Chapter 4

Exchange Rate Determination

1. The value of the Australian dollar (A$) today is $0.73. Yesterday, the value of the Australian dollar was $0.69. The Australian dollar !y ". A) de#re$iated% &.'0 () de#re$iated% ).00 *) a##re$iated% &.'0 +) a##re$iated% ).00 A,-./01 * SOLUTION: ($0.73 2 $0.69)3$0.69 4 &.'0" 5. 6f a $urren$y7s s#ot rate 8ar9et is lar;e #ur$hase or sale transa$tion. A) li<uid% hi;hly sensitive () illi<uid% insensitive *) illi<uid% hi;hly sensitive +) none of these A,-./01 * 3. A) () *) +) /) is not a fa$tor that $auses $urren$y su##ly and de8and s$hedules to $han;e. 0elative inflation rates 0elative interest rates 0elative in$o8e levels /:#e$tations All of these are fa$tors that $ause $urren$y su##ly and de8and s$hedules to $han;e. , its e:$han;e rate is li9ely to !e to a sin;le

A,-./01 / ). A lar;e in$rease in the in$o8e level in =e:i$o alon; with no ;rowth in the >.-. in$o8e level is nor8ally e:#e$ted to $ause (assu8in; no $han;e in interest rates or other fa$tors) a(n) in =e:i$an de8and for >.-. ;oods, and the =e:i$an #eso should . A) in$rease% a##re$iate () in$rease% de#re$iate *) de$rease% de#re$iate +) de$rease% a##re$iate A,-./01 (

158

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International Financial Management

the >.-.

&. An in$rease in >.-. interest rates relative to ?er8an interest rates would li9ely de8and for euros and the su##ly of euros for sale. A) redu$e% in$rease () in$rease% redu$e *) redu$e% redu$e +) in$rease% in$rease A,-./01 A

6. 6nvestors fro8 ?er8any, the >nited -tates, and (ritain fre<uently invest in ea$h other !ased on #revailin; interest rates. 6f (ritish interest rates in$rease, ?er8an investors are li9ely to !uy dollar@deno8inated se$urities, and the euro is li9ely to relative to the dollar. A) fewer% de#re$iate () fewer% a##re$iate *) 8ore% de#re$iate +) 8ore% a##re$iate A,-./01 A 7. .hen the ArealB interest rate is relatively low in a ;iven $ountry, then the $urren$y of that $ountry is ty#i$ally e:#e$ted to !e1 A) wea9, sin$e the $ountry7s <uoted interest rate would !e hi;h relative to the inflation rate. () stron;, sin$e the $ountry7s <uoted interest rate would !e low relative to the inflation rate. *) stron;, sin$e the $ountry7s <uoted interest rate would !e hi;h relative to the inflation rate. +) wea9, sin$e the $ountry7s <uoted interest rate would !e low relative to the inflation rate. A,-./01 + '. Assu8e that the inflation rate !e$o8es 8u$h hi;her in the >.C. relative to the >.-. This will #la$e #ressure on the value of the (ritish #ound. Also, assu8e that interest rates in the >.C. !e;in to rise relative to interest rates in the >.-. The $han;e in interest rates will #la$e #ressure on the value of the (ritish #ound. A) u#ward% downward () u#ward% u#ward *) downward% u#ward +) downward% downward A,-./01 * 9. 6n ;eneral, when s#e$ulatin; on e:$han;e rate 8ove8ents, the s#e$ulator will !orrow the $urren$y that is e:#e$ted to a##re$iate and invest in the $ountry whose $urren$y is e:#e$ted to de#re$iate. A) true. () false. A,-./01 (

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160

10. (aylor (an9 !elieves the ,ew Dealand dollar will a##re$iate over the ne:t five days fro8 $.)' to $.&0. The followin; annual interest rates a##ly1 Currency +ollars ,ew Dealand dollar (,D$) Lending Rate 7.10" 6.'0" Borro ing Rate 7.&0" 7.5&"

(aylor (an9 has the $a#a$ity to !orrow either ,D$10 8illion or $& 8illion. 6f (aylor (an97s fore$ast if $orre$t, what will its dollar #rofit !e fro8 s#e$ulation over the five@day #eriod (assu8in; it does not use any of its e:istin; $onsu8er de#osits to $a#italiEe on its e:#e$tations)F A) $&51,35&. () $&00,&50. *) $10),565. +) $)13,)19. /) $50',0)). A,-./01 / SOLUTION: 1. (orrow $& 8illion. 5. *onvert to ,D$1 $&,000,0003$.)' 4 ,D$10,)16,667. 3. 6nvest the ,D$ at an annualiEed rate of 6.'0" over five days. ,D$10,)16,667 G H1 I 6.'0" (&3360)J 4 ,D$10,)56,&0& ). *onvert the ,D$ !a$9 to dollars1 ,D$10,)56,&0& G $.&0 4 $&,513,5&5 &. 0e#ay the dollars !orrowed. The re#ay8ent a8ount is1 $&,000,000 G H1 I 7.&" (&3360)J 4 $&,000,000 G H1.0010)J 4 $&,00&,50' 6. After re#ayin; the loan, the re8ainin; dollar #rofit is1 $&,513,5&5 2 $&,00&,50' 4 $50',0))

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11. Assu8e the followin; infor8ation re;ardin; >.-. and /uro#ean annualiEed interest rates1 Currency >.-. +ollar ($) /uro (K) Lending Rate 6.73" 6.'0" Borro ing Rate 7.50" 7.5'"

Trensor (an9 $an !orrow either $50 8illion or K50 8illion. The $urrent s#ot rate of the euro is $1.13. Lurther8ore, Trensor (an9 e:#e$ts the s#ot rate of the euro to !e $1.10 in 90 days. .hat is Trensor (an97s dollar #rofit fro8 s#e$ulatin; if the s#ot rate of the euro is indeed $1.10 in 90 daysF A) $&79,')&. () $&'3,'00. *) $&'',500. +) $&'),5)&. /) $9'0,5)&. A,-./01 A SOLUTION: 1. (orrow K50 8illion.

2. *onvert the K50 8illion to K50,000,000 G $1.13 4 $55,600,000. 3. 6nvest the $55,600,000 at an annualiEed rate of 6.73" for 90 days.
$55,600,000 G H1 I 6.73" (903360)J 4 $55,9'0,5)& ). +eter8ine euros owed1 K50,000,000 G H1 I 7.5'" (903360)J 4 K50,36),000. &. +eter8ine dollars needed to re#ay euro loan1 K50,36),000 G $1.10 4 $55,)00,)00.

6. The dollar #rofit is1

$55,9'0,5)& 2 $55,)00,)00 4 $&79,')&.

Chapter 4: Exchange Rate Determination

165

15. The e<uili!riu8 e:$han;e rate of #ounds is $1.70. At an e:$han;e rate of $1.75 #er #ound1 A) >.-. de8and for #ounds would e:$eed the su##ly of #ounds for sale and there would !e a shorta;e of #ounds in the forei;n e:$han;e 8ar9et. () >.-. de8and for #ounds would !e less than the su##ly of #ounds for sale and there would !e a shorta;e of #ounds in the forei;n e:$han;e 8ar9et. *) >.-. de8and for #ounds would e:$eed the su##ly of #ounds for sale and there would !e a sur#lus of #ounds in the forei;n e:$han;e 8ar9et. +) >.-. de8and for #ounds would !e less than the su##ly of #ounds for sale and there would !e a sur#lus of #ounds in the forei;n e:$han;e 8ar9et. /) >.-. de8and for #ounds would !e e<ual to the su##ly of #ounds for sale and there would !e a shorta;e of #ounds in the forei;n e:$han;e 8ar9et. A,-./01 + 13. Assu8e that -wiss investors have fran$s availa!le to invest in se$urities, and they initially view >.-. and (ritish interest rates as e<ually attra$tive. ,ow assu8e that >.-. interest rates in$rease while (ritish interest rates stay the sa8e. This would li9ely $ause1 A) the -wiss de8and for dollars to de$rease and the dollar will de#re$iate a;ainst the #ound. () the -wiss de8and for dollars to in$rease and the dollar will de#re$iate a;ainst the -wiss fran$. *) the -wiss de8and for dollars to in$rease and the dollar will a##re$iate a;ainst the -wiss fran$. +) the -wiss de8and for dollars to de$rease and the dollar will a##re$iate a;ainst the #ound. A,-./01 * 1). The real interest rate adMusts the no8inal interest rate for1 A) e:$han;e rate 8ove8ents. () in$o8e ;rowth. *) inflation. +) ;overn8ent $ontrols. /) none of these. A,-./01 * 1&. 6f >.-. inflation suddenly in$reased while /uro#ean inflation stayed the sa8e, there would !e1 A) an in$reased >.-. de8and for euros and an in$reased su##ly of euros for sale. () a de$reased >.-. de8and for euros and an in$reased su##ly of euros for sale. *) a de$reased >.-. de8and for euros and a de$reased su##ly of euros for sale. +) an in$reased >.-. de8and for euros and a de$reased su##ly of euros for sale. A,-./01 +

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16. 6f inflation in ,ew Dealand suddenly in$reased while >.-. inflation stayed the sa8e, there would !e1 A) an inward shift in the de8and s$hedule for ,D$ and an outward shift in the su##ly s$hedule for ,D$. () an outward shift in the de8and s$hedule for ,D$ and an inward shift in the su##ly s$hedule for ,D$. *) an outward shift in the de8and s$hedule for ,D$ and an outward shift in the su##ly s$hedule for ,D$. +) an inward shift in the de8and s$hedule for ,D$ and an inward shift in the su##ly s$hedule for ,D$. A,-./01 A 17. 6f the >.-. and Na#an en;a;e in su!stantial finan$ial flows !ut little trade, dire$tly influen$e their e:$han;e rate the 8ost. 6f the >.-. and -witEerland en;a;e in 8u$h trade !ut little finan$ial flows, dire$tly influen$e their e:$han;e rate the 8ost. A) interest rate differentials% interest rate differentials () inflation and interest rate differentials% interest rate differentials *) in$o8e and interest rate differentials% inflation differentials +) interest rate differentials% inflation and in$o8e differentials /) inflation and in$o8e differentials% interest rate differentials A,-./01 + 1'. 6f inflation in$reases su!stantially in Australia while >.-. inflation re8ains un$han;ed, this is e:#e$ted to #la$e #ressure on the value of the Australian dollar with res#e$t to the >.-. dollar. A) u#ward () downward *) either u#ward or downward (de#endin; on the de;ree of the in$rease in Australian inflation) +) none of these% there will !e no i8#a$t A,-./01 ( 19. Assu8e that (ritish $or#orations !e;in to #ur$hase 8ore su##lies fro8 the >.-. as a result of several la!or stri9es !y (ritish su##liers. This a$tion refle$ts1 A) an in$reased de8and for (ritish #ounds. () a de$rease in the de8and for (ritish #ounds. *) an in$rease in the su##ly of (ritish #ounds for sale. +) a de$rease in the su##ly of (ritish #ounds for sale. A,-./01 * 50. The e:$han;e rates of s8aller $ountries are very sta!le !e$ause the 8ar9et for their $urren$y is very li<uid. A) true. () false. A,-./01 ( 51. The #hrase Athe dollar was 8i:ed in tradin;B 8eans that1 A) the dollar was stron; in so8e #eriods and wea9 in other #eriods over the last 8onth. () the volu8e of tradin; was very hi;h in so8e #eriods and low in other #eriods.

Chapter 4: Exchange Rate Determination

*) the dollar was involved in so8e $urren$y transa$tions, !ut not others. +) the dollar stren;thened a;ainst so8e $urren$ies and wea9ened a;ainst others. A,-./01 +

16)

55. Assu8e that the >.-. #la$es a stri$t <uota on ;oods i8#orted fro8 *hile and that *hile does not retaliate. Ooldin; other fa$tors $onstant, this event should i88ediately $ause the >.-. de8and for *hilean #esos to and the value of the #eso to . A) in$rease% in$rease () in$rease% de$line *) de$line% de$line +) de$line% in$rease A,-./01 * 53. Any event that in$reases the >.-. de8and for euros should result in a(n) euro with res#e$t to , other thin;s !ein; e<ual. A) in$rease% >.-. dollar () in$rease% nondollar $urren$ies *) de$rease% nondollar $urren$ies +) de$rease% >.-. dollar A,-./01 A 5). Any event that redu$es the >.-. de8and for Na#anese yen should result in a(n) of the Na#anese yen with res#e$t to , other thin;s !ein; e<ual. A) in$rease% >.-. dollar () in$rease% nondollar $urren$ies *) de$rease% nondollar $urren$ies +) de$rease% >.-. dollar A,-./01 + 5&. Any event that in$reases the su##ly of (ritish #ounds to !e e:$han;ed for >.-. dollars should result in a(n) in the value of the (ritish #ound with res#e$t to , other thin;s !ein; e<ual. A) in$rease% >.-. dollar () in$rease% nondollar $urren$ies *) de$rease% nondollar $urren$ies +) de$rease% >.-. dollar A,-./01 + in the value in the value of the

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International Financial Management

56. Any event that redu$es the su##ly of -wiss fran$s to !e e:$han;ed for >.-. dollars should result in a(n) in the value of the -wiss fran$ with res#e$t to , other thin;s !ein; e<ual. A) in$rease% >.-. dollar () in$rease% nondollar $urren$ies *) de$rease% nondollar $urren$ies +) de$rease% >.-. dollar A,-./01 A 57. Assu8e that the >.-. e:#erien$es a si;nifi$ant de$line in in$o8e, while Na#an7s in$o8e re8ains steady. This event should #la$e #ressure on the value of the Na#anese yen, other thin;s !ein; e<ual. (Assu8e that interest rates and other fa$tors are not affe$ted.) A) u#ward () downward *) no +) u#ward and downward (offsettin;) A,-./01 ( 5'. ,ews of a #otential sur;e in >.-. inflation and Eero *hilean inflation #la$es the value of the *hilean #eso. The #ressure will o$$ur . A) u#ward% only after the >.-. inflation sur;es () downward% only after the >.-. inflation sur;es *) u#ward% i88ediately +) downward% i88ediately A,-./01 * 59. Assu8e that *anada #la$es a stri$t <uota on ;oods i8#orted fro8 the >.-. and that the >.-. does not retaliate. Ooldin; other fa$tors $onstant, this event should i88ediately $ause the su##ly of *anadian dollars to !e e:$han;ed for >.-. dollars to and the value of the *anadian dollar to . A) in$rease% in$rease () in$rease% de$line *) de$line% de$line +) de$line% in$rease A,-./01 + 30. Assu8e that Na#an #la$es a stri$t <uota on ;oods i8#orted fro8 the >.-. and the >.-. #la$es a stri$t <uota on ;oods i8#orted fro8 Na#an. This event should i88ediately $ause the >.-. de8and for Na#anese yen to , and the su##ly of Na#anese yen to !e e:$han;ed for >.-. dollars to . A) in$rease% in$rease () in$rease% de$line *) de$line% de$line +) de$line% in$rease A,-./01 * 31. .hi$h of the followin; is not 8entioned in the te:t as a fa$tor affe$tin; e:$han;e ratesF A) relative interest rates. #ressure on

Chapter 4: Exchange Rate Determination

() relative inflation rates. *) ;overn8ent $ontrols. +) e:#e$tations. E) All of these are 8entioned in the te:t as fa$tors affe$tin; e:$han;e rates. A,-./01 / 35. 6f a $ountry e:#erien$es hi;h inflation relative to the >.-., its e:#orts to the >.-. should its i8#orts should , and there is #ressure on its $urren$y7s e<uili!riu8 value. A) de$rease% in$rease% u#ward () de$rease% de$rease% u#ward *) in$rease% de$rease% downward +) de$rease% in$rease% downward /) in$rease% de$rease% u#ward A,-./01 *

166

33. 6f a $ountry e:#erien$es an in$rease in interest rates relative to >.-. interest rates, the inflow of >.-. funds to #ur$hase its se$urities should , the outflow of its funds to #ur$hase >.-. se$urities should , and there is #ressure on its $urren$y7s e<uili!riu8 value. A) in$rease% de$rease% downward () de$rease% in$rease% u#ward *) in$rease% de$rease% u#ward +) de$rease% in$rease% downward /) in$rease% in$rease% u#ward A,-./01 * 3). An in$rease in >.-. inflation relative to -in;a#ore inflation #la$es u#ward #ressure on the -in;a#ore dollar. A) true. () false. A,-./01 A 3&. .hen e:#e$tin; a forei;n $urren$y to de#re$iate, a #ossi!le way to s#e$ulate on this 8ove8ent is to !orrow dollars, $onvert the #ro$eeds to the forei;n $urren$y, lend in the forei;n $ountry, and use the #ro$eeds fro8 this invest8ent to re#ay the dollar loan. A) true. () false. A,-./01 (

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36. -in$e su##ly and de8and for a $urren$y are $onstant (#ri8arily due to ;overn8ent intervention), $urren$y values seldo8 flu$tuate. A) true. () false. A,-./01 ( 37. 0elatively hi;h Na#anese inflation 8ay result in an in$rease in the su##ly of yen for sale and a redu$tion in the de8and for yen. A) true. () false. A,-./01 A 3'. The 8ain effe$t of interest rate 8ove8ents on e:$han;e rates is throu;h their effe$t on international trade. A) true. () false. A,-./01 ( 39. *ountry P fre<uently en;a;es in trade flows with the >.-. (su$h as i8#orts and e:#orts). *ountry Y fre<uently en;a;es in $a#ital flows with the >.-. (su$h as finan$ial invest8ents). /verythin; else held $onstant, an in$rease in >.-. interest rates would affe$t the e:$han;e rate of *ountry P7s $urren$y 8ore than the e:$han;e rate of *ountry Y7s $urren$y. A) true. () false. A,-./01 (

)0. 6n$reases in relative in$o8e in one $ountry vs. another result in an in$rease in that $ountry7s $urren$y value. A) true. () false. A,-./01 ( )1. Trade@related forei;n e:$han;e transa$tions are 8ore res#onsive to news than finan$ial flow transa$tions. A) true. () false. A,-./01 ( )5. -i;nals re;ardin; future a$tions of 8ar9et #arti$i#ants in the forei;n e:$han;e 8ar9et so8eti8es result in overrea$tions. A) true. () false. A,-./01 A

Chapter 4: Exchange Rate Determination

16'

)3. The 8ar9ets that have a s8aller a8ount of forei;n e:$han;e tradin; for s#e$ulatory #ur#oses than for trade #ur#oses will li9ely e:#erien$e 8ore volatility than those where trade flows #lay a lar;er role. A) true. () false. A,-./01 A )). Qi<uidity of a $urren$y $an affe$t the e:tent to whi$h s#e$ulation $an i8#a$t the $urren$y7s value. A) true. () false. A,-./01 A )&. Lore$astin; a $urren$y7s future value is diffi$ult, !e$ause it is diffi$ult to identify how the fa$tors affe$tin; the $urren$y value will $han;e, and how they will intera$t to i8#a$t the $urren$y7s value. A) true. () false. A,-./01 A )6. The standard deviation should !e a##lied to values rather than #er$enta;e 8ove8ents when $o8#arin; volatility a8on; $urren$ies. A) true. () false. A,-./01 ( )7. =ove8ents of forei;n $urren$ies tend to !e 8ore volatile for shorter ti8e horiEons. A) true. () false. A,-./01 (