1215 Words Nov 18th, 2012 5 Pages
Chapter 4

Practice Problems

Percentage Depreciation
• Assume the spot rate of the British pound is \$1.73. The expected spot rate one year from now is assumed to be \$1.66. What percentage depreciation does this reflect?
• (\$1 66 – \$1 73)/\$1 73 = –4.05% (\$1.66 \$1.73)/\$1.73 4 05% Expected depreciation of 4.05% percent

Inflation Effects on Exchange Rates
• Assume that the U.S. inflation rate becomes high relative to Canadian inflation. Other things being equal, how should this affect the (a) U.S. demand for Canadian dollars, (b) supply of Canadian dollars for sale, and (c) equilibrium value of the Canadian dollar?
 Demand for Canadian dollars should increase,  Supply of Canadian dollars for sale should decrease, and  The
2

Effects of Real Interest Rates
• What is the expected relationship between the relative real interest rates of two countries and the exchange rate of their currencies?
 The higher the real interest rate of a country relative to another country, the stronger will be its home currency, other things equal.

Speculative Effects on Exchange Rates
• Explain why a public forecast about future interest rates could affect the value of the dollar today. Why do some forecasts by well-respected economists have no impact on today’s value of the dollar?
 Speculators can use anticipated interest rate movements to forecast exchange rate movements.  Th may purchase f i securities b They h foreign iti because of their f th i expectations about currency movements, since their yield will be affected by changes in a currency’s value.  These purchases of securities require an exchange of currencies, which can immediately affect the equilibrium value of exchange rates.  It was already anticipated by market participants or is not different from investors’ original expectations.

Interaction of Exchange Rates
• Assume that there are substantial capital flows among Canada, the U.S., and Japan. If interest rates in Canada decline to a level below the U.S. interest rate, and inflationary expectations remain unchanged, how could this affect the value of the Canadian dollar against the U.S. dollar?
 If interest rates in Canada decline, there may be an increase

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