1. A, B. The International Monetary Fund (IMF) was created to manage the Bretton Woods currency exchange system, which was in place from 1945 until 1971. Separately answering as parts A and B, identify and explain two different tools the IMF had to handle a country’s trade imbalance (trade deficit).
C. The Bretton Woods system came to an end in 1971. Explain how the Bretton Woods system inevitably collapsed, specifically due to the policy choices made by the IMF and/or the Federal Reserve Bank (FRB) of the USA and/or the governments of other participating nations.
2. A. Describe a price weighted stock market index. How is it computed? What is one reason for its use, rather than using a different type of stock market index?
B. Describe a value weighted stock market index. How is it computed? What is one reason for its use, rather than using a different type of stock market index?
C. Give two reasons why it is impossible for a mutual fund, that follows any stock market index, to earn as much money as the index upon which it is based?
3. A, B. Consider a country whose central bank wants to cause its own currency to appreciate in value, relative to foreign currencies. (Appreciate: You get more foreign currency in exchange for your own.) Separately answering as parts A and B, give and explain two different intervention methods to cause the currency to appreciate. Separately explain how each method would work.
C. After the currency has appreciated, due to the official intervention, would inflation, deflation or no domestic price changes, be most likely? (note: No sterilization has taken place in this example.) You may draw upon Irving Fisher’s quantity theory of money and/or the Fisher effect and/or PPP to explain the most likely outcome.
4. Bull Call Spreads:
A stock’s current price is $49.
A call option with an exercise price of $70 can be bought or sold today for a price of $12.
A call option with an exercise price of $90 can be bought or sold today for a price of $4.
Draw the number line for the bull call spread.
What will be the final net gain, or loss, if one undertakes the bull call spread today, and on the exercise date that the stock’s price has become.: (Show all work.)
A. $55. B. $69. C. $75. D. $ 89. E. $100.
Special Bonus: 5 points extra credit for solving the break even final stock price.
5. A, B, C. A person invests his/her own money only for one purpose: to have money to spend in the future. One danger of investing is that over the long run inflation can reduce the value of one’s investment.
A. Identify one type of investment that almost always loses total real value due to inflation in the long run. What makes this type of investment’s inflation losses almost always greater than its nominal rate of return.
B, C. Separately answering as parts B and C, identify two separate long term investments that are unlikely to decline in value due to inflation, but rather almost always give the investor more real spending power in the future than he/she invests today. For each type of investment (B and C) what is its attribute that prevents real overall losses due to inflation?
***(note: This question is about an individual investor’s losses due to inflation. Do not change subject.)
6. A. What is the relative (or weak) purchasing power parity? How does relative purchasing power parity explain long term currency exchange rate changes? Create one simple example (country 1 and country 2) between the two countries’ currencies to demonstrate this result?
B. How do long term interest rates between different countries affect long term currency exchange rates (i.e. interest rate parity)? Create one simple example (country 1 and country 2) between two countries’ currencies to demonstrate this result?