1. Suppose the CFO of an American corporation with surplus cash flow had $100 million to invest last July 15 and the corporation did not believe it would need to utilize these funds to retool or expand production capacity for 1 year. Suppose further that the interest rate on 1 year CD deposits in US banks was .5%, while the rate on 1 year CD deposits in England (denominated in British Pounds) was 2% at the time. Suppose further that the exchange rate at that time was $1.68 per British pound.
A) Suppose that now a year later the exchange rate is $1.55 per US pound. What rate of return did the CFO earn on the investment in the British CD? (Note: a specific numeric answer.)
B) What must the CFO have expected about the value of the British pound in $ today to believe that investment in British CD’s was more profitable than investment in US CD’s last July?
2. Between February 2008 and Summer 2009 the Fed supplemented its open market operations with a greatly expanded program of direct lending (both overnight and short term 28 and 84 day loans) to commercial banks, investment banks, brokerage and primary dealer units of bank holding companies. It also agreed to accept a wider range of short term securities (instead of accepting only T-Bills) as collateral on these loans and even initiated a program to buy commercial paper from money market funds.
Explain why the Fed created all these extraordinary direct lending facilities instead of simply relying on traditional open market purchases of Treasury securities