Question

# exchange rate 1. Suppose the Federal Reserve Board unexpectedly decreases interest rates in the United...

# exchange rate

1. Suppose the Federal Reserve Board unexpectedly decreases interest rates in the United States. How will this action affect the value of the dollar in the international dollar market?(Will the dollar appreciate, depreciate or stay the same?) Graphically show the impact on the international dollar market. Label all curves and axis.
2)
Rate
Spot. 0.7570
1 month 0.7574
3 months. 0.7570
6 months. 0.7569
1 Year 0.7674
2 years. 0.7611
3 years. 0.7668
4 years. 0.7730
The exchange rates are in U.S. Dollars per 1 Canadian Dollar. The forward premia (+) or discounts(-1) are expressed in basis points (100-th of a US cent).
A. What is spot rate for the US dollar (using the Canadian Dollar as the base currency)?
B. What is the spot rate for the Canadian Dollar (using the US Dollar as the base currency)?
C. Is the American dollar selling at a forward premium or a forward discount?
3)Apply the International Fisher Effect to predict the direction and magnitude of exchange rate changes based on this information:
Nominal interest rates in Canada are 6% and in Mexico are 14%. What do we expect to happen between the values of these currencies? Which will depreciate?
4) What is the current exchange rate between the US dollar and the Mexican Peso (list spot rate and date). Over the last 6 months has the US dollar appreciated or depreciated against the Peso? Holding all else constant, how has the value of the dollar against the Peso changed our trade situation. (Should the US be importing more goods from Mexico or exporting more goods to Mexico based on this change?)

Homework Answers

Answer #1

Q1) Now, if Federal Reserve Board unexpectedly reduces the interest rates, it will tend to decrease the value of the countrys currency in respect to other currencies. This is because lower interest rates imply that foreign investors can make less money from that country's assets, because they are yielding less interest. So, domestic currency becomes unattractive for foreign investment, and thus reduces the currency's relative value.

So, because there is a fall in r, people would want to hold fewer US dollars, so the demand for US dollars in the international market will reduce. The demand curve will shift left, This will cause the value of the dollar to fall, i.e. the US dollar will depreciate because of the rate cut. Take a look at graph 1.

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