International International Economics, Economics, 10e 10e (Krugman/Obstfeld/Melitz)
Chapter 14 (3) Exchange ates and the !"reign Exchange Mar#et$ %n %sset %ppr"ach %ppr"ach
14.1 Exchange Rates and International Transactions Transactions 1) How many dollars would it cost to buy b uy an Edinburgh Woolen Woolen Mill sweater costing ! "ritish #ounds i$ the exchange rate is 1.% dollars #er one "ritish #ound& ') ! dollars ") (! dollars ) *! dollars +) (%. dollars E) 4! "ritish #ounds 'nswer, + -age Re$, 4%/4( +i$$iculty, Easy %) How many dollars would it cost to buy b uy an Edinburgh Woolen Woolen Mill sweater costing ! "ritish #ounds i$ the exchange rate is 1.! dollars #er one "ritish #ound& ') ! dollars ") (! dollars ) *! dollars +) 0! dollars E) * dollars 'nswer, E -age Re$, 4%/4( +i$$iculty, Easy ) How many dollars would it cost to buy b uy an Edinburgh Woolen Woolen Mill sweater costing ! "ritish #ounds i$ the exchange rate is 1.0! dollars #er one "ritish #ound& ') 4! dollars ") ! dollars ) ! dollars +) 1!! dollars E) dollars 'nswer, " -age Re$, 4%/4( +i$$iculty, Easy 4) The 2a#anese currency is called the ') +M. ") 3en. ) Euro. +) +ollar. E) -ound. 'nswer, " -age Re$, 4%/4( +i$$iculty, Easy 1 o#yright %!1 -earson Education5 Inc.
) How many "ritish #ounds would it cost to buy a #air o$ 'merican designer 6eans costing 74 i$ the exchange rate is 1.! dollars #er "ritish #ound& ') 1! "ritish #ounds ") %! "ritish #ounds ) ! "ritish #ounds +) "ritish #ounds E) % "ritish #ounds 'nswer, -age Re$, 4%/4( +i$$iculty, Easy () How many "ritish #ounds would it cost to buy a #air o$ 'merican designer 6eans costing 74 i$ the exchange rate is 1.0! dollars #er "ritish #ound& ') 1! "ritish #ounds ") % "ritish #ounds ) %! "ritish #ounds +) ! "ritish #ounds E) 4! "ritish #ounds 'nswer, " -age Re$, 4%/4( +i$$iculty, Easy *) How many "ritish #ounds would it cost to buy a #air o$ 'merican designer 6eans costing 74 i$ the exchange rate is %.!! dollars #er "ritish #ound& ') %%. "ritish #ounds ") %. "ritish #ounds ) 1%. "ritish #ounds +) 4! "ritish #ounds E) ! "ritish #ounds 'nswer, ' -age Re$, 4%/4( +i$$iculty, Easy 0) How many "ritish #ounds would it cost to buy a #air o$ 'merican designer 6eans costing 74 i$ the exchange rate is 1.(! dollars #er "ritish #ound& ') 0.1% "ritish #ounds ") %0.1% "ritish #ounds ) 40.1% "ritish #ounds +) 0.1% "ritish #ounds E) 10.1% "ritish #ounds 'nswer, " -age Re$, 4%/4( +i$$iculty, Easy
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) What is the exchange rate between the dollar and the "ritish #ound i$ a #air o$ 'merican 'merican 6eans costs ! dollars in 8ew 3or9 3or9 and 1!! -ounds in :ondon& ') 1. dollars #er "ritish #ound ") !. dollars #er "ritish #ound ) %. dollars #er "ritish #ound +) . dollars #er "ritish #ound E) % dollars #er "ritish #ound 'nswer, " -age Re$, 4%/4( +i$$iculty, Easy 1!) What is the exchange rate between the dollar and the "ritish #ound i$ a #air o$ 'merican 6eans costs (! dollars in 8ew 3or 3or9 9 and ! -ounds in :ondon& ') 1. dollars #er "ritish #ound ") !. dollars #er "ritish #ound ) %. dollars #er "ritish #ound +) . dollars #er "ritish #ound E) % dollars #er "ritish #ound 'nswer, E -age Re$, 4%/4( +i$$iculty, Easy 11) When a country;s currency de#reciates d e#reciates ') $oreigners $ind that its ex#orts are more ex#ensi
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1) Which one o$ the $ollowing statements is the M>?T accurate& ') ' de#reciation o$ a country;s currency ma9es its goods chea#er $or $oreigners. ") ' de#reciation o$ a country;s currency ma9es its goods more ex#ensi
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1*) In the year %!1%5 ?hinBo 'be became #rime minister o$ 2a#an5 #romising bold #olicies to im#ro
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1) om#ute how many dollars it would cost to buy an Edinburgh Woolen Woolen Mill sweater costing ! "ritish #ounds $or the $ollowing exchange rates.
'nswer,
-age Re$, 4%/4( +i$$iculty, Easy
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%!) om#ute how many "ritish #ounds it would cost to buy a #air o$ o $ 'merican 'merican designer 6eans costing 74.
'nswer,
-age Re$, 4%/4( +i$$iculty, Easy
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%1) Find the exchange rate between the dollar and the "ritish #ounds $or the $ollowing cases.
'nswer,
-age Re$, 4%/4( +i$$iculty, Moderate
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14.% The Foreign Exchange Mar9et 1) The largest trading o$ $oreign exchange occurs in ') 8ew 3or9. ") :ondon. ) To9yo. +) Fran9$urt. E) ?inga#ore. 'nswer, " -age Re$, 4(/% +i$$iculty, Easy %) Which o$ the $ollowing ty#e o$ $unds cater to wealthy indi
) Which one o$ the $ollowing statements is the M>?T accurate& ') ?#ot exchange rates are always higher than $orward exchange rates. ") ?#ot exchange rates are always alwa ys lower than $orward exchange rates. ) ?#ot exchange rates and $orward exchanges rates are always eGual. +) ?#ot exchange rates and $orward exchanges rates are eGual when the
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) The $ollowing is an exam#le o$ Radio ?hac9 hedging its $oreign currency ris9 ') needing to #ay 5!!! yen #er radio to its su##liers in a month5 Radio ?hac9 ma9es a $orward/ exchange deal to buy yen. ") needing to #ay 5!!! yen #er radio to its su##liers in a month5 Radio ?hac9 ma9es a $orward/ exchange deal to sell yen. ) needing to #ay 5!!! yen #er radio to its su##liers in a month5 Radio ?hac9 buys yen at a s#ot/exchange 1 month $rom now. +) needing to #ay 5!!! yen #er radio to its su##liers in a month5 Radio ?hac9 sells yen at a s#ot/exchange 1 month $rom now. E) needing to #ay 5!!! yen #er radio to its su##liers in a month5 Radio ?hac9 sells yen in a $orward/exchange deal. 'nswer, ' -age Re$, 4(/% +i$$iculty, Easy 1!) Which o$ the $ollowing is 8>T an exam#le o$ a $inancial deriT a ma6or actor in the $oreign exchange mar9et& ') cor#orations ") central ban9s ) commercial ban9s +) non/ban9 $inancial institutions E) tourists 'nswer, E -age Re$, 4(/% +i$$iculty, Easy
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1) "y '#ril %!1! ') only about 1! #ercent o$ $oreign exchange trades were against euros. ") only about %4 #ercent o$ $oreign exchange trades were against euros. ) only about #ercent o$ $oreign exchange trades were against euros. +) only about 4% #ercent o$ $oreign exchange trades were against euros. E) only about (! #ercent o$ $oreign exchange trades were against euros. 'nswer, -age Re$, 4(/% +i$$iculty, Easy 14) Which o$ the $ollowing statements is TRE about a
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1*) Exxon Mobil wants to #ay 1(!5!!! to a Jerman Jerman su##lier. They get an exchange rate rate Guotation $rom its own commercial ban9 and instructs it to debit their dollar account and #ay 1(!5!!! to the su##lier;s Jerman account. I$ the exchange rate Guoted is 71.% #er euro5 how much is debited to Exxon Mobil;s account& ') 71(!5!!! ") 71*%5!!! ) 710!5!!! +) 71%5!!! E) 71!5!!! 'nswer, + -age Re$, 4(/% +i$$iculty, Easy 10) Who are the ma6or #artici#ants in the $oreign exchange excha nge mar9et& 'nsw 'nswer er,, @1) omme ommerc rcia iall ban9s ban9s @%) or#or or#orati ations ons @) 8onban9 $inanci $inancial al instituti institutions ons @4) entral entral ban9s ban9s -age Re$, 4(/% +i$$iculty, Easy 1) Ex#lain what is a C
'nswer, To show that s#ot and $orward exchange rates are in general close to each other. -age Re$, 4(/% +i$$iculty, Easy
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%1) Ex#lain the #ur#ose o$ the $ollowing $igure 14/% $rom the text in the context co ntext o$ the interest rates on the dollar and the 2a#anese 3en 3en between 10! and %!1!.
'nswer, ?ince the dollar and the 3en 3en interest interest rates are not measured in com#arable terms5 they can mo
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) What is the ex#ected dollar rate o$ return on euro de#osits i$ today;s exchange rate is 71.1(* 71 .1(* #er euro5 next year;s ex#ected exchange rate is 71.1! #er euro5 the dollar interest rate is 1!D5 and the euro interest rate is D& ') 1!D ") 11D ) /1D +) !D 'nswer, -age Re$, %/(1 +i$$iculty, Easy 4) The dollar rate o$ return on euro de#osits is ') a##roximately the euro interest rate #lus the rate o$ de#reciation o$ the dollar against the euro. ") a##roximately the euro interest rate minus the rate o$ de#reciation o$ the dollar against the euro. ) the euro interest rate minus the rate o$ in$lation against the euro. +) the rate o$ a##reciation o$ the dollar against the euro. E) the euro interest rate #lus the rate o$ in$lation against the euro. 'nswer, ' -age Re$, %/(1 +i$$iculty, Easy ) I$ the dollar interest rate is 1! #ercent and the euro interest rate is ( #ercent5 then an in
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*) I$ the dollar interest rate is 1! #ercent5 the euro interest rate is ( #ercent5 then ') an in
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1!) ' the beginning o$ %!1%5 you #ay 71!! $or a share o$ stoc9 that then #ays you a di
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1) For the $ollowing 1 cases5 com#are the dollar rates o$ return on dollar and euro de#osits.
'nswer,
-age Re$, %/(1 +i$$iculty, Moderate 10 o#yright %!1 -earson Education5 Inc.
14) For the table below calculate the EK'T relationshi#.
'nswer,
-age Re$, %/(1 +i$$iculty, Moderate 1 o#yright %!1 -earson Education5 Inc.
1) 'ssume 'ssume that the euro interest rate is constant at a t #ercent5 and that the ex#ected exchange rate is 1.! dollars #er one euro. Find the ex#ected dollar return on o n euro de#osits $or the $ollowing cases.
'nswer,
-age Re$, %/(1 +i$$iculty, Moderate
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1() sing the data in the table abo
-age Re$, %/(1 +i$$iculty, Moderate
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1*) +etermine $or each5 whether the interest #arity condition holds or not5 i$
1.1!
'nswer,
-age Re$, %/(1 +i$$iculty, Moderate 14.4 EGuilibrium in the Foreign Exchange Mar9et 1) Which one o$ the $ollowing statements is the M>?T accurate& ') ?ince dollar and yen interest rates are measured in com#arable terms5 they can mo
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%) ?u##ose that the one/year $orward #rice # rice o$ euros in terms o$ dollars is eGual to 71.11 #er euro. Further5 assume that the s#ot exchange rate is 71.! #er euro5 and the interest rate on dollar de#osits is 1! #ercent and on euro it is 4 #ercent. nder these assum#tions ') interest #arity does not hold. ") interest #arity does hold. ) it is hard to tell whether interest #arity does or does not hold. +) 8ot enough in$ormation is gi
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-age Re$, (1/( +i$$iculty, Easy 4) Ex#lain why the interest #arity condition must hold i$ the $oreign exchange mar9et is in eGuilibrium. 'nswer, The $oreign exchange mar9et is in eGuilibrium when de#osits o$ all currencies o$$er o$$er the same ex#ected rate o$ return. -otential holders o$ $oreign currency de#osits
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) alculate the interest rate in the nited ?tates5 i$ interest #arity condition holds5 $or the $ollowing 1 cases.
'nswer,
-age Re$, (1/( +i$$iculty, Moderate
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() alculate the interest rate in the euro Bone i$ interest #arity condition holds5 $or the $ollowing 1 cases.
'nswer,
-age Re$, (1/( +i$$iculty, Moderate
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*) 'ssume 'ssume the .?. interest rate is 1! #ercent5 #e rcent5 and the interest rate on euro de#osits is #ercent. For the $ollowing exchange rates5 $ind the $orward exchange rates.
'nswer, sing the co
-age Re$, (1/( +i$$iculty, Moderate
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0) alculate the Ex#ected +ollar +e#reciation Rate against the euro and the ex#ected dollar return on euro de#osits i$ the ex#ected exchange rate is 71.1! #er euro.
'nswer,
-age Re$, (1/( +i$$iculty, Moderate 14. Interest Rates5 Ex#ectations5 and EGuilibrium 1) Which one o$ the $ollowing statements is the M>?T accurate& ') ' rise in the interest rate o$$ered by dollar de#osits de#o sits causes the dollar to a##reciate. ") ' rise in the interest rate o$$ered by dollar de#osits causes the dollar to de#reciate. ) ' rise in the interest rate o$$ered by dollar de#osits does not a$$ect the .?. dollar. +) For a gi
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%) Which one o$ the $ollowing statements is the M>?T accurate& ') For a $ixed interest rate5 a rise in the ex#ected $uture exchange rate causes a rise in the current exchange rate. ") For a $ixed interest rate5 a rise in the ex#ected $uture exchange rate causes a $all in the current exchange rate. ) For a $ixed interest rate5 a rise in the ex#ected $uture exchange rate does not cause a change in the current exchange rate. +) For a gi
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) +iscuss the e$$ects o$ a rise in the dollar interest rate on the exchange rate. 'nswer, There are two e$$ects to consider. ' rise in the interest rate o$$ered by dollar de#osits combined with a constant ex#ected exchange rate will cause the dollar to a##reciate @see Figure 14/ $rom the text). Howe
Figure 14/
Figure 14/( -age Re$, ((/*! +i$$iculty, Moderate
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4) +iscuss the e$$ects o$ a rise in the interest rate #aid by euro de#osits on the exchange rate. 'nswer, There are two e$$ects to consider. consider. I$ we ma9e the unrealistic assum#tion assum#tion that the ex#ected exchange rate will not change5 then a rise in the interest rate #aid by Euro de#osits de#o sits causes the dollar to de#reciate. Howe
-age Re$, ((/*! +i$$iculty, Moderate ) Ex#lain why @holding interest rates constant)5 a rise in the ex#ected de#reciation in a country;s currency leads to de#reciation o$ that currency today. 'nswer, ' rise in the ex#ected de#reciation rate o$ the dollar raises the ex#ected dollar return on euro de#osits. 8ow5 there are excess su##ly o$ dollar de#osits @euro de#osits o$$er higher ex#ected rate o$ return than do dollar de#osits). The dollar must de#reciate to remo
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() ?how gra#hically a dro# in the interest rate #aid by euro de#osits. de#o sits. What is the e$$ect on the dollar& 'nswer, ' dro# in the interest rate $rom R17 to R%7 causes the dollar to de#reciate $rom @#oint %) to
@#oint 1). @?ee Figure 14/ $rom the text.)
-age Re$, ((/*! +i$$iculty, +i$$icult
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*) ?how gra#hically a dro# in the interest rate o$$ered by dollar de#osits5 R 75 and the e$$ect on the exchange rate5 . 'nswer, ' dro# in the interest rate #aid by euro de#osits causes the dollar to a##reciate $rom @#oint %) to
@#oint 1). The ex#ected $uture exchange rate also dro#s. @?ee Figure 14/(
$rom the text.)
-age Re$, ((/*! +i$$iculty, +i$$icult 14.( '##endix to to ha#ter 14, Forward Exchange Rates Rates and o
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%) The co
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