11. Exchange Rated Protected Deposit (ERPD)

Question 1

Payoffs
* Call option
…

Answer 1

• Effective return = max{i,x}
• Treasury/CB pays max{0,x-i}

Question 2

Returns
* Country A, with currency peso, introduces Exchange Rate Protected Deposit (ERPD). * Promised net interest rate of r = 10%.
* x = rate at which the peso depreciates against $.
* x has a uniform distribution between 0% and 30%.
* Depositors put 100 pesos in the bank. What is her expected net return from ERPD? * What is the expected cost to the Treasury?

Answer 2

Return and cost
* For x < 10%, effective return is r=10%. This has a probability of 1/3. * For x > 10%, effective return is x. This has a probability of 2/3.
* Find the expected return when x > 10%.
* From the uniform distribution, this is (10% + 30%)/2 = 20%.
* Expected net return from ERPD = 1/3x10% + 2/3x20% = 50/3 = 16.67%. * Expected cost to the Treasury = 100 x (16.67%-10%) = 6.67.

Question 3

• Is it possible to end up in point A?
• No need to use the guarantee (exercise the option) * What would be the conditions for that?
• Current account surplus? How to curb inflation?

Answer 3

• How will the guarantee be paid?
• Exit strategy
• Cost sharing
• Treasury, taxes, printing money?
• Path of inflation, depreciation, further use of the guarantee * Sustainable? For how long?

(to be answered later, might be exam questions)