3. The diagram below shows the foreign exchange market between Korean Won (W) an

Question

3. The diagram below shows the foreign exchange market between Korean Won (W) and US dollars (S). Dollars per Won (s/M) : 0.08 .. 10 15 20 w (Bilions) a. The price of which currency is shown on the vertical axis How many Won and how many dollars are in trade in equilibrium at point A In the diagram, the supply of W rises from St" to S. List 2 factors that might cause such a shift. If the Bank of Korea (South Korea's central bank) maintains a flexible exchange rate regime, what would happen to the value of the Won with the increase in supply of Won (appreciate or depreciate)? e. Suppose the Bank of Korea chose to prevent this and to fix the exchange rate at its initial level at A Would it have to buy or sell Won as part of its official settlements balance? How many Won would it have to buy or sell? What would be the impact on the Bank of Korea's stock of foreign reserves (rise or fall)?_

Explanation / Answer

a) the price of won is given on the y axis.

10 billion won are traded at equilibrium point A. At A exchange rate is $0.1/ 1 W. So 10 billion won is equal to 1 billion dollar.

Two factors which might cause a shift in supply curve are:

1) Interest rate of Korea falls below interest rate of USA so that people sell won to buy dollars for the higher interest rate.

2) People expect won to depreciate so people actually sell won to avoid losses.

b) With increased supply of Won, Won would depreciate.

c) The govt would have to buy 5 billion won in order to meet the excess demand of 5 billion won. Korea's foreign reserves would fall as it sells dollar to get won.

Please post a clearer picture of thesecond page.

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