HW ch15

Chapter 14 – Foreign Exchange Markets and Exchange Rates
Chapter 15 – Exchange Rate Determination

(total 30 points)
Multiple Choice (1 point each)
1. From which of the following does a nation's demand for foreign exchange arise?
A) inflow of foreign investments
B) exports of goods and services to other nations
C) residents visiting foreign countries
D) all of the above
Answer: Page: 366-367
2. From which of the following does a nation's supply of foreign exchange arise?
A) inflow of foreign investment
B) exports of goods and services to other nations
C) investment returns received from abroad
D) all of the above
3. Which of the following would occur if the price level in the US decreases relative to the UK?
A) The US will now find imports from the UK more expensive
B) The demand curve for pound will shift down (to the left)
C) The supply curve for pound will shift down (to the right)
D) All of the above
Answer: Page: lecture notes
4. Which of the following would occur if the interest rate in the US increases relative to that in
the UK?
A) US dollar will appreciate against British pound
B) The demand curve for pound will shift down (to the left)
C) The supply curve for pound will shift down (to the right)
D) All of the above
5. In 2017, banks in which country take the leading role in the foreign exchange market trading?
A) US
B) UK
C) Japan
D) Hong Kong
Answer: Page: 368
1
6. Today, about _____ of foreign exchange trading is used to finance international trade.
A) 10%
B) 25%
C) 50%
D) 90%
Answer: Page: 368
7. If the exchange rate between US dollar and Japanese yen changes from $1 = ¥100 to $1 = ¥80,
the dollar is said to have __________ against yen and the yen has __________ against dollar.
A) appreciated, depreciated
B) depreciated, appreciated
C) appreciated, appreciated
D) depreciated, depreciated
Answer: Page: 371
8. According to the law of one price, in order for commodity arbitrage to equalize the price of
homogeneous traded commodities, it is necessary that which of the following do not exist?
A) Transportation costs
B) Tariffs
C) Nontariff barriers
D) All of the above
Answer: Page: 402
9. If the price for a Big Mac in the US is $2 and the exchange rate between the dollar and the
pound is $1.6=₤1, what should be the price for a Big Mac in the UK according to the law of one
price?
A) ₤3.2
B) ₤2
C) ₤1.25
D) ₤0.8
10. If the price index is 120 in the US and 90 in the UK, what should be the equilibrium
exchange rate between dollar and pound according to the absolute PPP theory?
A) ₤1 = $0.75
B) ₤1 = $1.33
C) ₤1 = $0.25
D) ₤1 = $0.33
Answer: Page: 402
2
11. Suppose the price level in the US is 110 in 2010 and 132 in 2020, and the price level in the
Mexico is 150 in 2010 and 240 in 2020. According to the relative PPP theory, what would
happen to the exchange rate between dollar and Mexican peso over the period of 2010-2020?
A) Dollar depreciates by 25%
B) Dollar depreciates by 33%
C) Dollar appreciates by 25%
D) Dollar appreciates by 33%
Answer: Page: 404
12. Figure 15.2 shows the relationship between changes in relative national price levels and
changes in exchange rates for 18 industrial nations from 1973 to 2017. For which country is the
relative PPP theory clearly violated?
A) Australia
B) Germany
C) Spain
D) All of the above
Answer: Page: 406
13. Which of the following will happen when dollar appreciates in real terms against Chinese
yuan?
A) US exporters gain competitiveness in the Chinese market
B) Imports from China are sold at a lower price in the US
C) Chinese tourists find it cheaper to travel in the US
D) None of the above
14. Which of the following will happen when dollar depreciates in real terms against Chinese
yuan?
A) US exporters gain competitiveness in the Chinese market
B) Chinese investors find it cheaper to invest in the US.
C) US import-competing sectors gain competitiveness against imports from China
D) All of the above
3
Problem Sets
1. (10 points) Purchasing-Power Parity

The following table gives the prices indices in US and EMU in 2010 and 2020. Answer the
following questions.
2010 2020
Price index in US 125 180
Price index in EMU 120 144
A. (2 points) Calculate the PPP exchange rate between dollar and euro in 2020? Express the ex-
change rate as the dollar price per euro.
B. (4 points) Is euro expected to appreciate or depreciate against dollar over the period 2010-
2020 according to the relative purchasing-power parity? What is the expected rate of appreci-
ation or depreciation? Note that the rate of appreciation/depreciation is the PERCENTAGE
change of the exchange rate.
C. (4 points) Suppose the nominal exchange rate NR($/€) is 1 in 2010 and 1.4 in 2020. Did euro
appreciate or depreciate against dollar in nominal terms? What is the rate of appreciation or
depreciation in nominal terms? Calculate the real exchange rate RR($/€) in 2010 and 2020.
Did euro appreciate or depreciate against dollar in real terms? What is the rate of apprecia-
tion or depreciation in real terms?
4
2. (6 points) Monetary Approach to Exchange Rate Determination
The follow table provides the money supply and real output in US and UK in 2010 and 2020.
Assume that V, the velocity of circulation of money is 5 in the US and 4 in UK. Assuming a flex-
ible exchange rate system, answer the following questions according to the monetary approach.
M s in US M ¿s in UK Y in US Y* in UK
2010 6000 1200 15 3
2020 9000 1800 18 4
A. (2 points) Calculate the price levels in US and UK in 2010 and 2020.

B. (2 points) Calculate the exchange rate between dollar and pound in 2010 and 2020.
C. (1 point) Did dollar appreciate or depreciate against pound over the period 2010-2020? Cal-
culate the rate of appreciation or depreciation.
D. (1 point) Is your result in part C consistent with the statement that the currency of a high-in-
flation nation should experience depreciation against that of a low-inflation nation? Explain
briefly.
Hint: Be aware that Y (the real output) changes over time. You must use this information in order
to get the correct price levels in each country (this is part a). Once you have the correct price
levels, you should be able to get the exchange rate in each year (this is part b), which are then
used to calculate the rate of appreciation/depreciation in part c.

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Chapter 14 – Foreign Exchange Markets and Exchange Rates

Chapter 15 – Exchange Rate Determination

Multiple Choice (1 point each)

Answer: Page: 366-367

Answer: Page: 366-367

Answer: Page: lecture notes

Answer: Page: lecture notes

Answer: Page: 368

Answer: Page: 368

Answer: Page: 371

Answer: Page: 402

Answer: Page: 402-404

Answer: Page: 402

Answer: Page: 404

Answer: Page: 406

Answer: Page: lecture notes

Answer: Page: lecture notes

1. (10 points) Purchasing-Power Parity

A. (2 points) Calculate the price levels in US and UK in 2010 and 2020.

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