Currency Management Question (help please!)

CFA Level III
#1

When the text says… Depreciation in the JPY/NZD.

Does this mean the Japanese Yen will depreciate vs the New Zealand (NZ) dollar? Or the opposite? Japanese yen is appreciating?

Question text:

After studying the economic prospects for both Japan and NZ, she expects that the inflation rate for NZ is about to accelerate over the next few years, whereas the inflation rate for Japan should remain relatively stable.

Question: Based on her inflation forecasts, all else equal, she would be more likely to expect an:

A) depreciation in the JPY/NZD

b) increase in capital flows from Japan to New Zealand

c) more acommodative money policy by the Reserve bank of NZ.

From the question text, it sounds like Japan is in a better position than NZ. Inflation is bad is what i was thinking… but also… Interest rates are also increasing. So isn’t this good for investors that want higher interest rates?

I’m pretty confused, so any help/thoughts/way you think about this would be highly appreciated.

Thanks!

#2

it usually pertains to the base so you should expect to be able to purchase less JPY per NZD.

I reviewed currency a few weeks ago so take this w a grain of salt but I would choose A

Unless she believes in the carry trade / forward premium which exploits uncovered IRP, one would normally expect the inflation to lead to a depre currency.

C is out of the question (so i’d narrow it bt A and B). Damn, i need to review capital/current account flows

Whats the answer?

#3

You are correct. answer is A. Heres the next question.

Text: Turning her attention to the economic situation in India, McYelland believes that the indian authorities are about to tighten monetary policy, and that this change has not been fully priced into the mkt. She reconsiders her short-term view for the Indian rupee (the INR/USD spot rate) after conducting this analysis.

Question 2: Given her analysis for India, McYelland’s short-term market view for the INR/USD spot rate is most likely to be:

A) biased toward appreciation

B) Biased toward depreciation

C) unchanged because it is only a short-run view.

My thought process is that India plans on tightening monetary policy, so that means increasing short-term interest rates. This will cause more investors in invest in India for a higher rate, increasing the INR. Is that right? I think im just getting the INR/USD confused.

#4

tightening monetary policy will decrease inflation, which will cause the INR/USD to depreciate (the base, USD will depreciate against the price, INR, so even though the INR will appreciate, you would say the INR/USD will depreciate

#5

i chose the same answer, however my justification was based on interest rates differentials. If you think about it, the impact from monetary policy is more often felt on interest rates rather than inflation. Inflation follows later (and maybe even never), in a intermediate to long term view. For short term, the focus is on change in interest rates rather than changes in purchasing power (to which the purchasing power parity would apply)

#6

Thanks for putting this question here @BaseballRedhawks

I came to this question and was confused as well.

Could anyone please explain the logic of the INR answer? I get that the INR should appreciate because of increasing inflows, but doesnt that violate the rule of covered interest parity that the currency with the higher real interest rate should depreciate?

#7

^you’re absolutely right.

However, in a carry trade we often see that CIRP is violated which means traders are borrowing in the currency with a cheaper interest rate and invested in the currency with the higher rate. Often times the currency with the higher interest rates does not actually depreciate as much as IRP would imply.