1. The text lists 4 economic factors that determine the exchange rate over the long run. Briefly describe each of these factors.

Transcription

1 Study Questions for Week The text lists 4 economic factors that determine the exchange rate over the long run. Briefly describe each of these factors. 2. Examine table 2.2. What does the author mean by the phrase US preferences increase and why would this lead to a depreciation of the US dollar? 3. Examine figure 12.2 on page400. Explain each of the 8 outcomes (effects) on the long run exchange rate for the US$. For each of the 8 cases, draw the corresponding S&D diagram. 4. State the law of one price. Suppose the price of wheat in Canada is $5 (Canadian dollars) per bushel. The price of wheat in the US is $6 (US dollars). The exchange rate is currently $.95(Canadian) per US $. Is the price in Canada too high or too low? How much profit could you make buying one bushel of wheat in Canada and selling it in the US? When traders start buying Canadian wheat and selling it in the US, what will happen to the price of wheat in Canada?, the price in the US? 5. Suppose the average price of a Big Mac in the United States is $3.50 while in Japan the average price is 400 yen. If the price of a dollar is 100 yen per dollar, the purchasing power parity model of exchange rate determination suggests: The yen is currently (overvalued, undervalued) and the exchange will eventually change to a rate (greater than, less than) 100 yen per US$. 6. Inspect table According to these data for 2005, the price of a Big Mac is highest in ( ). 7. Inspect table Which currencies are overvalued the most, the least. Now check to see what has happened over time. Inspect the Big Mac Index for Did things change as predicted? 8. What is purchasing power parity? How is this related to the Big Mac index? 9. Examine the data which present national income per capita, compared to the US, using two methods; converting by the exchange rate, and converting by common prices (a ppp like method). Summarize the results for richer countries like Norway and Switzerland. Now summarize the results for poorer countries like China and Thailand. Compare the differences in results. 10. The chart below shows GNP per capita on the vertical axis measured using the World Bank PPP index. Per capita GNP is on the horizontal axis. Each red dot shows the data point for one country. The little blue circles show the 45 degree line where GNP (ppp)=gnp(not using PPP). Countries above the 45 degree line have a GNP (ppp) higher than GNP (not ppp). Which types of countries tend to lie above the 45 degree line? Which tend to lie below it?

2 7. The author states that the evidence presented in table 12.4 are consistent with the predictions of PPP. Explain why these data are consistent with PPP. 8. Examine the data presented in Figure 12.3 rates of British rates of inflation have been (higher, lower) than US rates of inflation. As a result the British pound has (appreciated, depreciated) during the period Examine table If the British interest rate increases, in the (short, long) run, the pound will (appreciate, depreciate). 11. Examine Figure In panel a, what causes the demand for pounds to increase? What causes the supply curve for pounds to decrease? 12. According to your text, does the large US current account deficit cause the dollar to depreciate? 13. Exchange rate overshooting can occur when. Some Practice MC questions: 1. Which of the following choices for an investor starts with dollars and wants to end up with dollars is an example of covered international investment? a. Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and sign a forward exchange contract to buy the foreign currency.

3 b. Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and sign a forward exchange contract to buy dollars. c. Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and then buy dollars at the future spot rate. d. Buy a dollar-denominated financial asset. 2. Suppose the interest rate on 6-month treasury bills is 7 percent per year in the United Kingdom and 4 percent per year in the United States. If today s spot price of the pound is $2.00 while the 6-month forward price of the pound is $1.98. By investing in U.K. treasury bills rather than U.S. treasury bills, and covering exchange rate risk, U.S. investors earn an extra return for the 6 months of: a. 0.5 percent b. 1.5 percent c. 2.5 percent d. 3 percent 3. A decrease in the foreign interest rate relative to the domestic interest rate the exchange rate value of a foreign currency in the short run. a. Raises b. Lowers c. Does not affect d. Depreciates 4. In the short run, an increase in interest rates in the United States will lead to: a. Depreciation of the dollar. b. Outflows of capital from the United States. c. Capital inflows into the United States. d. A decrease in the demand for dollar-denominated financial assets. 5. Suppose the average price of a Big Mac in the United States is $3.50 while in Japan the average price is 400 yen. If the price of a dollar is 100 yen per dollar, the purchasing power parity model of exchange rate determination suggests: a. The yen is overvalued. b. The yen is undervalued. c. The price of a Big Mac in Japan will rise. d. The dollar will depreciate against the yen. 6. Domestic currency when the domestic inflation rate is greater than the foreign rate of inflation. a. Depreciates in the long-run b. Appreciates in the long-run c. Remains unchanged in the long-run. d. Appreciates in the short-run but depreciates in the long-run. 7. Exchange rates are determined in the long-run by: a. Interest rate differentials. b. Real growth rates. c. Purchasing power parity.

4 d. Financial asset pricing. 8. The exchange rate is the market rate between two currencies. a. Nominal b. Real c. Purchasing Power 9. The exchange rate is a weighted average of the real bilateral exchange rates across a number of foreign countries. a. Nominal b. Real bilateral 10. According to the Financial Times rating of MBA programs, one difficulty in comparing starting salaries for different MBA programs is that a. Many MBAs are unemployed b. Many MBAs earn unreported perks c. Converting salaries using exchange rates doesn t account for price differences in different countries. d. Different countries have different tax rates.

5 Answers to MC 1 B 2 A 3 B 4 C 5 A 6 A 7 C 8 A 9 D 10 C