RQ_Solution_Ch_14.docx

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Department
Economics
Course Code
ECO365H1
Professor
Iris Wu

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Description
ECMC61Chapter 14 Review Questions Answer KeyQuestion 1 Problems 6eEERREInterest rate parity Let USDbe domestic currency and pound sterlingbe foreign currencySuppose the dollar interest rate and the pound sterling interest rate are the same 5 per year RR005eEEee0 E EE EEFor IRP to hold 0This implies eThe current exchange rate E must equal the expected future exchange rate E with equality of nominal interest rates there can be no expected increase or decrease in theexchange rate in equilibriumSuppose the expected futureexchange rate 152 per pound remains constant as Britains interest rate rises to 10 per yearIf the US interest rate also remains constant at 5 the new equilibriumexchange rate isE15201005EGiven the above information IRP implies E152005 01005EFor IRP to hold The expected rate of appreciation of the dollar is 5 per yearSolve for E E15209516Question 2 Problems 7If market traders learn that the interest rate on dollar will decrease in the near future They expect the US dollar to depreciate because investing in US dollar deposit is not as attractive as beforeee0EEThe dollar is expected to depreciate against euro iedepreciates fromto e1EeEHolding and R a depreciation of the expectedexchange rate increases the eEEREexpectedreturn ondeposit eEEREThis shifts thecurve up and to the right1
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