1. a. Suppose the dollar/Real exchange rate is fixed but Brazilian prices are rising faster than U.S. prices. Is the Brazilian appreciating or depreciating in real terms?

b. If the dollar is appreciating against the British pound in nominal terms but depreciating against the pound in real terms, what do we know about British and U.S. inflation rates?

c. Suppose the nominal peso/dollar exchange rate is fixed. If the inflation rates in Mexico and the United States are constant (but not necessarily equal in both countries), will the real value of the peso/dollar exchange rate also be constant over time?

d. Does it make sense to borrow during times of high inflation because you can repay the loan in cheaper dollars?

2. Monica and Stephanie have started their own foreign currency trading desk and specialize in cross-rate arbitrage. They notice the following quotes:

Swiss francs/dollar                        = SFr 1.5965/$

Australian dollar/dollar                   = A$1.8230/$

Australian dollar/Swiss franc           = A$1.1445/SFr

a. Ignoring transaction costs, do they have an arbitrage opportunity based on these quotes?

b. If there is an arbitrage opportunity, what steps should John take to make an arbitrage profit, and how much will be the profit if he has $1,000,000 available for this transaction?

c. Describe the impact on exchange rates of this arbitrage transaction. Explain in detail.

3. Mashira Stevens is trying to understand the factors that cause exchange rates to change. For each of the following scenarios, say whether the value of the dollar will appreciate, depreciate, or remain the same relative to the Japanese yen. Explain each answer. Assume that the exchange rates are free to vary and that other factors are held constant.

I. The growth rate of national income is higher in Japan than in the United States

II. U.S. wages rise relative to Japanese wages, while American productivity falls behind Japanese productivity

III. Prices in Japan and United States are rising at the same rate

IV. Real interest rates are higher in Japan than in the United States

V. Japan imposes import duties on goods imported from the U.S. and U.S. does not retaliate

4. a. Suppose Arielle is in charge of handling foreign currency cash flows for Carla, Inc. She receives quotes of $0.1464-$0.1471 for the Chinese yuan and $0.1282 - $0.1290 for the Hong Kong dollar.

I. How many U.S. dollars will Julie receive from the sale of Yuan75 million?

II. What is the U.S. dollar cost to Julie of buying Yuan1 billion?

III. How many HK$ will Julie receive for USD500,000?

IV. How many yuan will Julie receive for HK$200 million?

V. What is the yuan cost to Julie of buying HK$80 million?

b. Dominic is an advisor to many Asian governments on intervention in the foreign exchange markets to influence exchange rates. On the advice of Mr. Acosta, these governments have attempted to promote their export competitiveness by holding down the values of their currencies through foreign exchange market intervention.

I. What is the likely impact of this policy on Asian foreign exchange reserves? On Asian inflation? On Asian export competitiveness? On Asian living standards?

II. Some Asian countries have attempted to sterilize their foreign exchange market intervention by selling bonds. What are the likely consequences of sterilization on interest rates? On exchange rates in the longer term? On export competitiveness?