CH 17

Question 1

What is a Foreign Exchange Market?

Answer 1

A market in which one country’s currency is traded for another country’s.

Question 2

What is the definition of the Exchange Rate?

What are the two ways it is expressed with dollars?

Answer 2

The amount of one country’s currency that is traded for one unit of another’s currency.

• -Units of Foreign Currency per Dollar– L/$
• -Dollars per Unit of Foreign Currency– $/L

Question 3

If the exchange rate for Dollars per L is 1.5820, how would you get the L per Dollar?

Answer 3

By taking the reciprocal we can convert the exchange rates.

1/1.5820= .6321 L per $

Question 4

Why do American’s demand the British Pound?

Answer 4

2 Reasons:

To buy Goods and Services from British Firms
&
To buy British Assets

Same with any demand of Foreign Currency

Question 5

What is the Demand Curve for Foreign Currency?

Which way does it slope?

Answer 5

A curve indication the quantity of a specific foreign currency that Americans will want to buy, during a given period, at each different exchange rate.

–Downward Sloping–

Question 6

What moves us Along the Demand for British Pounds Curve?

Answer 6

Price Level Moves us Along the Curve. At a lower price level, there is a higher Demand for Pounds.

Question 7

What Shifts the whole Demand for British Pound Curve?

Answer 7

US Real GDP
Relative Price Level (inverse)
Americans' Taste for British Goods
Relative Interest Rate
Expected Changes in the Exchange Rate

Question 8

What is the Supply Curve for Foreign Currency?

Which way does it slope?

Answer 8

A curve indicating the quantity of a specific foreign currency that will be supplied, during a given period, at each different exchange rate.

–Upward Sloping–

Question 9

Why do the British want to supply Pounds in the Dollar-Pound Market? (Why do they want dollars)

Answer 9

2 Reasons:

To buy Goods and Services from American Firms
&
To buy American Assets

Question 10

What moves us Along the Supply of Pounds Curve?

Answer 10

Price Level Moves us ALONG the Curve. At a lower Price level, people want to supply less Pounds.

Question 11

What Shifts the whole Supply of Pounds Curve?

Answer 11

British Real GDP
Relative Price level (inverse)
British taste for US Goods
Relative Interest Rate
Expected change in the Exchange Rate

Question 12

What is a Floating Exchange Rate?

Answer 12

An exchange rate that is freely determined by the forces of Supply and Demand in the Market.

Question 13

What is Currency Appreciation? What is the concept underlying it?

Answer 13

An increase int he price of a currency in a floating-rate system.

Underlying: Purchasing Power Parity

Question 14

What is the Currency Depreciation? What is the concept underlying it?

Answer 14

A decrease int he price of a currency in a floating-rate system.

Underlying: Purchasing Power Parity

Question 15

When a floating exchange rate changes….

Answer 15

One country’s currency will appreciate (rise in price) while another country’s currency will depreciate (fall in price)

Question 16

How do exchange rate change over time? Give the three time period..

Answer 16

The Very Short Run– Weeks, Days, Minutes
The Short Run– Several Months, A year or two
The Long Run– Two years+

Question 17

What causes Exchange Rate to change in the Very Short Run? What is “Hot Money”?

Answer 17

Hot Money is large amounts of money at the hand of investors and traders that can be moved very quickly.

In the VSR: Relative Interest Rates and Expectations on Future Exchange Rates are the forces moving the exchange rate.

Question 18

What causes Exchange Rate to change in the Short Run?

Answer 18

In the SR: Exchange rates are largely caused by (Macro) Economic Fluctuations

(change in GDP)
GDP Increase– Currency Depreciation
GDP Decrease– Currency Appreciation

Question 19

What causes Exchange Rate to change in the Long Run? What does this reflect?

Answer 19

Relative Price Levels and Concept of Purchasing Power Parity. Reflects the PRICE RATIO between two countries.

Question 20

Define Purchasing Power Parity?

How will the currency’s change?

Answer 20

The idea that exchange rates will adjust in the long run so that the average price of goods in two countries will be roughly the same.

The currency of a country with high inflation will depreciate against the currency of a country whose inflation rate is lower.

Question 21

Give a situation that explains the PPP?

Answer 21

When there is a special deal that (the price ratio) is better than the exchange rate, People will take advantage and trade that item, raising demand and pushing the ratio towards the actual exchange rate.