Chapter 4 Risks of financial institutions Answers to end-of-chapter questions Questions and problems What is the process of asset transformation performed by a financial institution? Why does this process often lead to the creation of interest rate risk? What is interest rate risk? Asset transformation by an FI involves purchasing primary assets and issuing secondary assets as a source of funds. The primary securities purchased by the FI often have maturity and liquidity characteristics that are different from the secondary securities issued by the FI. For example, a bank buys medium- to long-term bonds and makes medium-term loans with funds raised by issuing short-term deposits. Interest rate risk occurs because the prices and reinvestment income characteristics of long-term assets react to changes in market interest rates differently from the prices and interest expense characteristics of short-term deposits. Interest rate risk is the effect on prices (value) and interim cash flows (interest coupon payment) caused by changes in the level of interest rates during the life of the financial asset. What is refinancing risk? How is refinancing risk part of interest rate risk? If an FI funds long-term fixed-rate assets with short-term liabilities, what will be the impact on earnings of an increase in the rate of interest? A decrease in the rate of interest? Refinancing risk is the uncertainty of the cost of a new source of funds that are being used to finance a long-term fixed-rate asset. This risk occurs when an FI is holding assets with maturities greater than the maturities of its liabilities. For example, if a bank has a 10-year fixed-rate loan funded by a two-year time deposit, the bank faces a risk of borrowing new deposits, or refinancing, at a higher rate in two years. Thus, interest rate increases would reduce net interest income. The bank would benefit if the rates fall as the cost of renewing the deposits would decrease, while the earning rate on the assets would not change. In this case, net interest income would increase. What is reinvestment risk? How is reinvestment risk part of interest rate risk? If an FI funds short-term assets with long-term liabilities, what will be the impact on earnings of a decrease in the rate of interest? An increase in the rate of interest? Reinvestment risk is the uncertainty of the earning rate on the redeployment of assets that have matured. This risk occurs when an FI holds assets with maturities that are less than the maturities of its liabilities. For example, if a bank has a two-year loan funded by a 10-year fixed-rate time deposit, the bank faces the risk that it might be forced to lend or reinvest the money at lower rates after two years, perhaps even below the deposit rates. Also, if the bank receives periodic cash flows, such as coupon payments from a bond or monthly payments on a loan, these periodic cash flows will also be reinvested at the new lower (or higher) interest rates. Besides the effect on the income statement, this reinvestment risk may cause the realised yields on the assets to differ from the a priori expected yields. The sales literature of a managed fund claims that the fund has no risk exposure since it invests exclusively in federal government securities that are free of default risk. Is this claim true? Explain why or why not. Although the fund’s asset portfolio comprises securities with no default risk, the securities remain exposed to interest rate risk. For example, if interest rates increase, the market value of the fund’s Treasury security portfolio will decrease. Further, if interest rates decrease, the realised yield on these securities will be less than the expected rate of return because of reinvestment risk. In either case, investors who liquidate their positions in the fund may sell at a net asset value (NAV) that is lower than the purchase price. How can interest rate risk adversely affect the economic or market value of an FI? When interest rates increase (or decrease), the value of fixed-rate assets decreases (or increases) because of the discounted present value of the cash flows. To the extent that the change in market value of the assets differs from the change in market value of the liabilities, the difference is realised in the economic or market value of the equity of the FI. For example, for most depository institutions, an increase in interest rates will cause asset values to decrease more than liability values. The difference will cause the market value, or share price, of equity to decrease. 6 A financial institution has the following market value balance sheet structure: Assets Liabilities and equity Cash $1 000 Certificate of deposit $10 000 Bond $10 000 Equity $1 000 Total assets $11 000 Total liabilities and equity $11 000 The bond has a 10-year maturity and a fixed-rate coupon of 10 per cent. The certificate of deposit has a one-year maturity and a 6 per cent fixed rate of interest. The FI expects no additional asset growth. (a) What will be the net interest income (NII) at the end of the first year? (Note: Net interest income equals interest income minus interest expense.) Interest income $1000 $10 000 × 0.10 Interest expense 600 $10 000 × 0.06 Net interest income (NII) $400 (b) If at the end of year one market interest rates have increased 100 basis points (1 per cent), what will be the net interest income for the second year? Is the result caused by reinvestment risk or refinancing risk? Interest income $1000 $10 000 × 0.10 Interest expense 700 $10 000 × 0.07 Net interest income (NII) $300 The decrease in net interest income is caused by the increase in financing cost without a corresponding increase in the earnings rate. Thus, the change in NII is caused by refinancing risk. The increase in market interest rates does not affect the interest income because the bond has a fixed-rate coupon for 10 years. Note: This answer makes no assumption about reinvesting the first year’s interest income at the new, higher rate. (c) Assuming that market interest rates increase 1 per cent, the bond will have a value of $9446 at the end of year one. What will be the market value of the equity for the FI? Assume that all of the NII in part (a) is used to cover operating expenses or is distributed as dividends. Cash $1 000 Certificate of deposit $10 000 Bond $9 446 Equity $446 Total assets $10 446 Total liabilities and equity $10 446 (d) If market interest rates had decreased 100 basis points by the end of year one, would the market value of equity be higher or lower than $1000? Why? The market value of the equity would be higher ($1600) because the value of the bond would be higher ($10 600) and the value of the CD would remain unchanged. (e) What factors have caused the change in operating performance and market value for this firm? The operating performance has been affected by the changes in the market interest rates that have caused the corresponding changes in interest income, interest expense and net interest income. These specific changes have occurred because of the unique maturities of the fixed-rate assets and fixed-rate liabilities. Similarly, the economic market value of the firm has changed because of the effect of the changing rates on the market value of the bond. 7 How does the policy of matching the maturities of assets and liabilities work (a) to minimise interest rate risk, and (b) against the asset-transformation function of FIs? A policy of maturity matching will allow changes in market interest rates to have approximately the same effect on both interest income and interest expense. An increase in rates will tend to increase both income and expense, and a decrease in rates will tend to decrease both income and expense. The changes in income and expense may not be equal because of different cash flow characteristics of the assets and liabilities. The asset-transformation function of an FI involves investing short-term liabilities into long-term assets. Maturity matching clearly works against successful implementation of this process. 8 Corporate bonds usually pay interest semi-annually. If a company decided to change from semi-annual to annual interest payments, how would this affect the bond’s interest rate risk? The interest rate risk would increase as the bonds are being paid back more slowly and therefore the cash flows would be exposed to interest rate changes for a longer period of time. Thus any change in interest rates would cause a larger inverse change in the value of the bonds. 9 Two 10-year bonds are being considered for an investment that may have to be liquidated before the maturity of the bonds. The first bond is a 10-year premium bond with a coupon rate higher than its required rate of return and the second bond is a zero-coupon bond that pays only a lump-sum payment after 10 years with no interest over its life. Which bond would have more interest rate risk? That is, which bond’s price would change by a larger amount for a given change in interest rates? Explain your answer. The zero-coupon bond would have more interest rate risk. Because the entire cash flow is not received until the bond matures, the entire cash flow is exposed to interest rate changes over the entire life of the bond. The cash flows of the coupon-paying bond are returned with periodic regularity, thus allowing less exposure to interest rate changes. In effect, some of the cash flows may be received before interest rates change. The effects of interest rate changes on these two types of assets will be explained in greater detail in the next section of the text. 10 Consider again the two bonds in Question 9. If the investment goal is to leave the assets untouched until maturity, such as for a child’s education or for one’s retirement, which of the two bonds has more interest rate risk? What is the source of this risk? In this case the coupon-paying bond has more interest rate risk. The zero-coupon bond will generate exactly the expected return at the time of purchase because no interim cash flows will be realised. Thus the zero-coupon bond has no reinvestment risk. The coupon-paying bond faces reinvestment risk each time a coupon payment is received. The results of reinvestment will be beneficial if interest rates rise, but decreases in the interest rate will cause the realised return to be less than the expected return. 11 A cash management trust bought $1 million of two-year Treasury notes six months ago. During this time, the value of the securities has increased, but for tax reasons the trust wants to postpone any sale for two more months. What type of risk does the trust face for the next two months? The cash management trust faces the risk of interest rates rising and the value of the securities falling. 12 A bank invested $50 million in a two-year asset paying 10 per cent interest per annum and simultaneously issued a $50 million, one-year liability paying 8 per cent interest per annum. What will be the bank’s net interest income each year if at the end of the first year all interest rates have increased by 1 per cent (100 basis points)? Net interest income is not affected in the first year, but NII will decrease in the second year. Year 1 Year 2 Interest income $5 000 000 $5 000 000 Interest expense $4 000 000 $4 500 000 Net interest income $1 000 000 $500 000 13 What is market risk? How do the results of this risk surface in the operating performance of financial institutions? What actions can be taken by FI management to minimise the effects of this risk? Market risk is the risk of price changes that affect any firm that trades assets and liabilities. The risk can arise because of changes in interest rates, exchange rates or any other prices of financial assets that are traded rather than held on the balance sheet. Market risk can be minimised by using appropriate hedging techniques such as futures, options and swaps, and by implementing controls that limit the amount of exposure taken by market makers. 14 What is credit risk? Which types of FIs are more susceptible to this type of risk? Why? Credit risk is the possibility that promised cash flows may not occur or may only partially occur. FIs that lend money for long periods of time, whether as loans or by buying bonds, are more susceptible to this risk than those FIs that have short investment horizons. For example, life insurance companies and depository institutions generally must wait a longer time for returns to be realised than money market mutual funds and property-casualty insurance companies. 15 What is the difference between firm-specific credit risk and systematic credit risk? How can an FI alleviate firm-specific credit risk? Firm-specific credit risk refers to the likelihood that specific individual assets may deteriorate in quality, while systematic credit risk involves macroeconomic factors that may increase the default risk of all firms in the economy. Thus, if Standard & Poor’s lowers its rating on IBM stock, for example, and if an investor is holding only this particular stock, the investor may face significant losses as a result of this downgrading. However, portfolio theory in finance has shown that firm-specific credit risk can be diversified away if a portfolio of well-diversified stocks is held. Similarly, if an FI holds well-diversified assets, the FI will face only systematic credit risk that will be affected by the general condition of the economy. The risks specific to any one customer will not be a significant portion of the FI’s overall credit risk. 16 Many US banks and savings institutions that failed in the 1980s had made loans to oil companies in Louisiana, Texas and Oklahoma. When oil prices fell, these companies, the three state economies and the banks and savings institutions in these states all experienced financial problems. What types of risk were inherent in the loans that were made by these banks and savings institutions? The loans in question involved credit risk. Although the geographic risk area covered a large region of the US, the risk was more closely characteristic of firm-specific risk than systematic risk. More extensive diversification by the FIs to other types of industries would have decreased the amount of financial hardship these institutions had to endure. 17 What is the nature of an off-balance-sheet activity? How does an FI benefit from such activities? Identify the various risks that these activities generate for an FI and explain how these risks can create varying degrees of financial stress for the FI at a later time. Off-balance-sheet activities are contingent commitments to undertake future on-balance-sheet investments. The usual benefit of committing to a future activity is the generation of immediate fee income without the normal recognition of the activity on the balance sheet. As such, these contingent investments may be exposed to credit risk (if there is some default risk probability), interest rate risk (if there is some price and/or interest rate sensitivity) and foreign exchange rate risk (if there is a cross-currency commitment). What two factors provide potential benefits to FIs that expand their asset holdings and liability funding sources beyond their domestic economies? FIs can realise operational and financial benefits from direct foreign investment and foreign portfolio investments in two ways. First, the technologies and firms across various economies differ from each other in terms of growth rates, extent of development, etc. Second, exchange rate changes may not be perfectly correlated across various economies. What is foreign exchange risk? What does it mean for an FI to be net long in foreign assets? What does it mean for an FI to be net short in foreign assets? In each case, what must happen to the foreign exchange rate to cause the FI to suffer losses? Foreign exchange risk involves an adverse effect on the value of an FI’s assets and liabilities that are located in another country when the exchange rate changes. An FI is net long in foreign assets when the foreign currency-denominated assets exceed the foreign currency-denominated liabilities. In this case, an FI will suffer potential losses if the domestic currency strengthens relative to the foreign currency when repayment of the assets will occur in the foreign currency. An FI is net short in foreign assets when the foreign currency-denominated liabilities exceed the foreign currency-denominated assets. In this case, an FI will suffer potential losses if the domestic currency weakens relative to the foreign currency when repayment of the liabilities will occur in the domestic currency. If you expect the euro to depreciate in the near future, would an Australian-based FI in Paris prefer to be net long or net short in its asset positions? Discuss. The Australian FI would prefer to be net short (liabilities greater than assets) in its asset position. The depreciation of the euro relative to the dollar means that the Australian FI would pay back the net liability position with fewer dollars. In other words, the decrease in the foreign assets in dollar value after conversion will be less than the decrease in the value of the foreign liabilities in dollar value after conversion. If international capital markets are well integrated and operate efficiently, will banks be exposed to foreign exchange risk? What are the sources of foreign exchange risk for FIs? If there are no real or financial barriers to international capital and goods flows, FIs can eliminate all foreign exchange rate risk exposure. Sources of foreign exchange risk exposure include international differentials in real prices, cross-country differences in the real rate of interest (perhaps as a result of differential rates of time preference), regulatory and government intervention and restrictions on capital movements, trade barriers and tariffs. If an FI has the same amount of foreign assets and foreign liabilities in the same currency, has that FI necessarily reduced to zero the risk involved in these international transactions? Explain. Matching the size of the foreign currency book will not eliminate the risk of the international transactions if the maturities of the assets and liabilities are mismatched. To the extent that the assets and liabilities are mismatched in terms of maturities, or more importantly durations, the FI will be exposed to foreign interest rate risk. 23 An Australian insurance company invests $1 million in a private placement of British bonds. Each bond pays £300 in interest per year for 20 years. If the current exchange rate is £1.7612/A$1, what is the nature of the insurance company’s exchange rate risk? Specifically, what type of exchange rate movement concerns this insurance company? In this case, the insurance company is worried about the value of the pound falling. If this happens, the insurance company would be able to buy fewer dollars with the pounds received. This would happen if the exchange rate rose to say £1.88/A$1 since now it would take more pounds to buy one dollar, but the bond contract is paying a fixed amount of interest and principal. 24 Assume that a bank has assets located in Singapore worth S$150 million on which it earns an average of 8 per cent per year. The bank has S$100 million in liabilities on which it pays an average of 6 per cent per year. The current spot rate is S$1.50/A$1. (a) If the exchange rate at the end of the year is S$2.00/A$1, will the Australian dollar have appreciated or depreciated against the Singapore dollar? The Australian dollar will have appreciated, or conversely, the Singapore dollar will have depreciated. (b) Given the change in the exchange rate, what is the effect in Australian dollars on the net interest income from the foreign assets and liabilities? (Note: The net interest income is interest income minus interest expense.) Measurement in S$ = S$ Interest received 12 million Interest paid 6 million Net interest income 6 million Measurement in A$ before S$ devaluation = S$ Interest received in dollars 8 million Interest paid in dollars 4 million Net interest income 4 million Measurement in A$ after S$ devaluation = S$ Interest received in dollars 6 million Interest paid in dollars 3 million Net interest income 3 million (c) What is the effect of the exchange rate change on the value of assets and liabilities in Australian dollars? The assets were worth $100 million (S$150m/1.50) before depreciation, but after devaluation they are worth only $75 million. The liabilities were worth $66.67 million before depreciation, but they are worth only $50 million after devaluation. Since assets declined by $25 million and liabilities by $16.67 million, net worth declined by $8.33 million using spot rates at the end of the year. 25 Six months ago, Quality bank Ltd issued a $100 million, one-year maturity CD denominated in euro (euro CD). On the same date, $60 million was invested in a euro-denominated loan and A$40 million was invested in an Australian Treasury bond. The exchange rate on this date was €1.7382/A$1. Assume no repayment of principal and an exchange rate today of €1.3905/A$1. (a) What is the current value of the euro CD principal (in A$ and €)? Today’s principal value on the euro CD is €173.82 and $125m (173.82/1.3905). (b) What is the current value of Quality bank’s loan principal (in A$ and €)? Today’s principal value on the loan is €104.292 and $75 (104.292/1.3905). (c) What is the current value of the Australian Treasury bill (in A$ and €)? Today’s principal value on the Australian Treasury bill is $40m and €55.62 (40 × 1.3905), although for an Australian bank this does not change in value. (d) What is Quality bank’s profit/loss from this transaction (in A$ and €)? Quality bank’s loss is $10m or €13.908. Solution matrix for Problem 25: At issue date: Dollar transaction values (in millions) D-Marks transaction values (in millions) Euro loan $60 €-CD $100 Euro loan €104.292 €-CD €173.82 Aust T-bill $40 Aust T-bill €69.528 $100 $100 €173.82 €173.82 Today: Dollar transaction values (in millions) D-Marks transaction values (in millions) Euro loan $75 €-CD $125 Euro loan €104.292 €-CD €173.82 Aust T-bill $40 Aust. T-bill €55.620 $115 $125 €159.912 €173.82 26 Suppose you purchase a 10-year AAA-rated Swiss bond for par that is paying an annual coupon of 8 per cent. The bond has a face value of 1000 Swiss francs (SF). The spot rate at the time of purchase is SF1.50/$1. At the end of the year, the bond is downgraded to AA and the yield increases to 10 per cent. In addition, the SF appreciates to SF1.35/$1. (a) What is the loss or gain to a Swiss investor who holds this bond for a year? What portion of this loss or gain is due to foreign exchange risk? What portion is due to interest rate risk? Beginning of the year End of the year The loss to the Swiss investor (SF875.06 + SF60 – SF1000)/$1000 = –6.49 per cent. The entire amount of the loss is due to interest rate risk. (b) What is the loss or gain to an Australian investor who holds this bond for a year? What portion of this loss or gain is due to foreign exchange risk? What portion is due to interest rate risk? Price at beginning of year = SF1000/SF1.50 = $666.67 Price at end of year = SF875.06/SF1.35 = $648.19 Interest received at end of year = SF60/SF1.35 = $44.44 Gain to Australian investor = ($648.19 + $44.44 – $666.67)/$666.67 = +3.89%. The Australian investor had an equivalent loss of 6.49 per cent from interest rate risk, but he had a gain of 10.38 per cent (3.89 – (–6.49)) from foreign exchange risk. If the Swiss franc had depreciated, the loss to the Australian investor would have been larger than 6.49 per cent. 27 What is country or sovereign risk? What remedy does an FI realistically have in the event of a collapsing country or currency? Country risk involves the interference of a foreign government in the transmission of funds transfer to repay a debt by a foreign borrower. A lender FI has very little recourse in this situation unless the FI is able to restructure the debt or demonstrate influence over the future supply of funds to the country in question. This influence would likely involve significant working relationships with the IMF and the World Bank. 28 What is technology risk? What is the difference between economies of scale and economies of scope? How can these economies create benefits for an FI? How can these economies prove harmful to an FI? Technology risk occurs when investment in new technologies does not generate the cost savings expected in the expansion in financial services. Economies of scale occur when the average cost of production decreases with an expansion in the amount of financial services provided. Economies of scope occur when an FI is able to lower overall costs by producing new products with inputs similar to those used for other products. In financial service industries, the use of data from existing customer databases to assist in providing new service products is an example of economies of scope. 29 What is the difference between technology risk and operational risk? How does internationalising the payments system among banks increase operational risk? Technology risk refers to the uncertainty surrounding the implementation of new technology in the operations of an FI. For example, if an FI spends millions on upgrading its computer systems but is not able to recapture its costs because its productivity has not increased commensurately or because the technology has already become obsolete, it has invested in a negative NPV investment in technology. Operational risk refers to the failure of the back-room support operations necessary to maintain the smooth functioning of the operation of FIs, including settlement, clearing and other transaction-related activities. For example, computerised payment systems such as RITS, RTGS, CHESS, AUSTRACLEAR and SWIFT allow modern financial intermediaries to transfer funds, securities and messages across the world in seconds of real time. This creates the opportunity to engage in global financial transactions in the short term in an extremely cost-efficient manner. However, the interdependence of such transactions also creates settlement risk. Typically, any given transaction leads to other transactions as funds and securities cross the globe. If there is either a transmittal failure or high-tech fraud affecting any one of the intermediate transactions, this could cause an unravelling of all subsequent transactions. 30 Characterise the risk exposure(s) of the following FI transactions by choosing one or more of the risk types listed below: (a) Interest rate risk (b) Credit risk (c) Off-balance-sheet risk (d) Technology risk (e) Foreign exchange rate risk (f) Country or sovereign risk (i) A bank finances a $10 million, six-year fixed-rate commercial loan by selling one-year certificates of deposit. Answer: (a), (b) (ii) An insurance company invests its policy premiums in a long-term municipal bond portfolio. Answer: (a), (b) (iii) A French bank sells two-year fixed-rate notes to finance a two-year fixed-rate loan to a British entrepreneur. Answer: (b), (e), (f) (iv) A Japanese bank acquires an Austrian bank to facilitate clearing operations. Answer: (a), (b), (c), (d), (e), (f) (v) A mutual fund completely hedges its interest rate risk exposure using forward contingent contracts. Answer: (b), (c) (vi) A bond dealer uses his own equity to buy Mexican debt on the less-developed country (LDC) bond market. Answer: (a), (b), (e), (f) (vii) A securities firm sells a package of mortgage loans as mortgage-backed securities. Answer: (a), (b), (c) 31 Consider these four types of risks: credit, foreign exchange, market and sovereign. These risks can be separated into two pairs of risk types in which each pair consists of two related risk types, with one being a subset of the other. How would you pair off the risk types, and which risk types may be considered a subset of the othe type in the pair? Credit risk and sovereign risk comprise one pair, while FX and market risk make up the other. Sovereign risk is a type of credit risk in that one reason why a loan may default is because of political upheaval in the country in which the borrower resides. FX risk is a type of market risk in that one reason why the market value of an outstanding loan or security may change is due to a change in exchange rates. 32 What is liquidity risk? What routine operating factors allow FIs to deal with this risk in times of normal economic activity? What market reality can create severe financial difficulty for an FI in times of extreme liquidity crises? Liquidity risk is the uncertainty that an FI may need to obtain large amounts of cash to meet the withdrawals of depositors or other liability claimants. In times of normal economic activity, depository FIs meet cash withdrawals by accepting new deposits and borrowing funds in the short-term money markets. However, in times of harsh liquidity crises, the FI may need to sell assets at significant losses in order to generate cash quickly. 33 Why can insolvency risk be classified as a consequence or outcome of any or all of the other types of risks? Insolvency risk involves the shortfall of capital in times when the operating performance of the institution generates accounting losses. These losses may be the result of one or more of interest rate, market, credit, liquidity, sovereign, foreign exchange, technological and off-balance-sheet risks. 34 Discuss the interrelationships among the different sources of bank risk exposure. Why would the construction of a bank risk-management model to measure and manage only one type of risk be incomplete? Measuring each source of bank risk exposure individually creates the false impression that they are independent of each other. For example, the interest rate risk exposure of a bank could be reduced by requiring bank customers to take on more interest rate risk exposure through the use of floating rate products. However, this reduction in bank risk may be obtained only at the possible expense of increased credit risk. That is, customers experiencing losses resulting from unanticipated interest rate changes may be forced into insolvency, thereby increasing bank default risk. Similarly, off-balance-sheet risk encompasses several risks since off-balance-sheet contingent contracts typically have credit risk and interest rate risk as well as currency risk. Moreover, the failure of collection and payment systems may lead corporate customers into bankruptcy. Thus, technology risk may influence the credit risk of FIs. As a result of these interdependencies, FIs have focused on developing sophisticated models that attempt to measure all of the risks faced by the FI at any point in time. WEB QUESTION 35. Go to the RBA website www.rba.gov.au/statistics/cash-rate/ and Trading Economics website www.tradingeconomics.com/australia/currency. Compare the RBS’s target cash rate decisions with the value of the Australian dollar at the time of each decision since February 2013. What does this tell us about the relationship between interest rates and foreign exchange rates (hint: set the graph of exchange rates to a moving average, and line graph)? Generally, when there is a fall in interest rates, the value of the Australian dollar falls. Conversely, when there is an increase in the target cash rate, the value of the Australian dollar rises. However, these movements don’t happen in all cases, and so this tells us that other factors must also be influencing the value of the Australian dollar. As of my last update in January 2022, I'm unable to browse external websites such as the RBA website or Trading Economics. However, I can provide you with general guidance on how to compare the Reserve Bank of Australia's (RBA) target cash rate decisions with the value of the Australian dollar (AUD) using data from these sources: 1. RBA Website-Cash Rate Data: • Visit the RBA website at www.rba.gov.au/statistics/cash-rate/. • Access historical data or announcements related to the RBA's target cash rate decisions. The RBA typically announces changes to the cash rate during monthly monetary policy meetings. • Note down the dates and corresponding cash rate decisions made by the RBA since February 2013. 2. Trading Economics Website-Exchange Rate Data: • Visit the Trading Economics website at www.tradingeconomics.com/australia/currency. • Access historical data on the exchange rate of the Australian dollar against other currencies, such as the US dollar (USD), euro (EUR), or Japanese yen (JPY). • Set the graph to display a moving average of the exchange rate over a specific period (e.g., 50-day or 100-day moving average) to smooth out fluctuations and identify trends. 3. Comparison and Analysis: • Plot the RBA's target cash rate decisions and the corresponding values of the Australian dollar on a graph, with time on the horizontal axis. • Analyze the relationship between changes in the cash rate and movements in the exchange rate of the Australian dollar. Look for patterns or correlations between the two variables. • Generally, a higher cash rate may attract foreign investment, leading to increased demand for the Australian dollar and appreciation of its value. Conversely, a lower cash rate may reduce the attractiveness of Australian assets, leading to depreciation of the Australian dollar. • Consider other factors that may influence exchange rates, such as economic indicators, geopolitical events, and global market sentiment. By comparing the RBA's target cash rate decisions with the value of the Australian dollar over time, you can gain insights into the relationship between interest rates and foreign exchange rates and how monetary policy decisions impact currency markets. Solution Manual for Financial Institutions Management Anthony Saunders, Marcia Cornett, Patricia McGraw 9780070979796, 9780071051590
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