Solutions to the End-of-Chapter Questions, Problems, and Data
Exercises
8.1 Exchange Rates and Trade
Learning objective: Explain the difference between nominal and real exchange rates.
Review Questions
1.1 The nominal exchange rate is the price of one country’s currency in terms of another country’s
currency. That is, nominal exchange rates tell you how many yen or euros or Canadian dollars you
1.2 Direct quotations express exchange rates as units of domestic currency per unit of foreign currency.
1.3 European exports will increase because European products will sell for lower dollar prices in the
Problems and Applications
1.6 You should agree. As the euro depreciates, it becomes less expensive for U.S. citizens to travel to
1.7 A change in the exchange rate from ¥75 = $1 to ¥90 = $1 means that the yen has depreciated against
the dollar. The declining value of the yen against the dollar would be good news for Sony because it
1.8 a. A “high yen” means that it takes fewer yen to exchange for one U.S. dollar; that is, the value of the
b. A high yen may cause Japanese goods to sell for a higher price in the domestic currency of the
© 2014 Pearson Education, Inc.
Chapter 8 The Market for Foreign Exchange 92
1.9 a. The exchange rate is the price of one country’s currency in terms of another country’s currency and,
b. A developing country may have a higher percentage of GDP in exports and imports than a
1.10 Applying the expression for the real exchange rate given on page 229 of the text: The dollar-yen real
8.2 Foreign-Exchange Markets
Learning objective: Explain how markets for foreign exchange operate.
Review Questions
2.2 A spot transaction involves exchanging currency immediately, whereas a forward transaction
involves agreeing today to exchange currency in the future. Forward contracts are private
2.3 Exchange-rate risk is the risk that a firm will suffer losses because of fluctuations in exchange rates.
To hedge against a fall in the exchange rate, firms can sell forward or futures contracts, or buy a put
Problems and Applications
2.5 a. To “bid up options” means that fund managers demand more options, raising the price (premium) of
options.
© 2014 Pearson Education, Inc.
Chapter 8 The Market for Foreign Exchange 93
2.6 a. Alcoa faces the exchange-rate risk of the British pound declining in value in exchange for the U.S.
c. Alcoa can sell £1,333,333.33 at the forward rate to hedge the risk of the pound falling. That is, Alcoa
2.7 a. Daimler, the German firm, is exposed to the exchange-rate risk that over the next 90 days the value
b. Daimler can buy euro futures or enter into a forward contract to buy euros. Daimler can, also, buy a
c. Daimler can hedge against a rise in the value of the euro by entering into a forward contract. That is,
2.8 a. ¥250 million in one year/1.04 ¥240.38462 million today; ¥240.38462 million/100 yen per dollar
b. ¥250 million/98 yen per dollar forward rate $2,551,020.40 needed in one year to settle the forward
c. Halliburton doesn’t know. The firm accepts exchange-rate risk because the amount of dollars the
e. We can use the nominal interest parity condition, which states that exchanging currency today at the
8.3 Exchange Rates in the Long Run
Learning objective: Explain how exchange rates are determined in the long run.
Review Questions
3.1 The law of one price is the fundamental economic idea that identical products should sell for the same
© 2014 Pearson Education, Inc.
Chapter 8 The Market for Foreign Exchange 94
Problems and Applications
3.4 Foreign-exchange traders might not find purchasing power parity useful as they trade currencies
3.5 No, Reinhardt is likely to have used the purchasing power parity exchange rate, not the current
exchange rate. The current exchange rate often does not reflect differences in price levels across
3.6 a. If purchasing power parity holds for Big Macs, then their price should be the same, $4.33, in every
country when we use the exchange rate to convert the domestic currency price into dollars. Using
3.7 a. Using the equation given on page 236 of the text, we know that if the United States experiences a
b. Putting tariffs and quotas on many imported goods will increase the demand for dollars to pay for
c. The United States experiencing deflation while Mexico experiences inflation means that the inflation
8.4 A Demand and Supply Model of Short-Run Movements in Exchange Rates
Learning objective: Use a demand and supply model to explain how exchange rates are determined in
the short run.
Review Questions
4.1 a. The demand curve for foreign exchange is downward sloping because as the exchange rate falls it
b. The supply curve for foreign exchange is upward sloping because the quantity of dollars supplied
© 2014 Pearson Education, Inc.
Chapter 8 The Market for Foreign Exchange 95
c. U.S. households and firms importing or buying foreign goods, services, or assets would be interested
d. Foreign households and firms importing or buying U.S. goods, services, or assets would be
4.2 The interest-rate parity condition is:
The differences in interest rates reflect the expected changes in the exchange rate. The main reasons
Problems and Applications
© 2014 Pearson Education, Inc.
Chapter 8 The Market for Foreign Exchange 96
4.5 According to the interest-rate parity condition, if interest rates in Australia are higher than interest
4.6 The interest-rate parity condition states that: Interest rate on domestic bond Interest rate on foreign
4.7 The interest rate parity condition states that: Interest rate on domestic bond Interest rate on foreign
© 2014 Pearson Education, Inc.
Chapter 8 The Market for Foreign Exchange 97
b. The strategy is speculative because investors face exchange-rate risk. If the Hungarian currency,
4.9 a. An “emerging market” refers to the economies of countries, such as China and India, that have
Data Exercises
D8.1 a. Answers will vary by data. From December 1, 2011 to December 1, 2012, the euro declined by
b. The dollar appreciated slightly against the euro from December 1, 2011 to December 1, 2012 as it
D8.2
© 2014 Pearson Education, Inc.
Chapter 8 The Market for Foreign Exchange 98
a. The euro over the 2001 to 2012 period reached its highest value in 2008.
c. From January 2001 to December 2012, the euro went from 0.9376 dollars per euro to 1.3116 dollars
D8.3 a. The long-term trend since 1973 in the trade-weighted exchange rate for the U.S. dollar against major
© 2014 Pearson Education, Inc.
Chapter 8 The Market for Foreign Exchange 99
D8.4
a. The exchange rates are quoted as foreign currency per U.S. dollar: Japanese yen per U.S.
c. In Japan, a Big Mac would cost 300 yen/91.04 yen = $3.30.
d. You would want to purchase a Big Mac in China for 14 yuan, or $2.25, and sell the Big Mac in Japan
D8.5 The question involves the interest-rate parity condition where, the difference in interest rates on
similar bonds in different countries reflects expectations of future changes in exchange rates. The
difference between the U.S. 3-month Treasury bill rate and the Japanese government securities rate
© 2014 Pearson Education, Inc.
Chapter 8 The Market for Foreign Exchange 100
© 2014 Pearson Education, Inc.