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Assignment Finance
Abstract: This assignment consists of 6 different Finance topics
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Later on this assignment analyzed the monthly (end-of
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After that, using Uncovered Interest Parity Condition (UIP)
we calculated the 10 years ahead expected exchange rate
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In the last part it is discussed how the Federal Reserve may achieve a depreciation of the
US dollars against the foreign currency when the US policy rates and the foreign
economy reached the zero-lower bond (ZLB)
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Figure 1
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S
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The values that determine the
supply of money in the money market are the nominal money supply (MS)
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While the values that determine the demand for money include the national income (Y) or
in other words the GDP, and the short-term interest rate (R)
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On the left side of Figure 1 is presented the Forex Market
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In Figure
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The intersection of the
money demand curve with the money supply curve in money market gives the equilibrium
interest rate, which due to UIP ( Uncovered Interest Parity) it goes to the FR curve (expected
return on the foreign deposits) and figure out what the exchange rate should be in the
equilibrium
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As the US experienced a recession it means that the inflation rate will experience a decrease
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The decrease in the domestic interest rate will depreciate the US
currency against the NOK one, all else equal
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(ii) an increase in the real money supply in the foreign economy?

If Central Banks increase the real money supply, it means that they imply lower interest rates
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The decrease in interest rate will cause the exchange rates to increase, as well as the
real money supply line to shift to the right (see Figure 2)
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As it is shown in Figure 2, a decrease in interest rate will
lead to an increase of the real money supply, and an increase of the exchange rates as well
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Period of analyses: March 1987 to March 2021

Figure 3
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Period of analyses: March 1987 to March 2021

Figure 4
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Figure 5
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Line Fit Plot

Using the data we get in Exercise C, as well as Uncovered Interest Parity condition, we
calculated the 10-years ahead expected exchange rate by the formula below:

R𝑈𝑆= R*𝑁𝑂𝐾+

𝐸𝑒−𝐸
𝐸

We started to calculate the expected rate from March 1987, and continued to calculate everything
monthly until March 2021
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Regarding the next 10 years, the expected exchange rate was 11,723, while the spot USD/NOK
exchange rate in 1997 was 6,271
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When it comes to March 2021,
the predicted exchange rate and the spot exchange rate had the same value of 9,8067
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Regarding the comments written above about the expected exchange rate and the exchange rate
of USD/NOK it can be concluded that there are big differences between the expected exchange

rate line and the actual exchange rate line
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Thus it can be concluded that the (uncovered) interest parity condition
as a prediction model for the realized exchange rate is considered a failure
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Make a table to report your results
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Comment on possible reasons for the success/failure
of the (uncovered) interest parity condition
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Figure 8
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Ho: UIP is a good prediction model for the exchange rate

H1: UIP is not a good prediction model for the exchange rate

The results gained from Figure 5, 7, 8, 9 indicate that when using the UIP prediction model to
find the expected exchange rate it can lead to wrong and incorrect predictions
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122817372 , which is far from 1, meaning that there is a
huge difference between the expected exchange rate and the actual exchange rate
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Testing hypothesis

Confidence level = 95%, meaning that α = 5%/2 = 2
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From
Figure 9
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31984, and the T(0
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As 4,31984>1,960
means that we reject the H0, and accept the H1
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Statistically speaking the
expected exchange rate using UIP does not go one-to-one with the spot exchange rate of
USD/NOK
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Assume that the foreign economy is facing a similar situation
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When the zero-lower bound (ZLB) is reached, meaning that the interest rate falls to zero,
makes it unable for the domestic central bank to lower it more, and continues steering the economy
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If they do so it will create
several problems for the economy, causing actors not to keep currency in the different forms of loans,
Instead they hold the currency
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As the interest parity
condition includes interest rates at different maturities, means that the domestic central bank can
retrieve the power of monetary policy by changing longer-term interest rates through money supply

changes
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By asset purchases is meaning that in order to make the longer-term interest rate to fall, the central bank
increases the money supply to purchase bonds in the market at large scales
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REFERENCE:

Anderson, S
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Unemployment and Recession - What’s the Relation?
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Retrieved from:
https://www
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com/ask/answers/032515/why-does-unemployment-tend-rise-during-re
cession
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