Exercise Foreign Exchange Market

1.When the euro appreciates, are you more likely todrink California or French wine?

You are more likely to drink California wine because the euro appreciation makes French wine relatively more expensive than California wine.

2. “A country is always worse off when its currency isweak (falls in value).” Is this statement true, false,or uncertain? Explain your answer

False. Although a weak currency has the negative effect of making it more expensive to buy foreign goods or to travel abroad, it may help domestic industry. Domestic goods become cheaper relative to foreign goods, and the demand for domestically produced goods increases. The resulting higher sales of domestic products may lead to higher employment, a beneficial effect on the economy.

3. If the Japanese price level rises by 5% relative to theprice level in the United States, what does the theoryof purchasing power parity predict will happento the value of the Japanese yen in terms of dollars?

It predicts that the value of the yen will fall 5% in terms of dollars.

4.. If the demand for a country’s exports falls at the sametime that tariffs on imports are raised, will the country’scurrency tend to appreciate or depreciate in the

long run?

In the long run, the fall in the demand for a country’s exports leads to a depreciation of its currency, but the higher tariffs lead to an appreciation. Therefore, the effect on the exchange rate is uncertain.

5.In the mid- to late 1970s, the yen appreciated relativeto the dollar even though Japan’s inflation rate washigher than America’s. How can this be explained byan improvement in the productivity of Japanese

industry relative to American industry?Even though the Japanese price level rose relative to the American, the yen appreciated because the increase in Japanese productivity relative to American productivity made it possible for the Japanese to continue to sell their goods at a profit due to the high value of the yen.

6.If American auto companies make a breakthrough inautomobile technology and are able to produce a carthat gets 60 miles to the gallon, what will happen tothe U.S. exchange rate?

The dollar will appreciate. The increase in U.S. productivity raises the expected future exchange rate and thus raises the expected return on dollar assets at any exchange rate. The resulting rightward shift of the demand curve leads to a rise in the equilibrium exchange rate.

7. If the Indian government unexpectedly announcesthat it will be imposing higher tariffs on foreign goodsone year from now, what will happen to the value ofthe Indian rupee today?

The Indian rupee will appreciate. The announcement of tariffs will raise the expected future exchange rate for the rupee and so increase the expected appreciation of the rupee. This means that the demand for rupee-denominated assets will increase, shifting the demand curve to the right, and the rupee exchange rate therefore rises.

8.If the European Central Bank decides to pursue a contractionary monetary policy to fight inflation,what will happen to the value of the US$?

The 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 expected return on dollar assets. The demand curve will then shift to the left, and the dollar will depreciate.

9.If a strike takes place in France making it harder to buy French goods, what will happen to the value of the US $?

Consider France to be the domestic country. Because it is harder to get French goods, people will buy more foreign goods and the value of the euro in the future will fall. The expected depreciation of the euro lowers the expected return on euro assets at any exchange rate, so the demand curve shifts to the left and the value of the euro will fall.

10. In 1999, the euro was trading at 0.9$ per euro. If the euro is now trading at 1.16$ per euro, what is the percentage change in the euro’s value? Is this an appreciation or a depreciation?

% Change = (1.16 – 0.90)/0.90 = 28.88%The dollar has depreciated by 28.88%

11. The Mexican peso is trading at 10 pesos per dollar. If the expected US inflation rate is 2% while the expected Mexican inflation rate is 23% over the next year, given PPP, what is the expected exchange rate in one year?

Expected rate = 10 × (1.23/1.02) = 12.059 pesos per dollar12. 1. A German sports car is selling for 70,000 euros. What is the dollar price in the United

States for the German car if the exchange rate is 0.90 euros per dollar?

13. The current exchange rate between the Japanese yen and the U.S. dollar is ¥120 per dollar. If the dollar is expected to depreciate by 10% relative to the yen, what is the new expected exchange rate?

120*.9=108 yen per dollar