Quiz 5: Exchange Rate Systems

Business

An illegal exchange market of Z indicates that the Zim (currency of country Z) is incorrectly valued at Z$38/USD. In this situation, Zim is over-valued and speculators want to purchase foreign currency and it invests in foreign country. The central bank of Z was maintaining the overvalued rate through international reserves. The government of Z want to control foreign currency. In this situation, the central bank would hold foreign currency because Zim is overvalued. High inflation in Z, which indicates highly unstable political regime in Z. In this situation, U.S. dollars are a better store of value than Z dollars. The situation in Z deteriorated into hyperinflation, and Z is going to the abandonment of the Zim

To quantify currency risk in a floating exchange rate system in which it characterise the risk of a currency options. In currency risk, one advantage of floating exchange rate system is that; past records provides data that indicates past currency volatility. It indicates that higher the volatility, higher would be the risk; for having a long positions in the volatile currency. The historical data are useful in pining down a realistic volatility number for the future. At last, the volatility is the adequate indicator of risk when exchange rate changes are approximately normally distributed. The risk of a large movement of the exchange rate in one direction or another, in a floating exchange rate system these are reasonable symmetric unless a currency has strengthened or weakened systematically for several years.

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