Question

Suppose the inflation rate is expected to be 1.1 percent in the U.S. and 1.8 percent in South Korea in 2020.

a. If the nominal interest rate on the 10-year U.S. Treasury bond is 2.4 percent, what is the real interest rate on that instrument?

b. If the nominal exchange rate between the U.S. dollar and the South Korean Won is expected to fall by 5 percent by the end of the year, what is the change in the real exchange rate? Assume that the actual inflation in each country is equal to the expected inflation.

c - f. Consider the following price and exchange rate data:

Products |
Domestic Price |
15 May 2020: US$1 = 1,233.1 Won |
31 Dec 2020: US$1 = 1,171.4Won |

U.S. exports computers |
$1,200 |
(c) |
(e) |

S. Korea exports steel |
1,500,000 Won |
(d) |
(f) |

Fill in the values for (c) - (f).

g. What would happen to U.S. exports and imports in this situation?

Answer #1

a) given nominal rate of interest=2.4%

therefore real rate of interest= nominal rate of interest- inflation rate=2.4-1.1=1.3%

b)real rate of exchange = nominal rate of echange/price

if nominal exchange rate falls by 5% then subsequently real exhange will also falls cosidring price to be constant.

c)

Products |
Domestic Price |
15 May 2020: US$1 = 1,233.1 Won |
31 Dec 2020: US$1 = 1,171.4Won |

U.S. exports computers |
$1,200 |
(c)$1200*1233.1=1479720won |
(e)$1200*1171.4=1405680won |

S. Korea exports steel |
1,500,000 Won |
(d)1500000won/1233.1=$1216.44 |
(f)1500000won/1171.4=$1280.52 |

d)as there is appreciation in us currency in comparision to south korea there will be increase in imports as well as there will be encouragement to exporters to export more giviing them subsequently more profit.

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