Testing

Go to Text Chapter 6, “Small Business Dilemma” section.

Answer & discuss questions 1 & 2 with two separate reply posts to instructor posts 1 and 2

Forecast whether the British pound will weaken or strengthen based on the information provided.

If the Bank of England decides to flood the market with pounds, it will put downward pressure on the pound causing it to weaken. This will cause the exchange rate to drop. SEC has a contract in place for a set price in pounds, the exchange rate drop will cost SEC because it will take more BPS to buy USD. I walked through this example to get it straight in my head. if in month 1 the British company purchases footballs for £10,000 and the exchange rate is $1.611, SEC will buy $16,110 in the spot market exchange. In month 2, if the exchange rate drops to $1.55 then the same £10,000 will buy $15,500.

The British government can flood the market by selling off pounds which will add more into the market. This influx will devalue the pound and drive the exchange rate down. Flooding the market is one of the ways that a central bank can intervene. This can be done as a non sterilized intervention, meaning that the money supply will increase (Madura, 2012, p.190) or it can be done as a sterilized intervention where to offset the new money in the market, securities are exchanged so that there is no net change to the money supply (Madura, 2012, p.191). Depending on the method used there may be differing affects on the exchange rate. With a non sterilized intervention, the central bank’s order to buy or sell currency sends s signal to the market which may further strengthen or weaken the currency. Albildgren (2005) says that “If the intervention be the central bank influences the exchange rate in a particular direction, certain market participants may ‘jump on the bandwagon’ and thereby amplify the exchange-rate effect of the intervention”. With a sterilized intervention the sale or purchase of foreign currency is offset with...