Reading 15: currency exchange rates Flashcards
One year ago, the nominal exchange rate for USD/EUR was 1.300. Since then, the real exchange rate has increased by 3%. This most likely implies that:
the nominal exchange rate is less than USD/EUR 1.235.
the purchasing power of the euro has increased approximately 3% in terms of U.S. goods.
inflation in the euro zone was approximately 3% higher than inflation in the United States.
An increase in the real exchange rate USD/EUR (the number of USD per one EUR) means a euro is worth more in purchasing power (real) terms in the United States. Changes in a real exchange rate depend on the change in the nominal exchange rate relative to the difference in inflation. By itself, a real exchange rate does not indicate the directions or degrees of change in either the nominal exchange rate or the inflation difference. (LOS 15.a)
Sell-side participants in the foreign exchange market are most likely to include:
banks.
hedge funds.
insurance companies.
Large multinational banks make up the sell side of the foreign exchange market. The buy side includes corporations, real money and leveraged investment accounts, governments and government entities, and retail purchasers of foreign currencies. (LOS 15.c)
Suppose that the quote for British pounds (GBP) in New York is USD/GBP 1.3110. What is the quote for U.S. dollars (USD) in London (GBP/USD)?
0.3110.
0.7628.
1.3110.
1 / 1.311 = 0.7628 GBP/USD. (LOS 15.a)
The Canadian dollar (CAD) exchange rate with the Japanese yen (JPY) changes from JPY/CAD 75 to JPY/CAD 78. The CAD has:
depreciated by 3.8%, and the JPY has appreciated by 4.0%.
appreciated by 3.8%, and the JPY has depreciated by 4.0%.
appreciated by 4.0%, and the JPY has depreciated by 3.8%.
The CAD has appreciated because it is worth a larger number of JPY. The percent appreciation is (78 – 75) / 75 = 4.0%. To calculate the percentage depreciation of the JPY against the CAD, convert the exchange rates to direct quotations for Japan: 1 / 75 = 0.0133 CAD/JPY and 1 / 78 = 0.0128 CAD/JPY. Percentage depreciation = (0.0128 – 0.0133) / 0.0133 = –3.8%. (LOS 15.b)
Today’s spot rate for the Indonesian rupiah (IDR) is IDR/USD 2,400.00, and the New Zealand dollar trades at NZD/USD 1.6000. The NZD/IDR cross rate is:
0.00067.
1,492.53.
3,840.00.
Start with one NZD and exchange for 1 / 1.6 = 0.625 USD. Exchange the USD for 0.625 × 2,400 = 1,500 IDR. We get a cross rate of 1,500 IDR/NZD or 1 / 1,500 = 0.00067 NZD/IDR. (LOS 15.d)
The NZD is trading at USD/NZD 0.3500, and the SEK is trading at NZD/SEK 0.3100. The USD/SEK cross rate is:
0.1085.
8.8573.
9.2166.
USD/NZD 0.3500 × NZD/SEK 0.3100 = USD/SEK 0.1085.
Notice that the NZD term cancels in the multiplication. (LOS 15.d)
The spot CHF/GBP exchange rate is 1.3050. In the 180-day forward market, the CHF/GBP exchange rate is –42.5 points. The 180-day forward CHF/GBP exchange rate is closest to:
1.2625.
1.3008.
1.3093.
The 180-day forward exchange rate is 1.3050 – 0.00425 = CHF/GBP 1.30075. (LOS 15.e)
The spot rate on the New Zealand dollar (NZD) is NZD/USD 1.4286, and the 180-day forward rate is NZD/USD 1.3889. This difference means:
interest rates are lower in the United States than in New Zealand.
interest rates are higher in the United States than in New Zealand.
it takes more NZD to buy one USD in the forward market than in the spot market.
Interest rates are higher in the United States than in New Zealand. It takes fewer NZD to buy one USD in the forward market than in the spot market. (LOS 15.f)
The current spot rate for the British pound in terms of U.S. dollars is $1.533 and the 180-day forward rate is $1.508. Relative to the pound, the dollar is trading closest to a 180-day forward:
discount of 1.63%.
premium of 1.66%.
discount of 1.66%.
To calculate a percentage forward premium or discount for the U.S. dollar, we need the dollar to be the base currency. The spot and forward quotes given are U.S. dollars per British pound (USD/GBP), so we must invert them to GBP/USD. The spot GBP/USD price is 1 / 1.533 = 0.6523 and the forward GBP/USD price is 1 / 1.508 = 0.6631. Because the forward price is greater than the spot price, we say the dollar is at a forward premium of 0.6631 / 0.6523 – 1 = 1.66%. Alternatively, we can calculate this premium with the given quotes as spot/forward – 1 to get 1.533 / 1.508 – 1 = 1.66%. (LOS 15.g)
The annual interest rates in the United States (USD) and Sweden (SEK) are 4% and 7% per year, respectively. If the current spot rate is SEK/USD 9.5238, then the 1-year forward rate in SEK/USD is:
9.2568.
9.7985.
10.2884.
The forward rate in SEK/USD is 9.5238(1.07/1.04)= 9.7985 Since the SEK interest rate is the higher of the two, the SEK must depreciate approximately 3%. (LOS 15.h)
The annual risk-free interest rate is 10% in the United States (USD) and 4% in Switzerland (CHF), and the 1-year forward rate is USD/CHF 0.80. Today’s USD/CHF spot rate is closest to:
0.7564.
0.8462.
0.8888.
We can solve interest rate parity for the spot rate as follows: With the exchange rates quoted as USD/CHF, the spot is 0.80(1.04/1.10)= 0.7564 Since the interest rate is higher in the United States, it should take fewer USD to buy CHF in the spot market. In other words, the forward USD must be depreciating relative to the spot. (LOS 15.h)
The monetary authority of The Stoddard Islands will exchange its currency for U.S. dollars at a one-for-one ratio. As a result, the exchange rate of the Stoddard Islands currency with the U.S. dollar is 1.00, and many businesses in the Islands will accept U.S. dollars in transactions. This exchange rate regime is best described as:
a fixed peg.
dollarization.
a currency board.
This exchange rate regime is a currency board arrangement. The country has not formally dollarized because it continues to issue a domestic currency. A conventional fixed peg allows for a small degree of fluctuation around the target exchange rate. (LOS 15.i)
A country that wishes to narrow its trade deficit devalues its currency. If domestic demand for imports is perfectly price-inelastic, whether devaluing the currency will result in a narrower trade deficit is least likely to depend on:
the size of the currency devaluation.
the country’s ratio of imports to exports.
price elasticity of demand for the country’s exports.
With perfectly inelastic demand for imports, currency devaluation of any size will increase total expenditures on imports (same quantity at higher prices in the home currency). The trade deficit will narrow only if the increase in export revenues is larger than the increase in import spending. To satisfy the Marshall-Lerner condition when import demand elasticity is zero, export demand elasticity must be larger than the ratio of imports to exports in the country’s international trade. (LOS 15.j)
A devaluation of a country’s currency to improve its trade deficit would most likely benefit a producer of:
luxury goods for export.
export goods that have no close substitutes.
an export good that represents a relatively small proportion of consumer expenditures.
A devaluation of the currency will reduce the price of export goods in foreign currency terms. The greatest benefit would be to producers of goods with more elastic demand. Luxury goods tend to have higher elasticity of demand, while goods that have no close substitutes or represent a small proportion of consumer expenditures tend to have low elasticities of demand. (LOS 15.j)
Other things equal, which of the following is most likely to decrease a country’s trade deficit?
Increase its capital account surplus.
Decrease expenditures relative to income.
Decrease domestic saving relative to domestic investment.
An improvement in a trade deficit requires that domestic savings increase relative to domestic investment, which would decrease a capital account surplus. Decreasing expenditures relative to income means domestic savings increase. Decreasing domestic saving relative to domestic investment is consistent with a larger capital account surplus (an increase in net foreign borrowing) and a greater trade deficit. (LOS 15.j)
