Question

Indicate what the Purchasing Power Theory tell us about a country with a relatively high rate of inflation, in terms what will normally happen to their currency and the effect on: (one sentence maximum each)

Currency value in foreign exchange

Volume of import Trade

Volume of export Trade

                   List here:                                                                                                                        List here:

  Two countries, Switzerland and the US produce just one product: mutton meat. Suppose that the price of mutton in the US is $3.00 per pound, and in Switzerland it is Swf 3.70 per pound.

According to PPP theory, what should the spot exchange rate be for?

                   Ans.1$=______Swf     Show work/why:

Suppose the price of mutton is expected to rise to $3.10 in the US, and to Swf4.65 in Switzerland.What should be the one year forward $/Swf rate be?

    Ans. 1$=_______Swf   Show work/why:

  You have been reading the Financial Times daily for the past several months and realize that while the U.S. Federal Reserve has raised interest rates, the Bank of Canada has not increased interest rates.. This means that interest rates have moved higher in the U.S. relative to Canada and earnings on savings are significantly higher in the U.S. than the Canada.

Would this policy and interest rate difference influence the relative strength of the U.S. dollar against the Canadian dollar over time? How? Why?

Answer 1

Currency rate will fall

Volume of import trade will fall as imports become dear

Volume of export trade will rise as exports will be become cheaper

2