CONFIDENTIAL
Annex II
Size of the Exchange Fund and Monetary Management
(This paper gives a technical analysis on the importance of the size of the Exchange Fund to effective monetary management in Hong Kong)
A. Direct intervention in the foreign exchange market
rate
The Exchange Fund can stabilize the exchange by buying or selling Hong Kong dollars against US dollars in the spot market. When the exchange rate is weaker than 7.80, the Exchange Fund can sell US dollars for Hong Kong dollars and vice versa when the exchange rate is stronger than 7.80. It is important to realize that such direct intervention in the foreign exchange market normally
normally only involves a change in the asset composition of the Exchange Fund and does not lead to any change in the overall size or net asset value of the Exchange Fund.
2.
The Exchange Fund usually maintains an adequate amount Of liquid assets in the two currencies that can be used any time. Some are, for example, in the form of call deposits with major banks.
The effect of the direct intervention in the foreign exchange market is to decrease the amount of such deposit of one currency while increasing those Of the other.
If the intervention is successful, as is expected to be the case, profits will be made in the form of exchange gains and higher interest received for the currency bought, thereby increasing the net asset value of the Exchange Fund.
3.
Occasionally, the cash flow position of the Exchange Fund is such that the amount of Hong Kong dollar deposits available at a particular point of time for intervention (to buy US dollars to prevent the Hong dollar from strengthening) may be inadequate and it may not be considered appropriate to sell part of the Fund's marketable assets. When this happens, the Exchange Fund has a number of choices to deal with the situation.
Kong
CONFIDENTIAL
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