This paper contains five questions. Answer all questions
Total word limit: 2000 words

Question 1
a) Key to understanding most theories is what they say and what they don’t. Name five
key limitations to the theory of comparative advantage. [10 marks]
b) Discuss why many emerging market economies prefer to adopt a fixed exchange rate.
Also discuss the advantages and disadvantages of the fixed exchange rate system.
[10 marks]

[Total: 20 marks]

Question 2
a) Business managers and investors need BOP data to anticipate changes in host
country economic policies that might be driven by BOP events. From the perspective
of business managers and investors, list three specific signals that a country’s BOP
data can provide. [10 marks]
b) Discuss whether a strong currency is good or bad for the domestic economy.
[10 marks]
[Total: 20 marks]

Question 3
a) Discuss the three major functions of the foreign exchange market. [10 marks]
b) A bid is the price in one currency at which a dealer will buy another currency. An ask
is the price at which a dealer will sell the other currency. Dealers bid (buy) at one price
and ask (sell) at a slightly higher price, making their profit from the spread between the
prices. List and explain three reasons/factors that could make the spread small.
[10 marks]
[Total: 20 marks]

Question 4

a) Some forecasters believe that foreign exchange markets for the major floating
currencies are “efficient” and forward exchange rates are unbiased predictors of future
spot exchange rates. Explain the rationale of this statement including the assumptions
made, the meaning of “efficient” and “unbiased,” and the empirical evidence.
[10 marks]

b) Define ‘uncovered interest arbitrage’. Explain what expectations an investor or
speculator would need to undertake an uncovered interest arbitrage investment.
[10 marks]

Total: 20 marks]

Question 5
a) Governments and central banks usually intervene in foreign exchange markets.
Explain what is meant by foreign currency intervention. Explain two approaches of
intervention. [10 marks]
b) Discuss the three basic theoretical approaches to exchange rate determination.
[10 marks]
[Total: 20 marks]

End of Paper