2. Causes of devaluation.

If a country follows a fixed exchange rate regime, what macroeconomic variables could
cause the fixed exchange rate to be devalued?
An interest rate that is lower when compared to other countries.
An inflation rate that is higher than other countries

3. Fixed versus flexible exchange rates. What are the advantages and disadvantages of fixed exchange rates?

Advantages: Price stability - this implies that changes in prices are small or expected. Another advantage is
economic stability and prosperity. A decreasing volatility may show price stability and signal when changes in
the market are coming

Disadvantages: All though the advantages listed above can be good in many cases. Many people would look at
them as disadvantages to. Some studies show that some of the best times in the market have been because of
large fluctuation in the average price level.

4. The impossible trinity. Explain what is meant by concept of the impossible trinity and why it is accurate?
Countries with floating rate regimes can maintain independence and financial integration but they may
sacrifice exchange rate stability
Countries that maintain exchange rate stability by having fixed rates give up the ability to have an
independent monetary policy

5. Currency board or dollarization. Fixed exchange rate regimes are sometimes implemented through a
currency board (Hong Kong) or dollarization (Ecuador). What is the difference between the two approaches?
In a currency board agreement, the country issues its own currency buy that currency is backed by other
foreign exchange holdings which is usually the U.S. dollar. A currency board operates with very strict rules
and limits discretionary monetary policy. In dollarization, the country gets rid of its won currency and uses
foreign currency.

Problem 3.8 Ranbaxy (India) in Brazil

Ranbaxy, an India-based pharmaceutical firm, has continuing problems with its cholesterol
reduction product's price in one of its rapidly growing markets, Brazil. All product is
produced in India, with costs and pricing initially stated in Indian rupees (Rps), but
converted to Brazilian reais (R$) for distribution and sale in Brazil. In 2009, the unit
volume was priced at Rps21,900, with a Brazilian reais price set at R$895. But in 2010, the
reais appreciated in value versus the rupee, averaging Rps26.15/R$. In order to preserve
the reais price and product profit margin in rupees, what should the new rupee price be set
at?
Assumptions
Original (2009) cholesterol unit price, rupees (Rps)
Original (2009) Brazilian reais price for sale and distribution
Average spot rate for 2010, rupees per reais

Values
21,900.00
895.00
26.15

First, the implied spot exchange rate for the previous year, 2009 must be found by dividing
the Indian rupee price by the Brazilian reais price selected for distribution and sale.
Implied original spot rate, Indian rupees per Brazilian reais

6.87

Assuming that Ranbaxy wishes to preserve the Brazilian reais price for competitiveness,
the same Brazilian reais price must be converted back into Indian rupees with the new spot
exchange rate in rupees per reais:
Recalcualted Indian rupee price of product
(Original reais price x Avg spot rate for 2010)

23,403.43

Because the Indian rupee depreciated in value against the Brazilian reais, the implied
Indian rupee price is actually HIGHER than it was the previous year. This means that
Ranbaxy would keep the same Brazilian reais price and either enjoy a much larger profit
margin in Indian rupees, or potentially keep the Indian rupee price the same as the previous
year and actually reduce the Brazilian reais price.

Problem 3.9 Toyota Exports to the United Kingdom

Toyota manufactures most of the vehicles it sells in the United Kingdom in Japan.
The base platform for the Toyota Tundra truck line is 1,650,000. The spot rate of the
Japanese yen against the British pound has recently moved from 197/ to 190/.
How does this change the price of the Tundra to Toyota's British subsidiary in British
pounds?
Assumptions
Original spot rate, Japanese yen/British pound
New spot rate, Japanese yen/British pound
Export price of Toyota Tunda truck, Japanese yen

Original Import Price in British pounds

Values
197.00
190.00
1,650,000

8,375.63

D13/D11

Export price in yen / Original spot rate in yen/pound

New Import Price in British pounds

8,684.21

Export price in yen / New spot rate in yen/pound

Percentage change in the price of the imported truck

3.68%

New price / Old price - 1

Because the price of the truck itself did not change, the percentage change in the
import price as expressed in British pounds is the same percentage change in the
value of the Japanese yen against the British pound itself.

D13/D12