Question

6. Assume that the current dollar-Euro exchange rate
(E_{$/€}) is equal to 1.05, the real exchange rate
(q_{us/Eur}) = 1.26, the price level equals 1 in the U.S.
and 1.2 in Europe. Assume that relative PPP holds.

a. If inflation is 4% in the U.S. but 1% in Europe, what will be the price levels in the U.S. and Europe a year from now?

b. Given your answer to part a, what will be the nominal
exchange rate (E_{$/€}) a year from now?

c. What will the real exchange rate be a year from now?

Answer #1

Soln : a) There is always a reverse relation between inflation and exchange rate of the countries, as inflation will increase the currency value depreciates.

Here in this case Exchange rate of $/euro = 1.05 i.e. 1Euro = $1.05 , US inflation = 4% and Euro inflation = 1%

Price level in US = 1*1.04 = 1.04 and in Europe = 1.2*1.01 = 1.212

Also, % change in exchange rate due to inflation difference = 4-1 = 3%

So ,we can say that now 1 Euro = 1.05*1.03 = 1.0815

(b) Nominal Exchange rate one year from now, 1Euro = 1.0815

c) Real exchange rate = Nominal Exchange rate * Price level in foreign/price level in domestic = 1.0815 *1.212/1.04 = 1.26

6) Assume that U.S. and British investors require a real return
of 3%. If the nominal U.S.
interest rate is 16%, and the nominal British interest rate is 13%,
then according to the
Real Interest Parity (RIP) as well as the Uncovered Interest Parity
(UIP), the British
inflation rate is expected to be about _________ the U.S. inflation
rate, and the British
pound is expected to _________.
A. 3 percentage points above; appreciate by about 3%
B. 3 percentage points...

Today’s spot rate of the euro is USD1.1676/EUR. Assume the
relative PPP holds, the
U.S. inflation over one year is expected to 3 percent, while the
EU inflation is expected to
be 2 percent. If you plan to go on vacation in Paris, France and
will need 5000 euros in
one year. What is the expected exchange rate of euro? What is
the expected amount of
dollars you need to pay for your trip in one year?

The current spot rate between the euro and dollar is €1.0957/$.
The annual inflation rate in the U.S is expected to be 2.98 percent
and the annual inflation rate in euroland is expected to be 2.43
percent. Assuming relative purchasing power parity holds, what will
the exchange rate be in two years?

2. Assume that purchasing power parity holds real exchange rates
close to E(f/d) = 1. Suppose:
a. The nom exchange rate e(EUR/CAD) is decreasing. Where is
inflation higher?___________
b. The nom exchange rate e(GBP/CAD) is increasing. Where is
inflation higher?____________
c. Using the information in a and b, where is inflation highest?
Europe or Canada or Great Britain

Assume that the exchange rate moves from $1 = €1.2 to $1 =
€0.97. This change in exchange rate indicates that:
the euro has depreciated in value.
the price of a holiday in Europe has become less expensive for
U.S. residents.
the U.S. dollar price of European chocolate has fallen.
the U.S. dollar has appreciated in value.
the euro has appreciated in value.

(a) Define real exchange rate.
(b) If the price levels (indices) in Canada and the U.S. are 125
and 110 respectively, what is the PPP rate for the U.S. dollar? If
prevailing spot rate is C$1.20/$, what is the real exchange rate of
the U.S. dollar? Which currency is overvalued/undervalued in PPP
terms?

Consider the Euro-dollar exchange rate (nominal exchange rate =
Euros/$US). For each of these examples, use a supply/demand diagram
for the foreign exchange market to show the impact on the exchange
rate. In each case, does the exchange rate appreciate or
depreciate?
a. A debt crisis in Europe causes investors holding Euro
denominated securities to move to dollar denominated
securities.
b. The European Central Banks raises interest rates, attracting
inflows from U.S. financial investors into European markets.
c. The European...

Assume the current Euro-Dollar exchange rate is 0.9
EUR/USD. Based on your analysis you expect the Euro to depreciate.
What is your trading strategy? Discuss. How much would you invest
in this strategy?

Assume the current Euro-Dollar exchange rate is 0.9
EUR/USD. Based on your analysis you expect the Euro to depreciate.
What is your trading strategy? Discuss. How much would you invest
in this strategy?

The current dollar−pound exchange rate is $2 per British pound.
A U.S. basket that costs $100 would cost $140 in the United
Kingdom. For the next year, the U.S. Fed is predicted to keep U.S.
inflation at 2% and the Bank of England is predicted to keep U.K.
inflation at 3%. The speed of convergence to absolute PPP is 15%
per year.
1. (Scenario: Monetary Approach in the Long-run) What is the
current U.S. real exchange rate with the United...

ADVERTISEMENT

Get Answers For Free

Most questions answered within 1 hours.

ADVERTISEMENT

asked 5 minutes ago

asked 15 minutes ago

asked 27 minutes ago

asked 27 minutes ago

asked 28 minutes ago

asked 28 minutes ago

asked 40 minutes ago

asked 41 minutes ago

asked 47 minutes ago

asked 56 minutes ago

asked 59 minutes ago

asked 1 hour ago