Suppose the Swiss national bank wants to fix the Swiss franc at a value with respect to the EUR with is below the market equilibrium value of the…

Suppose the Swiss national bank wants to fix the Swiss franc at a value with respect to the EUR with is below the market equilibrium value of the Swiss franc.

That is S(EUR/CHF) Peg < S( EUR/CHF) Market

Q1) Draw a supply-demand graph for the FX-market for this situation. Indicate the divergence between the level at which the FX-rate is pegged and the market equilibrium level and show the implications for the Swiss national bank, i.e. how does the Swiss national bank have to intervene in the FXmarket to keep the value of the Swiss franc below the value implied by market equilibrium?

Q2) You believe that the Swiss franc peg against the euro is unsustainable. You expect the Swiss national bank to give up the peg within one month and the Swiss franc to greatly appreciate then. Which zero-investment trading strategy based on money market deposits and loans (denominated in Swiss franc and euro) would you implement? List the positions and write down the payoff of your strategy denominated in Swiss franc in one month.

Q3) How can you implement this speculative trade with a one-month forward contract? Show that the forward based strategy is profitable if and only if the money-market strategy from (Q2) is profitable.

Q4) Suppose your speculative trade does not work out that is the Swiss national bank can successfully defend the peg. What would the payoff be in that case one month from now if you had used the money-market strategy?

Q5) How do Swiss exporters and Swiss importers adjust their payment behavior if they came to believe that the Swiss national bank has to give up the peg this month? Indicate in the supply-demand graph from (Q1) the effect of the sudden change of their behavior

· on the supply of and the demand for the Swiss franc,

· on the market equilibrium FX-rate (that would be attained if the Swiss national bank did not intervene), and

· on the size of the intervention necessary.

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