Exercise Foreign Exchange Market

1.When the euro appreciates, are you more likely to

drink California or French wine?
You are more likely to drink California wine because the euro appreciation
makes French wine relatively more expensive than California wine.

2. A country is always worse off when its currency is

weak (falls in value). Is this statement true, false,
or uncertain? Explain your answer
False. Although a weak currency has the negative effect of making it more
expensive to buy foreign goods or to travel abroad, it may help domestic
industry. Domestic goods become cheaper relative to foreign goods, and the
demand for domestically produced goods increases. The resulting higher
sales of domestic products may lead to higher employment, a beneficial
effect on the economy.
3. If the Japanese price level rises by 5% relative to the
price level in the United States, what does the theory
of purchasing power parity predict will happen
to the value of the Japanese yen in terms of dollars?
It predicts that the value of the yen will fall 5% in terms of dollars.
4.. If the demand for a countrys exports falls at the same
time that tariffs on imports are raised, will the countrys
currency tend to appreciate or depreciate in the
long run?
In the long run, the fall in the demand for a countrys exports leads to a
depreciation of its currency, but the higher tariffs lead to an appreciation.
Therefore, the effect on the exchange rate is uncertain.
5.In the mid- to late 1970s, the yen appreciated relative
to the dollar even though Japans inflation rate was
higher than Americas. How can this be explained by
an improvement in the productivity of Japanese

industry relative to American industry?

Even though the Japanese price level rose relative to the American, the yen
appreciated because the increase in Japanese productivity relative to American
productivity made it possible for the Japanese to continue to sell their goods at a
profit due to the high value of the yen.

6.If American auto companies make a breakthrough in

automobile technology and are able to produce a car
that gets 60 miles to the gallon, what will happen to
the U.S. exchange rate?
The dollar will appreciate. The increase in U.S. productivity raises the
expected future exchange rate and thus raises the expected return on dollar
assets at any exchange rate. The resulting rightward shift of the demand
curve leads to a rise in the equilibrium exchange rate.
7. If the Indian government unexpectedly announces
that it will be imposing higher tariffs on foreign goods
one year from now, what will happen to the value of
the Indian rupee today?
The Indian rupee will appreciate. The announcement of tariffs will raise the
expected future exchange rate for the rupee and so increase the expected
appreciation of the rupee. This means that the demand for rupeedenominated assets will increase, shifting the demand curve to the right, and
the rupee exchange rate therefore rises.
8.If the European Central Bank decides to pursue a contractionary monetary
policy to fight inflation,what will happen to the value of the US$?
The contraction of the European money supply will increase European
interest rates and raise the future value of the euro, both of which will
decrease the relative expected return on dollar assets. The demand curve
will then shift to the left, and the dollar will depreciate.

9.If a strike takes place in France making it harder to buy French goods, what
will happen to the value of the US $?
Consider France to be the domestic country. Because it is harder to get
French goods, people will buy more foreign goods and the value of the euro
in the future will fall. The expected depreciation of the euro lowers the
expected return on euro assets at any exchange rate, so the demand curve
shifts to the left and the value of the euro will fall.

10. In 1999, the euro was trading at 0.9$ per euro. If the euro is now trading
at 1.16$ per euro, what is the percentage change in the euros value? Is
this an appreciation or a depreciation?
% Change = (1.16 0.90)/0.90 = 28.88%
The dollar has depreciated by 28.88%

11. The Mexican peso is trading at 10 pesos per dollar. If the expected US
inflation rate is 2% while the expected Mexican inflation rate is 23% over
the next year, given PPP, what is the expected exchange rate in one
year?
Expected rate = 10 (1.23/1.02) = 12.059 pesos per dollar
12. 1.
A German sports car is selling for 70,000 euros. What is the
dollar price in the United States for the German car if the exchange rate
is 0.90 euros per dollar?
13.

The current exchange rate between the Japanese yen and the U.S.
dollar is 120 per dollar. If the dollar is expected to depreciate by 10%
relative to the yen, what is the new expected exchange rate?
120*.9=108 yen per dollar