Chapter 10

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( 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


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