Chapter 10
( 1+i ) =
( 1 + i* ) F/R
Suppose that the U.S. Open ticket costs $100 and the British Open ticket costs £50 and the exchange rate is $1.43. How much does the British Open ticket cost for an American attending the British Open?
$71.50
50% of all FX transaction
large commercial banks
Forward value =
P(1+i)
F =
[(1+i) R] / ( 1 + i*)
output of all final goods and services
aggregate supply
Suppose that the nominal exchange rate between the U.S. dollar and the Canadian dollar is 0.75 U.S. dollars per Canadian dollar. If Canada's rate of inflation is 0 percent and the U.S. rate is 10 percent, then the real exchange rate for the U.S. dollar will
appreciate by about 9 percent.
All else equal and given the current system of exchange rates, if the United States enters a period of exceptionally strong growth,
the pressure on the dollar is to depreciate.
Covered interest arbitrage involves both
the purchase of a foreign asset and a forward contract in the market for foreign exchange
Holding nominal exchange rates constant, if inflation in Europe exceeds inflation in the United States,
the real exchange rate ($/€) will rise, and the euro will buy more in the U.S.
When the purchasing power of currencies is the same,
the real exchange rate is equal to the nominal exchange rate
Participants in the Exchange Market
-Large commercial Banks -Non-bank financial institutions -Large non-financial businesses -Central Banks
Which of the following is true?
A soft peg is when a currency's exchange rate is only allowed to fluctuate within a set band.
Which of the following defines a flexible exchange rate?
An exchange rate determined by the market
Which of the following defines a soft peg?
An exchange rate that fluctuates within a set brand
Which of the following defines a hard peg?
An exchange rate that is not allowed to vary
If inflation is higher in the home market, what is expected to happen to the real value of the home currency as time passes?
Appreciates
What happens to the graph when there is Exp dec in European GDP
Dec Demand for euros Inc Supply of euros USD → appreciates EUR→ depreciates
What happens to the graph when there is USD expected to appreciate
Dec Demand for euros Inc Supply of euros USD → appreciates EUR→ depreciates
What happens to the graph when there is Rise in Ius
Dec demand for euros Inc supply of euros USD → appreciates EURO → depreciates
a monetary system that allows the exchange rate to be determined by supply and demand
Flexible/ Floating Exchange Rate System
the rate of exchange, agreed upon now, for a foreign exchange market transaction that will occur at a specified date in the future
Forward Exchange Rate
What happens to the graph when there is rise in US Prices
INC Demand for euros DEC Supply of euros USD → depreciates EUR→ appreciates
What happens to the graph when there is actual rise in US GDP
Increase demand for euros Supply of euros - unchanged USD → depreciates EUR→ appreciates
Which of the following is a FALSE statement concerning purchasing power parity?
It is rare to see deviations from the purchasing power parity value of currencies.
Which of the following is a FALSE statement concerning purchasing power parity?
It is rare to see deviations from the purchasing power parity value of currencies.
Suppose that there are only two countries, the U.S. and Japan. If real interest rates rise in Japan, which of the following is NOT true?
More Japanese yen will be supplied in exchange for dollars.
the current price level in the market to directly exchange one currency for another, for delivery on the earliest possible value date
Spot Exchange Rate
The nominal interest rate in the U.S. is 5% and the nominal interest rate in Canada is 3%. The spot value of the U.S. dollar is 1 ($/Canadian dollar) and the forward rate is 1.2 ($/Canadian dollar). Which of the following is NOT true?
The dollar is likely to appreciate in spot markets.
The real exchange rate is defined as
The market exchange rate adjusted for price differences.
According to the text, which of the following factors may make the theory of purchasing power parity unrealistic?
Trading countries may stop exchanging goods once prices between them equalize.
Demand for Euros is determined by
YUS = US income Pus / PEUR = price level in US relative to EUR Ius = interest rate in US I EUR = interest rate in EUR Expected future asset price in US and Europe (Which is determined by expected incomes Exp YUS and Exp YEUR)
When most shocks originate in the monetary sector, it is generally better to have
a fixed rate system
When most shocks to the economy are external, it is generally better to have
a flexible rate system.
the sum of expenditures on final goods and services by households, businesses, governments and foreigners
aggregate demand
an increase in value
appreciation
if domestic currency appreciates, exports
are more expensive
Suppose the exchange rates between the United States and Canada are in long-run equilibrium as defined by the idea of purchasing power parity. If the law of one price holds perfectly, then differences between U.S. and Canadian rates of inflation would
be completely offset by changes in the nominal exchange rate.
Which of the following is incorrect. An increase in the U.S. demand for the Mexican peso
causes Mexican goods to be cheaper.
if domestic currency appreciates, imports are
cheaper
if the domestic currency depreciates, exports are
cheaper
Soft pegs that are periodically adjusted are called
crawling pegs
Exp rise in Yus→
dec demand for euros boom--> want to be holding US stocks
Exp fall in YEUR→
dec demand for euros recession in europe --> want to have US assets
fall in expected eUSD/EUR (aka exchange rate; its cheaper to buy USD; USD depreciates) →
dec demand in euros depreciation of euro app of us dollar want to be holding US dollars
exp fall in Yus
dec in supply of euros
exp rise in yeur
dec in supply of euros euro is more attractive
rise in PUS =
dec supply of euro Europeans want to buy cheap European goods
Fall in YEUR =
dec supply of euro europeans are buying less of everything
EXP rise in e USD/EUR =
dec supply of euros US expected to depreciate so europeans dont want to own it
fall in PEUR =
dec supply of euros europeans buy cheap european goods
fall in IUS relative to IEUR =
dec supply of euros europeans want european assets
if domestic currency appreciates, net exports
decrease
Rise in PEUR
decrease demand for euros buy cheap domestic goods
Rise in IUS relative to IEUR →
decrease demand for euros shift to american assets
Fall in YUS→
decrease in demand for euros Americans buy less of all goods
If the nominal exchange rate does not change, but U.S. prices rise, the real exchange rate has ________, and U.S. imports are likely to ________.
decreased; rise
decrease in value
depreciate
Suppose that the nominal exchange rate between the U.S. dollar and the Mexican peso is 0.10 dollars per peso. If Mexico's inflation is 10 percent and the United States' inflation is 0 percent, from the U.S. point of view, the real exchange rate
depreciates to 0.11 dollars per peso
Suppose the dollar is subject to a floating exchange rate system and that R is the number of dollars per unit of foreign exchange. If R increases, then the dollar
depreciates.
A firm that buys foreign exchange in order to take advantage of higher foreign interest rates is
engaging in interest rate arbitrage.
if the domestic currency depreciates, imports are
expensive
Fall in P(rice)US→
fall in demand for euros buy cheaper domestic goods
the value of a nation's money is set equal to a fixed amount of another country's currency
fixed exchange rate system
In the short run, exchange rates are most directly affected by which of the following?
flows of financial capital
exchange rate is not allowed to vary
hard peg
I =
i* + (F-R)/R
Exp fall in Yus→
inc dem euros recession → purchase european stocks
Exp rise in YEUR→
inc demand for euros boom in europe→ european stocks are more attractive
Rise in expected eUSD/EUR (aka exchange rate; its cheaper to buy USD; USD depreciates) →
inc demand for euros want to be holding EUR
Exp rise YUS =
inc supply of euro
EXP fall in e USD/EUR =
inc supply of euro US expected to appreciate
Exp fall YEUR
inc supply of euro euro equities less attractive
Fall in PUS =
inc supply of euro europeans buy cheap US goods
Rise in PEUR =
inc supply of euro europeans buy cheap US goods
Rise in IUS relative to IEUR =
inc supply of euro europeans shift to us assets
Rise in YEUR =
inc supply of euro europeans buy more of all goods
if the domestic currency depreciates, net exports
increase
Rise in PUS→
increase in demand for euros shift from US goods to cheap Foreign goods
Rise in YUS→
increase in demand for euros Americans buy more of all goods
Fall in PEUR→
increase in demand for euros shift from US goods to cheap Foreign goods
Fall in IUS relative to IEUR →
increase in demand for euros shift to european assets
what cause cause the aggregate supply curve to shift out?
increase in technological advancements and an increase in resource/resource quality
A reason why fixed exchange rate systems might lower growth is that
inflation may be higher
A single currency area requires
mobile labor and synchronized business cycles
The Bretton Woods exchange rate system was an example of a
modified gold standard.
Under a pure gold standard,
nations must buy and sell gold to settle international obligations.
If the dollar/pound exchange rate is $2/£, a Big Mac costs $5 in New York City and costs £4 in London, the pound is ________, and U.S. tourists will be ________.
overvalued; better off in New York
price changes in fixed markets are called
revaluation - value increase devaluation - value decrease
exchange rate is set within a band
soft peg
An American firm that buys foreign exchange because its managers expect the dollar to depreciate is
speculating.
Demand for USD →
supply of EURO
Purchasing Power Parity (PPP) implies
that in the long run, a given amount of money can buy the same amount of goods, whether they are purchased at home or abroad.
Under a fixed exchange standard, if the domestic demand for foreign exchange increases,
the central monetary authority must meet the demand out of its reserves.
All else equal, if Canada raises its interest rates,
the dollar depreciates.
In order to protect against foreign exchange risk, firms can use
the forward market for foreign exchange.
Economic research using data from the 1990s has shown that
there is no clear relationship between the exchange rate system and growth.
The traditional view of fixed rate systems was that
they improved inflation but were worse for growth.
The biggest disadvantage of a fixed exchange rate is the
tradeoff between supporting the exchange rate and maintaining economic growth.
If the dollar/pound exchange rate is $2/£, a Big Mac costs $5 in New York City and costs £2 in London, the pound is ________, and U.S. tourists will be ________.
undervalued; better off in London
