Chapter 10 – Foreign Exchange
94. Please state whether you agree or disagree with the following statement, and why: “An
increase in the price level of a country, relative to another country’s price level, will cause its
currency to appreciate.”
95. The price of a Big Mac in the U.S. is $2.00; the price in France is 3.35 euros. The current
exchange rate is 1.05€/$. What is the real exchange rate?
96. In looking at the foreign exchange rates in the Wall Street Journal you notice the dollar-
euro spot rate is 1.085€/$ and the six–month forward rate is 1.098€/$. What does this imply?
Chapter 10 – Foreign Exchange
97. The same laptop computer cost $2,000 in the United States, 220,000 Japanese yen,
1,300 British pounds, and € 1900 in Germany. If the law of one price holds, what are the
yen/$; /$ and €/$ exchange rates?
98. Explain why the law of one price may best be applied to financial assets.
99. In theory, the law of one price makes a lot of sense. So why do we see it fail so often?
Chapter 10 – Foreign Exchange
100. Explain why a real exchange rate that does not equal one implies purchasing power
parity does not hold.
101. A basket of goods cost $100 in the U.S. and 65 in the United Kingdom. If Purchasing
Power Parity holds, what is the dollar-pound exchange rate?
Chapter 10 – Foreign Exchange
102. What is the link between purchasing power parity, inflation and the exchange rate?
103. Chapter 10 presented data on 71 countries’ inflation rates relative to the U.S. rate of
inflation and the percent change in the exchange rate for the years 1980-2005. What was the
relationship between these two variables?
104. Chapter 10 presents the Big Mac Index. While it is a clever illustration, the Big Mac
Index is not really a good example to use to explain the theory of purchasing power parity.
Why not?
Chapter 10 – Foreign Exchange
105. If a country is running a current account deficit year after year, what should we expect to
happen to the exchange rate for that country? Explain.
106. For many years now the United States has been running large current account deficits.
What do you know about the capital account for the United States and what you predict for
the exchange rate in the future? Explain.
107. Considering the foreign exchange market, specifically the market for U.S. dollars and
British pounds, who is supplying dollars in this market?
Chapter 10 – Foreign Exchange
108. Using a model of supply and demand for the dollar-pound market, where the horizontal
axis is labeled quantity of British pounds, explain what happens when Americans have an
increased demand for British automobiles.
109. Considering the market for U.S. dollars and Japanese yen, where the horizontal axis is
the quantity of dollars, explain what is likely to happen to the demand and supply of dollars,
as well as the exchange rate, if U.S. interest rates rise relative to Japanese rates.
110. Assume that currently one $U.S. will purchase 0.65. Investors believe that one year
from now a dollar will purchase 0.72. If we consider the dollar-pound market, where the
horizontal axis measure the quantity of pounds, explain what we are likely to see in terms of
demand and supply and the exchange rate.
Chapter 10 – Foreign Exchange
111. Considering the foreign exchange market, identify four causes for an increase in the
supply of dollars.
112. Considering the foreign exchange market, identify at least four causes for a decrease in
the demand for dollars.
113. The government of a country that is experiencing strong currency appreciation might
find itself under pressure from some of its own citizens. Who would be likely to be bringing
pressure and why?
Chapter 10 – Foreign Exchange
10–40
114. Explain why the changes we observe in nominal exchange rates in the short run must be
due primarily to changes in the real exchange rate.
115. During the latter 1990s and into the early 2000s, the U.S. stock market boomed reflecting
rapid growth in the U.S. economy. In terms of demand for and supply of dollars, explain what
possible impacts this rapid increase in stock market values could have on the exchange rate.
Essay Questions
Chapter 10 – Foreign Exchange
116. Briefly describe the foreign exchange market.
117. Explain how a currency speculator would use something like the Big Mac Index in order
to make a profit trading currencies.
Chapter 10 – Foreign Exchange
118. Is it possible for a country to run a trade deficit and yet have the value of its currency not
change? Use a supply and demand model of a foreign exchange market to explain how this
could occur.
119. In the spring of 2002, the Japanese Ministry of Finance intervened in the foreign
exchange market by selling yen and purchasing dollars. Why? And why did the intervention
fail?
Chapter 10 – Foreign Exchange
120. Explain why many industrialized countries do not often intervene in the foreign
exchange market.