1) Mexico tends to have much higher inflation than United States, as well as much higher interest rates. Inflation and interest rates are much more volatile in Mexico than in industrialized countries. The value of Mexican peso is normally more volatile than currencies of industrialized countries from a U.S. perspective; it has classically depreciated from one year to next, but degree of depreciation has varied substantially. Bid/ask spread tends to be wider for peso than for currencies of industrialized countries.

a) Recognize the most clear economic reason for persistent depreciation of peso.

b) High interest rates are usually expected to strengthen the country’s currency as they can encourage foreign investment in securities in that country, that results in exchange of other currencies for that currency. Yet peso’s value has denied against dollar over most years, even though Mexican interest rates are classically much higher than U.S. interest rates. Therefore it appears that high Mexican interest rates don’t attract substantial U.S. investment in Mexico’s securities. Why do you think U.S. investors do not try to capitalize on high interest rates in Mexico?

c) Why do you think bid/ask spread is higher for pesos than it is for currencies of industrialized countries? How does this affect U.S. firm which does substantial business in Mexico?