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3. (Ch. 3) Carry Trade a. Explain "carry trade." ( 3 points) b. If the interest rates for the GBP, USD, and JPY are 6%,4%, and 1%, respectively, and you would like to have a carry trade, which currency would you like to borrow? ( 2 points) Why? (3 points) c. If you have a carry trade, what may you earn? ( 3 points) What risk may you have? ( 3 points) d. What will be expected in practice if everyone in the markets is doing the same thing with you (carry trade)? ( 3 points) 4. (Ch. 4) Aggregate Effects on Exchange Rates. Assume that United States residents invest heavily in the Australian government and stocks. In addition, Australian residents invest heavily in the United States. Because your firm imports goods from Australia, you are assigned to forecast the value of AUD (the Australian dollar) against the USD - i.e., you forecast S.(AUDUSD). Explain how each of the following conditions will affect the value of the AUD, holding other things equal. Then, aggregate all of these impacts to develop an overall forecast of the AUD's movement against the USD. (Please plot a figure to explain each condition, except for question f. No figures, no a. U.S, inflation has suddenly increased substantially, while Australian inflation remains low. (8 points) b. The U.S. interest rates have increased substantially, while the Australian interest rates remain the same. (8 points) c. The income level in the U.S. increased substantially, while the Australian income level has remained unchanged. ( 8 points) d. The U.S. is expected to impose a new small tariff on goods imported from Australia. (8 points) c. In Australia, the recent dysfunction within the two major political parties has seen seven different Prime Ministers take office in the past decade. You expect that this situation may be going to get worse and assume Australia is not a safe haven. ( 8 points) f. Combine all expected impacts to develop an overall forecast. ( 3 points) 5. (Ch. 4) Spot Exchange Rate Movements. Suppose you have a " buy EURUSD" position for some units of the EUR. You bought the EUR with the USD at S51 (EURUSD) =1.1780 on September 8 (seven days ago). Today is September 15 , with S1 (EURUSD) =1.1850. What is the annualized percent change in the exchange movements in these seven days? (Annualize by multiplying 4360/7) (6 points)

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