1) Exchange Rate Arbitrage: Suppose that you have $1,000,000 and you observe the following exchange rates: $1.60/1£; 0.80€/$1; and 0.75£/1€.
a. Is there an arbitrage opportunity? If so, explain how you would take advantage of it with your $1,000,000.
b. If the exchange rate between the dollar and the other two currencies stays the same what will happen to the exchange rates between the £ and €? (show your work)
2) Exchange Rates and Purchase Power Parity:
Country Nominal ERfx/$ Price of Basket Price of US Basket ($190) in local currency terms Real Exchange Rate in US
According to PPP, will $ appreciate or depreciate?
Brazil (real) 2.29/$1 520
Reals 435.1
Reals
India (rupee) 59.29/$1 10,000 rupees
Mexico (pesos) 12.95/$1 1,800
Pesos
South Africa (rand) 10.77/$1 2500
Rands
3) Flexible Exchange Rates: Using supply and demand curves for the British Pound ($/£) show how the following events would affect the exchange rate of the Pound under a system of floating rates.
a. British economy grows faster than the U.S.
b. US inflation rate exceeds the British inflation rate.
c. The Central Bank of England sells UK bonds to UK banks.
d. The British reduce their import tariffs on U.S. goods.
e. European investors increase their purchases of U.S. government bonds.
4) Exchange Rate Regimes: Go to Federal Reserve's Economic Data (FRED) at http://research.stlouisfed.org/fred2/ and use the search engine to find the monthly exchange rate data relative to the US dollar for the following:
a. Canadian Dollar from 1980-2009
b. Chinese Yuan from 1999-2005 and 2005-2009
c. Mexican Peso from 1993-1995 and 1995-2009
d. Thailand Baht from 1986-1997 and 1997-2009
e. Venezuela Bolivar from 2003-2009
Look at the graphs and make a judgment as to whether each currency is fixed (peg or band), crawling (peg or band), or floating relative to the US dollar each time frame given.
5) Uncovered Interest Parity:Suppose the interest rate on one year Canadian bonds is 5% while the interest rate on U.S. bonds is 3%. Currently, the spot rate for one Canadian dollar is $1.
a. What is the expected exchange rate for the Canadian Dollar in one year?
b. If all remains the same except U.S. interest rates fall to 2%, what will happen to the Canadian Dollar spot rate? (calculate the change)
c. In part (b) we changed the U.S. interest rate, but what other changes could occur that will have the same effect on the Canadian Dollar spot rate as in part (b)? (calculate the changes)
6) ER and The Quantity Theory of Money: Suppose Japan experiences slow growth of 1% per year while Korea grows at 6% per year. Suppose the Bank of Japan allows the money supply to grow at 2% per year, while the Bank of Korea allows the money supply to grow at 12% per year. To answer the following questions, use the quantity theory of money and assume that V is constant. Assume Korea is the home country.
a. What are the inflation rates in Korea and Japan? (show work)
b. How much do you expect the Korean Won to appreciate or depreciate against the Japanese Yen? (show work)
c. Suppose the Bank of Korea increases the money growth rate from 12% to 15%. If nothing in Japan changes, what will be the effect on the Korean Won? (show work)
7) Balance of Payments: Explain how the following transactions would be entered into the US balance of payments:
a. Macys purchases of $20,000 of wool socks from Australia.
b. An US citizen opens a $1,000 bank account in Switzerland.
c. A German citizen pays $600 with a credit card for her weekend stay at a Hotel in San Francisco
d. A US citizen receives a $2,500 dividend payment on the shares that he owns of BMW, a German company.
e. A disaster relief shipment of food valued at $10,000 from the US to the Philippines.
f. Chevron, a US company, buys $1 billion petroleum from the Saudi Arabian government, and the Saudis use the proceeds to buy a Las Vegas Hotel.
g. China's central bank purchases US dollars from a Chinese Bank.