Country
(currency)
Currency
Symbol
(1) Per $
(2) Per £
(3) Per €
(4) Per $
(5) Per £
(6) Per €
Canada
(dollar)
C$
1.063
1.59
1.302
1.161
1.913
1.629
Denmark
DKr
6.081
9.098
7.449
5.309
8.743
7.447
Euro (euro)
€
0.816
1.221
—
0.713
1.174
—
Japan (yen)
¥
88.49
132.39
108.39
96.49
158.9
135.34
Norway
(krone)
NKr
6.503
9.729
7.966
6.437
10.6
9.028
Sweden
(krona)
SKr
7.782
11.643
9.532
7.748
12.76
10.868
Switzerland
(franc)
SFr
1.078
1.613
1.321
1.088
1.791
1.536
United
Kingdom
(pound)
£
0.668
—
0.819
0.607
—
0.852
United
States
(dollar)
$
—
1.496
1.225
—
1.647
1.403
a. Calculate the U.S. dollar–Swiss franc exchange rate, E$/franc, and the U.S. dollar–
British pound exchange rate, E$/£ as of June 30, 2010. (Data and answers for this
question are included in the Excel workbook for this chapter.)
Answer:
b. What happened to the value of the U.S. dollar relative to the Swiss franc and the
British pound between 2009 and 2010? Calculate the percentage change in the
value of the U.S. dollar relative to each currency using the U.S. dollar–foreign
currency exchange rates you calculated in (a).
Answer: Between those two years, the value of the U.S. dollar depreciated
c. Using the information in the table for the most recent year, calculate the Japanese
yen–Norwegian krone exchange rate.
Answer:
2. Suppose that the U.S. dollar has appreciated relative to the Chinese yuan and
depreciated relative to the Mexican peso. What has happened to the value of the
dollar based on the effective exchange rate? How is your answer based on the relative
importance of U.S. trade with China and Mexico? Explain.
Answer: When the dollar depreciates against one currency (peso) and appreciates
relative to another (yuan), the effective exchange rate weights the percentage change
3. Use the table below to answer the following questions.
Exchange Rate Quotations
Foreign Currency Units per
U.S. dollar
Country
(currency)
Currency
Symbol
June 30, 2010
June 30, 2005
Brazil (real)
BRL
1.7973
2.3555
China (yuan)
¥ (CNY)
6.8086
8.2865
Mexico (peso)
MXN
12.8355
10.7630
Data from: http://www.oanda.com.
You and a friend Yi are considering a summer vacation to one of two locales, Mexico
or Brazil. Mexico’s currency unit is the Mexican (new) peso and the real is used in
a. Calculate the U.S. dollar price of a hotel room in Brazil and in Mexico for June
2005. Calculate these prices for 2010. Based on your answers, where would you
spend your vacation in June 2005? In June 2010?
Answer:
The U.S. dollar price of hotel rooms in June 2010:
b. For June 2005 and June 2010, calculate the following:
Real–yuan exchange rate, Ereal/yuan
Peso–yuan exchange rate, Epeso/yuan
Answer:
June 2005: Ereal/yuan = Ereal/$/Eyuan/$ = 1.7973/6.8086 = 0.2640 reals per yuan
c. Using your answers from (b) and the information in the table, calculate the
Chinese yuan price of a hotel room in Brazil and in Mexico for June 2005.
Calculate these prices for 2010. Based on your answers, where would Yi prefer to
spend her vacation in June 2005? In June 2010?
Answer:
June 2005 yuan price of hotel room:
Brazil: 200 reals per room/0.2843 reals per yuan = 703.5873 yuan per room
4. Go to the Federal Reserve Bank of St. Louis Economics Database (FRED) and look
up exchange rate data for the following currencies (relative to the U.S. dollar) for the
past four years: Chinese yuan, euro, Brazilian real, and Hong Kong dollar. Are these
exchange rates fixed or floating relative to the U.S. dollar? If the currency is floating
against the U.S. dollar, does the exchange rate change by more than 15% in a given
year?
Answer: The euro and the Brazilian real are floating against the U.S. dollar. The
5. As the volume of transactions in the foreign exchange market grows, how do you
expect this to affect the government’s ability to effectively intervene in the market?
Consider the different tools the government has and their effectiveness in influencing
exchange rates.
Answer: As the volume of transactions increases, the government’s ability to
6. Explain how triangular arbitrage works. Why is this important for vehicle currencies
in global markets?
Answer: A triangular trade occurs in the following way. First, the arbitrager buys one
currency, A. Then, she sells A for another currency, B. Finally, she sells B for a third
7. In June 2006, a Korean investor is considering investing in bank deposits in Korea
and Japan. The annual interest rate on Korean deposits is 6.25%, versus 3.75% on
deposits in Japan. Suppose that the forward rate in June 2006 is equal to Fwon/¥ = 8.2. In
June 2006, the expected exchange rate is 8.2 won/¥. For the remainder of this question,
please use the linear approximations for uncovered and covered interest rate parity. The
spot exchange rate in June 2006 is Ewon/¥ = 8.
a. Does covered interest parity hold in this example? If so, how do you know?
Calculate the expected return in Japanese deposits (denominated in Korean won)
in this case.
Answer:
CIP: iwon = i¥ + (Fwon/¥ − Ewon/¥)/Ewon/¥
b. Does uncovered interest parity hold in this example? If so, how do you know? If
not, what is the implied risk premium? Which deposits pay a higher expected
return? Calculate the return on Japanese deposits (denominated in Korean won) in
this case.
Answer:
UIP: iwon + i¥ + (EEwon/¥ − Ewon/¥)/Ewon/¥
c. Suppose the exchange rate in June 2007 is equal to 8.528 won per yen. Calculate
the Korean investor’s actual return, assuming that he invests in Japanese deposits
in June 2006. How do these answers compare with those from (b)?
Answer: We know what happened to the won. It appreciated by 6.6% against the
yen.
d. Consider two Korean investors: one uses speculation and the other uses hedging.
Based on your previous answers, which one earned a higher return (or smaller
loss) on Japanese assets between June 2006 and 2007? Explain briefly why.
Answer: Although investors expected a depreciation back in June 2006, the won
8. Consider an investor seeking to invest in France. Using the UIP condition (allowing
for risk), explain how each of the following would affect the value of the euro and
U.S. dollar.
a. A decrease in U.S. interest rates
b. An increase in France’s interest rates
c. A decrease in the expected future exchange rate, Ee$/€
9. Consider the different interest rate parity conditions studied in the chapter. Why
might the exchange rate used in forward contracts differ from the current spot rate?
Why might the forward rate differ from the future spot rate expected by investors?
Explain.
Answer: According to CIP, the difference between the forward rate and the current
