Case study on the Zeal Peso Essay Example | Topics and Well Written Essays - 2500 words

Case study on the Zeal Peso - Essay Example From the case, we know that the exchange rate at the beginning was 20ZPG per dollar; the total time from 1973 to 1995 is 22 years. Price levels in the US have moved from 70 to 140 representing 100% inflation while those in the Zeal have moved from 50 to 180 representing 260% inflation. Substituting these figures in equation 2 we get: This represents 1/36 = $0.027 per Zeal Peso. According to the case report, the peso had devalued to a figure of $0.0263 per peso, which is the same figure predicted using PPP. Assuming that PPP holds true, then we can conclude that the figure $0,0263/ZPG is the best prediction for the Zeal peso spot rate for the last 22 years. (Shapiro, 2006: pp137). Therefore we can conclude here that the currency has devalued enough. However, given that this is the figure for 1995, the figure might be expected to reduce with further increase in inflation by the end of 1996. In my opinion, it was possible to forecast the peso float. From an understanding of purchasing power parity it is clear that two currencies can only be in fixed parity if the rates of change of consumer prices in the two countries are equal through time. In so far as the changes in inflation rates in one country are more than the other it will not be possible for fixed parity to be maintained. Thus, the currency values must readjust to reflect the inflation differentials. In the case of the US and the Zeal, one can observe from table 2 that the consumer price index for both countries has been increasing but that for the Zeal witnessed higher increases than that for the United States. As purchasing power parity states, currencies with higher inflation rates should depreciate relative to currencies with lower rates of inflation (Shapiro, 2006). Therefore given that the inflation index for the Zeal was increasing at a rate that was higher than that for the US it should have been possib le to forecast the peso float. Question 3. According to Black (2002), foreign exchange reserves or international reserves represent liquid assets held by a country's government or central bank for the purpose of intervening in the foreign exchange market. These include gold or convertible foreign currencies. (Black, 2002). For example in the case of the Zeal this might refer to assets denominated in US dollars rather than the Zeal peso. Foreign exchange reserves can also include balances with international institutions, notably the International Monetary Fund (IMF). (Black, 2002). Looking at table 3, which shows the balance of payments for the Zeal from 1973 to 1995, including the international reserves, we can observe that the international reserves have been decreasing since 1973. The international reserves have dropped from $-45million in 1973 to $-150million. This implies that the country has more liquid liabilities and not assets in foreign currency and therefore less money has been transferred out of the country. Instead, more money has been moved into the country in foreign currency. This is contrary to the assertion in the case that many people transferred money out of the country. Question 4 Bodie et al (2002), Shapiro (2006) state that in a well functioning foreign exchange market, there should be a spot-futures exchange rate relationship that will