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Candidatesareadmittedtotheexaminationroomtenminutesbeforethestartoftheexamination.Onadmissiontotheexaminationroom,youarepermittedtoacquaintyourselfwiththeinstructionsbelowandtoreadthequestionpaper.Donotwriteanythinguntiltheinvigilatorinformsyouthatyoumaystarttheexamination.Youwillbegivenfiveminutesattheendoftheexaminationtocompletethefrontofanyanswerbooksused.May/June2009ECM832008/09A001Figure1forquestion3GraphpaperNon-programmablecalculatorsarepermittedProgrammablecalculatorswithoutanalphakeypadarepermittedDictionariesarenotpermittedTHEUNIVERSITYOFREADINGINTERNATIONALMONEY&FINANCE(ECM83)TwohoursAnswerTWOquestionsPage21.(a)Definetheconceptofthebilateralrealexchangerate(RER).Explainwhyitisimportantinopen-economyanalysis.(10marks)(b)BrieflydiscussthebenefitsanddisadvantagesofalternativemeasuresofthebilateralRER.(10marksperRERmeasure)2.(a)Deriveandinterpretthecoveredinterest-rateparity(CIP)condition.(20marks)(b)Howdoesuncoveredinterest-rateparity(UIP)relatetoanddifferfromCIP?(10marks)(c)Dotheseconditionsholdinthedata?Whyorwhynot?(20marks)3.Figure1presentstwopossibleequilibriainthemarketforforeignexchange.Thespotexchangerate,E,definedasthedomesticcurrencypriceof(aunitof)foreigncurrency,ismeasuredalongtheverticalaxis.Thequantitiesofforeignexchangedemanded,D(E),orsupplied,S(E),atanygivenexchangeratelevelaremeasuredalongthehorizontalaxis.Itis,furthermore,assumedthatdemandforforeigncurrencyandsupplyofforeigncurrencybothoriginateonlybecauseoftheunderlyingdemandforimportsandsupplyofexportsofgoods.(a)Why,underproducercurrencypricing(PCP),maythesupplycurveforforeigncurrencyS(E)beinitiallyanincreasingfunctionbutsubsequentlyadecreasingfunctionoftheexchangerate?WhydoesthispeculiaritynotariseforthedemandcurveD(E)?(30marks)(b)Whichofthepossibleequilibria,H1andH2inFigure1,isstableandwhichunstable,andwhy?(20marks)ECM832008/09A001Page34.ThestaticMundell-Flemingmodeloftheearly1960scanberepresentedbythefollow
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