Suggested answers to case study discussion questions
PPP from Time to Time: In the 1950s and 1960s, the major countries had fixed exchange rates
between their currencies, and these countries generally had rather low inflation rates. In this
setting any deviations from PPP were rather small and slow to develop. Essentially, PPP predicts
that the exchange rates between the currencies of countries that have similar inflation rates
should not change much, and fixed exchange rates meant that the exchange rates generally did
not change. Relative PPP held fairly well, but this was not that interesting—it simply seemed to
follow from having fixed exchange rates.
Price Gaps and International Income Comparisons:The list of countries is ordered by
national income per capita using common prices (sometimes called national income per capita at
PPP exchange rates), as shown in the middle column of numbers. Singapore is at the top of the
list because it has the highest value for this common-price income per capita. Yes, national
income per capita for Singapore is lower than the United States (and a number of other countries)
using market exchange rates to convert national income values into the same currency, as shown
in the first column. But, at those market exchange rates, Singapore has surprising low average
prices for goods and services, as shown in the third column. For example, average Singapore
prices are only 69 percent of the prices for the same bundle of goods and services in the United
States. After we adjust for the remarkably low Singapore prices (or, equivalently, for the high
purchasing power of Singapore currency within Singapore), Singapore’s real or
purchasing-power national income per capita is substantially higher than national income per
capita in the United States (and higher than any other country shown).
Suggested answers to end of chapter questions and problems
1. Disagree. First, exchange rates can be quite variable in the short run.
This much variability does not seem to be consistent with the gradual
changes in supply and demand for foreign currency that would occur
2. a. The euro is expected to appreciate at an annual rate of approximately ((1.005 −
b. If the interest rate on 180-day dollar-denominated bonds declines to 3%, then the spot
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3. a. If we use the approximation formula, uncovered interest parity holds
(approximately) when the foreign interest rate plus the expected rate of
appreciation of the foreign currency equals the domestic interest rate.
b. This shifts the uncovered di0erential in favor of investing in
dollar-denominated bonds. The additional demand for dollars in the
4. a. For uncovered interest parity to hold, investors must expect that the rate of change in the
spot exchange-rate value of the yen equals the interest rate differential, which is zero.
b. If investors expect that the exchange rate will be $0.0095/yen, then they expect the yen to
depreciate from its initial spot value during the next 90 days. Given the other rates,
investors tend to shift their investments toward dollar-denominated investments. The
extra supply of yen (and demand for dollars) in the spot exchange market results in a
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forwarded, distributed, or posted on a website, in whole or part.
5. a. Sell pesos. Weaker Mexican exports of oil in the future are likely to
lower the peso’s exchange-rate value.
b. Sell Canadian dollars. The expansion of money and credit is likely to
lower the exchange-rate value of the Canadian dollar because
c. Sell Swiss francs. Foreign investors are likely to pull some investments
6. The law of one price will hold better for gold. Gold can be traded easily so that any price
differences would lead to arbitrage that would tend to push gold prices (stated in a
7. As a tourist, you will be importing services from the country you visit.
You would like the currency of this foreign country to be relatively
8. According to PPP, the exchange rate value of the DM (relative to the dollar) increased
since the early 1970s because Germany experienced less inflation than did the United
States—the product price level rose less in Germany since the early 1970s than it rose in
9. According to purchasing power parity, attaining a stable exchange rate
between the peso and the dollar requires that the Mexican ination
10. a. Because the annual growth rate of the domestic money supply (Ms) is two percentage
points higher than it was previously, the monetary approach indicates that the exchange
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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
b. The faster growth of the country’s money supply eventually leads to a faster rate of
inflation of the domestic price level (P). Specifically, the annual inflation rate will be two
11. a. If we use 1990 as the base year, the nominal exchange rate of $1/pnut
corresponds to a ratio of U.S. prices to Pugelovian prices of 100/100.
b. If the actual exchange rate is $1/pnut in 2013, then the pnut is
12. a. For the United States in 1990, 20,000 = k100800, or k = 0.25.
b. For the United States, the quantity theory of money with a constant k
means that the quantity equation with k = 0.25 should hold in 2013:
65,000 = 0.252601,000. It does. Because the quantity equation
13. If PPP held, the exchange rate (e) should rise steadily by 2 percent per
year for #ve years, ending up 10 percent higher after #ve years. This
matches the path of changes in the domestic price level (relative to the
foreign price level) during these #ve years. PPP does not hold in the
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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
14.a. The tightening typically leads to an immediate increase in the country’s interest rates. In
addition, the tightening probably also results in investors’ expecting that the
exchange-rate value of the country’s currency is likely to be higher in the future. The
b. If everything else is rather steady, the exchange rate (the domestic currency price of
foreign currency) is likely to decrease quickly by a large amount. After this jump, the
15. Because the nominal spot exchange rate declined from 1.5 to 1.3 SFr
per Canadian dollar, the Canadian dollar experienced a nominal
depreciation. However, the Canadian ination rate was greater than
16. No. The change in the nominal e0ective exchange rate is a weighted
average of the changes in the two constituent nominal bilateral
exchange rates. Relative to the Canadian dollar, the euro experienced
a nominal appreciation (the Canadian dollar depreciated from 2.0 euro
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forwarded, distributed, or posted on a website, in whole or part.
Sample assignment
NEW YORKUNIVERSITY
SternSchool of Business
Economics of Global Business
Country Assignment #2
The text of your group’s answers to the assignment should be typed
single-spaced, with an extra space between each paragraph. The text must be
limited to a maximum of four pages. You may also attach additional tables and
charts to this four pages of text, if these tables and charts are of direct
importance to your text discussion.
The group members are not to discuss this assignment with anyone else who is
not in the group (except for consulting reference librarians in order to locate
materials). The group may utilize any published materials — you are not limited
to the sources noted in the assignment description below.
The Assignment
1. What have been the trends in the nominal exchange rate values (annual
averages) of your country’s currency since 1990, relative to the U.S.
dollar? Relative to the U.S. dollar, has the currency of your country tended
to appreciate or to depreciate?
Note: Most likely source of data (for this part and for the next part): IMF,
International Financial Statistics (IFS). Use period-average annual values
of exchange rates.
2. Calculate and report the real exchange rate values (annual averages) of
your country’s currency since 1990, relative to the U.S. dollar. If possible, use
price indexes called “Wholesale Prices,” “Producer Prices,” “Prices: Manufacturing Output,”
or a similar name, even if the names are somewhat different between your country and the
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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
3. You are a U.S. investor who calculates your income and wealth in U.S. dollars. Currently you
have no assets or liabilities denominated in your country’s currency. On the day that you
begin to research your answers to this part, you are considering an uncovered international
financial investment into a debt security denominated in your country’s currency, rather than
investing in a comparable U.S. dollar-denominated debt security.
In your answer to this part, use concepts and tools from the course that are relevant to the
analysis.
Discuss the ingredients that go into your analysis of whether or not to make this uncovered
international financial investment.
What factors suggest that the uncovered international investment is attractive?
What factors suggest that the uncovered international investment is unattractive?
What factors are approximately neutral?
As one part of your answer, refer back to your analysis of the real exchange rate (question 2
of this assignment) and how it could be relevant to your decision.
To conclude your answer to this part, indicate whether or not you would make this uncovered
international financial investment. Explain why you would or would not make the
investment.
Note: There are many possible sources of information and data. You may find information
from various Web sites (such as those for multilateral organizations (including the IFS from
the International Monetary Fund), the central bank or national government of your country,
and so forth). Another source that may be useful is the Economist Intelligence Unit
(eiu.com), including the EIU’sCountry Report.If you use a web site, be sure to consider
whether or not the information for the site is reliable.
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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.