Question

1.

a)

Suppose that you wake up one morning and find the following exchange rates:

                                    $1 = ¥100

                                    ¥1 = €0.05

                                    €1 = $0.50

In this example, since purchasing power parity does not hold, then it is possible to profit from international arbritrage.

True

False

b)

Assume that copper currently sells for $20 per pound in the United States, and for €10 per pound in Germany. The current exchange rate is €1 = $1.50.   It costs $1.00 to ship one pound of copper between the countries.

In this example, it is possible to profit from international arbitrage by purchasing copper in the United States and selling copper in Germany.

True

False

c)

In the question above, what would you expect to happen as copper is shipped from one country to the other?

	a.	The price of copper will fall in both countries.
	b.	The price of copper will increase in both countries.
	c.	The price of copper will fall in Germany and increase in the United States.
	d.	The price of copper will increase in Germany and fall in the United States.
	e.	The price of copper will be constant in both countries.

d)

In the question above, assume that due to price controls, the prices of copper are fixed in the United States and Germany. What exchange rate would bring Purchasing Power Parity to the two countries?

	a.	1 euro = $2.00
	b.	1 euro = $0.50
	c.	1 euro = $10.00
	d.	1 euro = $1.00
	e.	none of the above. There is no exchange rate that will bring Purchasing Power Parity between the two countries.

Answer 1

True

$1 can be made into $2.5 through arbitrage ime coverting in different currencies.

B. False

Cost of copper $ in US = 20

Cost of copper $ in Germany = €10*1.5 = $15

It would be a loss

C. Option D

As copper is cheaper in Germany, if trade takes place the market price of copper will increase due to lower supply and the market price of copper will decrease due to additional supply.

D. None of the above

€15 = $20

€1 = $1.33

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