Economics Currency Exchange Rates

Question 1

Calculate a Cross Rate

Answer 1

Cross Rate = (F/USD) / (D/USD)

- Imagine that “usd” is a common denominator

Question 2

Relative Purchasing Power Parity

Answer 2

ES1 = So X [(1+inflationF)^2 / (1+inflationD)^2]

Question 3

International Fisher Relation (determine if projected inflation rates are consistent)

Answer 3

(1+rF%USD)/(1+rF%F) = 1+expectedinfUSD/1+infF = should equal exp infF

(1+rF%D)/(1+rF%USD) = 1+infD / 1+expinfUSD = should equal exp infD

Question 4

Uncovered Interest Rate Parity Forecast

Answer 4

So[(1+rF%D)/(1+rF%F)] = Uncovered Interest Rate Parity Forecast

This is also how to calculate a no-arbitrage forward rate value.

Question 5

Mundell Flemming Model (expansionary Monetary Policy and Fiscal Policy)

Answer 5

Expansionary Monetary Policy

• Flexible exchange rates: lower interest rates and currency drops
• Fixed exchange rates: expansionary policy is futile and limited to FX reserves

Expansionary Fiscal Policy

• Flexible exchange rates: increases inflation&interest rates driving currency higher
• Fixed exchange rates: To prevent currency appreciation currency will be sold and increase money supply