the following questions. Each part of the question is not related to each other. a) The (home) country has a flexible exchange rate and its current account and financial accounts are in balanced (and assume capital account is always equal to zero). Suppose the country forms a customs union with its major trading partners. What happens to the country's exchange rate? Explain and support your answer with ONE foreign exchange market diagram (i.e., the demand-supply diagram for DC). (15 points) b) In the foreign exchange market, the following codes are used to represent the following currencies: ARS = Argentine peso; TRY = Turkish lira; USD = U.S. dollar Suppose you call the bank and obtain the following spot rates: EARS/TRY = 9.9334 EARS/USD = 73.1348 ETRY/USD = 7.3752 You realize that there is an arbitrage opportunity in using the USD as the vehicle currency and you have ARS 30 million for arbitrage, what should you do to capture the arbitrage profit? What will be your (total) arbitrage profit in millions of ARS? Also, find the ARS/TRY spot rate that would eliminate the arbitrage. (15 points)

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