Question One

Using demand and supply curves for a currency answer the following;

a) Demonstrate your understanding of

(i) Floating exchange rates

(ii) Fixed exchange rates

b) State two factors which affect the demand of a currency and two factors which affect supply of a currency. On two separate sketches, demonstrate the effects of a change in

(i) One of the factors affecting demand

(ii) One of the factors affecting supply

c) With examples, differentiate sterilised intervention from non-sterilised intervention (No need of curves for this question).

d) Explain three (3) sources of foreign exchange risks (No need of curves for this question)

Question Two

a) Suppose Vincent, a Zambian exporter has to receive $10, 000 in three months and the spot rate of the Kwacha against the Dollar is K10.10/$ while the three month forward rate is K10.15/$

i. How can Vincent hedge his/her foreign exchange risk?

ii. What happens if Vincent decides not to hedge and the spot rate in three months is: (i) K10.55/$ and (ii) K9.95/$

b) Consider the table below for international transactions between Zambia and the United States of America.

Exchange rate $/k	Price of Zambian Export in kwacha	Price of Zambian Export in $	Quantity Of Zambian export	Demand For Kwacha	Price Of US Export In $	Price Of US Export in kwacha	Quantity Of US export	Supply of kwacha
0.15	100		1500		21		800
0.2	100		1260		21		1200
0.25	100		1000		21		1600

a) Show your work and fill in the missing values in the table above. b) Graph the supply and demand for the kwacha, and show the equilibrium exchange rate and equilibrium quantity of kwacha supplied and demanded. Question Three

a)

Suppose that the interest rate on six month treasury bills is 12% in Pretoria and 10% in Lusaka on an annual basis. How much would a Zambian investor earn on covered interest arbitrage if the Rand is at a forward premium of 1% per year? What happens as covered interest arbitrage proceeds? What would happen if the Rand is at a forward discount of 4% per year? What is the relationship between the spot and forward rate of a foreign currency?

b)

Suppose that the rate on three month treasury bills offered by Bank of Zambia is 10%, meanwhile the equivalent interest rates in Botswana is 16%. The spot rate is K0.8/Pula and the Kwacha is at a forward premium of 2% per year. Calculate how much the Zambian investor gains when he/she uses K200, 000 for covered interest arbitrage. [Hint: all the interest rates are annualized.]