EC249 Final: FInals review Exchange Rates and the Foreign Exchange Market

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ultramarinebadger314

13 Apr 2016

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Chapter 3 exchange rates and the foreign exchange market. Changes in exchange rates are described as depreciations or appreciations. A depreciation of the pound against the dollar is a fall in the dollar price of pounds. Example change from . 50 per pound to . 25 per pound. A depreciation of a country"s currency makes its good more expensive for foreigners. An appreciation of the pound against the dollar is a rise in the dollar price of pounds. Example change from . 50 per pound to . 75 per pound. An appreciation of a country"s currency makes its good cheaper for foreigners. Currency depreciation = foreigners find its exports are cheaper and domestic residents find that imports from abroad are more expensive (lower price of exports, higher price for imports) Currency appreciation = foreigners pay more for the country"s products and domestic consumers pay less for foreign products (higher price for exports, lower price for imports) Simple rule for exchange rates and asset returns.

Related Questions

Which of the following statements is accurate in regards to the US dollar:

A.	The central bank is responsible for printing the domestic currency and the value of the currency is adjusted to maintain a fixed level to another currency.
B.	The central bank has no ability to print the domestic currency and dollarization was adopted to minimize domestic inflation.
C.	Banks are responsible for printing the domestic currency and there is a floating exchange rate.
D.	The central bank (e.g. Federal Reserve) is responsible for printing the domestic currency and there is a floating exchange rate.

Suppose that monetary policy in the United States leads to an increase in interest rates relative to those in Japan. Which of the following will occur in the capital account:

A.	The demand for yen will increase.
B.	The dollar will appreciate relative to the yen.
C.	The supply of dollars will increase.
D.	The dollar will depreciate relative to the yen.

An expansionary monetary policy by the Fed would tend to:

A.	Lower the U.S. inflation rate, make exports cheaper, make imports more expensive, and raise the value of the dollar.
B.	Raise the U.S. inflation rate, make exports more expensive, make imports cheaper, and lower the value of the dollar.
C.	Raise the U.S. inflation rate, make exports cheaper, make imports more expensive, and raise the value of the dollar.
D.	Lower the U.S. inflation rate, make exports more expensive, make imports cheaper, and lower the value of the dollar.

cerisecod404

Let the exchange rate be defined as the number of dollars per British pound. Assume there is a relatively lower rate of inflation in the U.S. relative to that of Britain.

(a.) Would this event cause the demand for the dollar to increase or decrease relative to the demand for the pound? Why?

(b.) Has the dollar appreciated or depreciated relative to the pound?

(c.) Does this change in the value of the dollar make imports cheaper or more expensive for Americans? Are American exports cheaper or more expensive for importers of U.S. goods in GreatBritain? Illustrate by showing the price of a U.S. cell phone in Britain, before and after the change in the exchange rate.

(d.) If you had a business exporting goods to Britain, and U.S.inflation fell as discussed above in this example, would you plan to expand production or cut back? Why?

copperhare643

Just as with the price of a good, the price, or exchange rate, of a currency is determined by supply and demand. However, rather than using a traditional supply and demand analysis as shown in Marthinsen, currency traders often consider whether foreign funds will flow into or out of a country as a result of a particular economic circumstance. If foreigners wish to make domestic purchases or investments, the foreign currency must first be exchanged for the domestic currency. Thus, foreign funds flowing into a country increase the demand for the domestic currency and it appreciates. Funds flowing out reverse this process leading to depreciation of the domestic currency. In the table, place an X to indicate whether each economic condition will cause foreign funds to flow in or out of the country and whether the domestic currency will appreciate or depreciate.

Domestic circumstance	Funds flow in	Funds flow out	Currency appreciates	Currency depreciates
Real interest rates are higher than in other countries
Risk of civil war
Business taxes are raised above the world average				X
Expected stock market returns are better than elsewhere
Inflation increases
A large deposit of rare earth minerals is discovered
Rapidly growing manufacturing sector imports more foreign raw materials

ultramarinepug302

EC249 Final: FInals review Exchange Rates and the Foreign Exchange Market

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