BUSA 4105, Chapter 8
Eurodollars are:
Dollar deposits in banks outside of the United States are called Eurodollars, and the market where they are bought and sold is called the Eurodollar market. Originally, Eurodollars referred only to dollar deposits in banks in Europe. However, today the term refers to deposits in any bank outside of the United States.
Suppose that the euro rises in value relative to the dollar. What is the likely effect on European exports to the United States? What is the likely effect on U.S. exports to Europe?
European exports to the United States will decrease, while U.S. exports to Europe will increase.
Who would be interested in exchanging yen for dollars?
Japanese companies importing or buying U.S. products.
When a newspaper article uses the term "the exchange rate," it is typically referring to the ____ exchange rate.
Newspapers are generally referring to the nominal exchange rate.
A student makes the following observation: It currently takes 80 yen to buy 1 U.S. dollar, which shows that the United States must be a much wealthier country than Japan. But it takes more than 1 U.S. dollar to buy 1 British pound, which shows that Great Britain must be a wealthier country than the United States. Do you agree with the student's reasoning? Why?
No, exchange rates do not measure the wealth of a country.
What is the difference between the nominal exchange rate and the real exchange rate?
Nominal exchange rates tell you how many, say, euros you will receive in exchange for a U.S. dollar, but they do not tell you how much of another country's goods and services you can buy with that U.S. dollar.
Why is the demand curve for foreign exchange downward sloping?
The demand curve for foreign exchange is downward sloping because as the exchange rate falls, it becomes cheaper to convert a foreign currency into dollars, and there is a larger quantity of dollars demanded. As the exchange rate declines, the foreign currency price of U.S. goods, services, and financial assets becomes relatively less expensive.
Why is the supply curve for foreign exchange upward sloping?
The supply curve for foreign exchange is upward sloping because the quantity of dollars supplied will increase as the exchange rate increases.
Who would be interested in exchanging dollars for yen?
U.S. companies importing or buying Japanese products.
The law of one price states that: How is it related to the theory of purchasing power parity (PPP)?
identical products should sell for the same price everywhere. The law of one price is the basis for the theory of purchasing power parity. PPP is the theory that exchange rates move to equalize the purchasing power of different currencies.
Suppose that an Apple iPhone costs $240 in the United States, £60 in the United Kingdom, and ¥40,000 in Japan. If the exchange rate between the pound and the dollar is $1.20 = £1, the real exchange rate between the pound and the dollar is ____. If the exchange rate between the dollar and the yen is ¥120 = $1, the real exchange rate between the dollar and the yen is ___.
(1.20*60)/240 =.30 (120*240)/40000=0.72
Why are forward contracts more widely used in the foreign-exchange market than are futures contracts?
Forward contracts are used 10 times more than futures contracts because the counterparty risk between big banks is relatively low, and these banks value the flexibility of the forward contract.
Suppose you are convinced that the value of the Canadian dollar will rise relative to the U.S. dollar. An investor might make a profit based on this conviction in all of the following ways, except:
Sell put contracts on the U.S. dollar
According to the theory of purchasing power parity, what should happen to the value of the U.S. dollar relative to the Mexican peso if the following occurs? The United States puts quotas and tariffs on many imported goods.
The peso depreciates relative to the dollar.
Which of the following are reasons why foreign-exchange traders might not find PPP to be useful as they trade currencies day-to-day?
Foreign-exchange traders might not find PPP to be useful as they trade currencies day-to-day because day-to-day movements in currencies are driven by news, short-term economic events, and to a large degree of random movements.
What is the difference between a spot transaction and a forward transaction in the foreign-exchange market?
A forward transaction is trade in the future, and a spot transaction is trade today.
Suppose that the U.S. firm Alcoa sells $2 million worth of aluminum to a British firm. If the exchange rate is currently $ 1.43 = £1 and the British firm will pay Alcoa £1,398,601.40 in 90 days, answer the following questions. What exchange-rate risk does Alcoa face in this transaction? What alternatives does Alcoa have to hedge this exchange-rate risk? To hedge this exchange-rate risk,
Alcoa faces the exchange-rate risk of the British pound falling. Alcoa can use currency futures or enter into a forward contract. It can also buy options contracts. Alcoa can sell £1,398,601.40 for dollars at the forward rate to hedge the risk of the pound falling. That is, Alcoa would agree today to sell the £1,398,601.40 it will receive in 90 days for dollars at the current forward rate. If the current forward rate is the same as the spot rate of $ 1.43 = £1, then Alcoa will have completely hedged its risk.
What are the key differences between foreign-exchange forward contracts and foreign-exchange futures contracts?
Forward contracts are private agreements among traders to exchange any amount of currency on any future date, while futures contracts are traded on exchanges and are standardized, including a stated settlement date. With futures contracts, the exchange rate changes continually as contracts are bought and sold on the exchange, and with forward contracts, the exchange rate is fixed at the time the contract is agreed to.
With respect to the theory of purchasing power parity, the statistics in this table are
If purchasing power parity held for Big Macs, the domestic currency prices (for the non-U.S. countries), when converted into dollars, would not differ markedly from $4.33. Alternatively, it could be said that PPP holds if $4.33, when converted into other currencies, is just sufficient to just purchase a Big Mac in the non-U.S. countries. Clearly this is not the case, as $4.33 can buy anywhere from 0.546 Big Macs in Venezuela to 1.485 Big Macs in Israel.
PPP (Purchasing Power Parity)
PPP is a long-run theory that generally only holds over a long period of time.
According to the theory of purchasing power parity, if the inflation rate in Japan is lower than the inflation rate in Canada, what should happen to the exchange rate between the Japanese yen and the Canadian dollar in the long run?
The Japanese yen will appreciate compared to the Canadian dollar because of the lower inflation in Japan than in Canada.
