Homework Assignment - 6 Answers

Homework Assignment 6 Chapter 15 – Questions 1. When the Euro Euro appreciate appreciates, s, are you more more likely likely to drink California or French wine?  You  Y ou are more more likely likely to drink California wine because the euro appreciation makes French wine relatively more epensive than California wine. !. "# country is always worse o$ when its currency currency is is weak %falls in value&.' (s the statement statement true, false or uncertain? Eplain your answer. False. #lthou)h a weak currency has the ne)ative e$ect of makin) it more epensive to buy forei)n )oods or to travel abroad, it may help domestic industry. *omestic )oods become cheaper relative relative to forei)n )oods, and the demand for domestically produced )oods increa increases. ses. +he resultin resultin) ) hi)her sales of domestic products may lead to hi)her employment, a benecial e$ect on the economy. -. (n a newspaper, newspaper, chose chose one echan)e echan)e rate rate from from each of the the re)ions listed in Followin) the Financial ews bo on p-/0. Which of these currencies have appreciated, and which have depreciated since une !-, !212? /. (f the apanese price level level rises by 34 relative relative to the price level in the 5nited 6tates, what does the theory of purchasin) power parity predict will happen to the value of the apanese Yen Yen in terms of 56 dollars? (t predicts that the value of the yen will fall 34 in terms of dollars. 3. (f the demand demand for a country7s country7s eport eports s falls at the same same time time that tari$s on imports are raised, will the country7s currency tend to appreciate or depreciate in the lon) run? (n the lon) run, the fall in the demand for a country7s eports leads to a depreciation of its currency, but the hi)her tari$s lead to an appreciation. +herefore, +herefore, the e$ect on the echan)e rate is uncertain. 8. (n the mid9to9late mid9to9late 1:027s, 1:027s, the yen yen appreciate appreciated d relative relative to the dollar even thou)h apan7s in;ation rate was hi)her than #merica7s. ecause epected 5.6. in;ation falls as a result of the announcement, there will be an epected appreciation of the dollar and so the epected return on dollar assets will rise. #s a result, the demand curve will shift to the ri)ht and the euilibrium value of the dollar will rise. @. (f the >ank of En)land prints money to reduce unemployment, what will happen to the value of the pound in the short run and the lon) run?  +he pound depreciates but overshoots, declinin) by more in the short run than in the lon) run. Consider >ritain to be the domestic country. +he rise in the money supply leads to a hi)her domestic price level in the lon) run, which leads to a lower epected future echan)e rate. (n addition, the rise in the money supply lowers the domestic interest rate on pound assets. >oth of these chan)es lower the epected return on pound assets at any )iven echan)e rate, shiftin) the demand curve to the left. +he short9run outcome is a lower value of the pound. ank decides to contract the money supply to )ht in;ation, what will happen to the value of the 56 dollar vs. the Euro?  +he contraction of the European money supply will increase European interest rates and raise the future value of the euro, both of which will decrease the relative epected return on dollar assets. +he demand curve will then shift to the left, and the dollar will depreciate. 13. (f there is a strike in France, makin) it harder to buy French )oods, what will happen to the value of the Euro? Consider France to be the domestic country. >ecause it is harder to )et French )oods, people will buy more forei)n )oods and the value of the euro in the future will fall. +he epected depreciation of the euro lowers the epected

return on euro assets at any echan)e rate, so the demand curve shifts to the left and the value of the euro will fall.

Chapter 15 – Quantitative Problems 1. # erman sports car is sellin) for 02,222 euros. What is the dollar price in the 5nited 6tates for the erman car if the echan)e rate is 2.:2 euros per dollar? 02,222 euros × %D12.:2 euros& = D00,000.00. !. #n investor in En)land purchased a :19day +9bill for D:@0.83. #t that time, the echan)e rate was D1.03 per pound. #t maturity, the echan)e rate was D1.@- per pound. What was the investor7s holdin) period return in pounds?  +he bond cost D:@0.83D1.03  G38/.-0. #t maturity, the D1,222 is worth D1,222D1.@-  G3/8./3.  +he holdin) period return is %3/8./3 H 38/.-0&38/.-0  H2.2-10. -. #n investor in Canada purchased 122 shares of (>A on anuary 1 at D:-.22 per share. (>A paid an annual dividend of D2.0! on *ecember -1 st. +he stock was sold that day as well for D122.!3.  +he echan)e rate was D2.8@ per Canadian *ollar on anuary 1 and D2.01 per Canadian dollar on *ecember -1. What is the investor7s total return in Canadian dollars?  +he price of each share is D:-.22D2.8@  1-8.08 Canadian dollars.  +he dividend is D2.0!D2.01  1.21/ Canadian dollars  +he sale price is D122.!3D2.01  1/1.!2 Canadian dollars  +he return  %1/1.!2 I 1.21/ H 1-8.08&1-8.08  2.2-:@@ /. +he current echan)e rate is 2.03 euro per dollar, but you believe that the dollar will decline to 2.80 euro per dollar in 19 years time. (f a euro9denominated bond is yieldin) !4, what return do you epect in 56 dollars? (f one takes 122 dollars and converts it into euros one has 03 euros. Jne can then invest this in a euro9denominated bond yieldin) !4. +hus one has 08.3 euros at the end of 1 year. Jne can then echan)e this back into 56 dollars at an echan)e rate of 2.80 eurodollars. +his )ives a value of 11/.1@. +hus the return in 56 dollars is 1/.1@4. 3. +he si9month forward rate between the >ritish pound and the 56 dollar is D1.03 per pound. (f si9month interest rates are -4 in the 5nited 6tates and 132 basis points hi)her in En)land, what is the current echan)e rate? 6pot rate = 1.03 × %1.2/31.2-&K2.3 = D1.08!G 8. (f the Canadian dollar to the 5.6. dollar echan)e rate is 1.!@ C#*56* and the >ritish =ound to 56 dollar echan)e rate is 2.8! >=56*, what must the Canadian dollar to >ritish =ound echan)e rate be?

6pot rate = 1.!@ × %12.8!& = !.28/3 Canadian dollarspound 0. +he L dollar to 56 dollar echan)e rate is 1.-8 L*56*, and the >ritish =ound to 56 dollar echan)e rate is 2.8! >=56*. (f you nd that the >ritish =ound to ew Lealand dollar echan)e rate is 2./: >=L*, what would you do to earn a riskless prot? Echan)e D1.22 into 1.-8 ew Lealand dollars. Echan)e the 1.-8 ew Lealand dollars into 2.888/ >ritish pounds. Echan)e the 2.888/ >ritish pounds into D1.20/@. @. (n 1:::, the Euro was tradin) at D2.:2 per euro. (f the euro is now tradin) at D1.18 per euro, what is the percenta)e chan)e in the Euro7s value? (s this an appreciation or depreciation? 4 Chan)e  %1.18 M 2.:2&2.:2  !@.@@4  +he dollar has depreciated by !@.@@4 :. +he >raNilian Oeal is tradin) at 2.-03 real per 56 dollar. What is the 56 dollar per real echan)e rate? !.8880 56* per real 12. +he Aeican peso is tradin) at 12 pesos per dollar. (f the epected 56 in;ation rate is !4 while the epected Aeican in;ation rate is !-4 over the net year, what is the epected echan)e rate in one year? Epected rate  12 P %1.!-1.2!&  1!.23: pesos per dollar 11. +he current echan)e rate between the 56 and >ritain is D1.@!3 per pound. +he si9month forward rate between the >ritish =ound and the 56 dollar is D1.0:. (f >ritish interest rates are 34 then what are 56 interest rates? #ssume interest rates are of the form ( 1 + r )t  . J+E ( OEWOJ+E +QEA >EC#56E #6 6+#+E*  +ritish =ounds %>=& into 6wiss Francs %Critish =ound %>=& into 6outh #frican Oand %L#O& is 1/.28 L#O>=. 89month interest rates in the 5U are 2.034 and 89month interest rates in 6outh #frica are 3.34. #ssume rates are of the form ( 1 + r )t  a. Would you epect that the forward FV rate to be hi)her or lower than today?