Exam 20: The Foreign Exchange Market

The "Big Mac" Index

Balance-of-payments accounting indicates that any surplus (deficit) in the current account must be offset by a deficit (surplus) in the financial account. Explain why this is so, using demand and supply curves of foreign exchange. Suppose that a country had a current account surplus. What would you expect to happen to the current account balance if there were a relative decline in the domestic interest rate? Why?

You and a friend get into a heated discussion about the value of the U.S. dollar in which you argue that the dollar is currently undervalued against the Japanese yen. Failing to resolve the issue, you decide to prove that your position has the greatest economic merit given what you have recently learned in your international economics class. How might you go about trying to demonstrate to your friend that you are correct and that, indeed, the dollar is undervalued?

The Wall Street Journal indicated, in its issue of Friday, November 9, 2012, that, in late trading on Thursday, November 8, 2012, the spot U.K. pound was selling at a price of $1.5983 per pound. At the same time, the six-months forward U.K. pound was selling at a price of $1.5974 per pound. Observation of these rates indicates that the U.K. pound was selling at a six-months forward __________ against the dollar, and, if covered interest parity had indeed been attained at that time, the conclusion could validly be reached that interest rates in the United Kingdom were __________ than comparable interest rates in the United States.

If, because of Japan's high saving rate (in excess of domestic investment spending), Japan invests overseas, then this investment can cause __________ of the Japanese yen And thus a consequent trade __________ for Japan.

If a "Big Mac costs $4.00 in the United States and 200 yen in Japan, then the implied "purchasing-power-parity" exchange rate using the "Big Mac" is __________. If the actual exchange rate in the market is 120 yen = $1, then an economist would say that the actual Japanese yen is __________ in comparison with its "purchasing-power-parity" rate.

If a speculator observes that the current 3-months forward rate on Swiss francs is $1.05 = 1 franc, but he/she expects that the spot rate in 3 months will be $1.10 = 1 franc, then this Speculator would now

If interest rates differ between two countries, it is an indication that the financial markets are not in equilibrium, and that investment flows should be taking place between the two countries. Agree? Disagree? Explain.

A simultaneous increase in U.S. demand for German products and decrease in the desire of German investors to send funds to the United States would, under a flexible exchange Rate system and with other things equal, lead to __________ of the U.S. dollar against the euro and to __________ of the euro against the dollar.

Suppose that the one-year interest rate in the United States is 6% and that the one-year interest rate in the United Kingdom is 3%. In the context of "uncovered" interest arbitrage and with other things equal, funds would tend to flow out of the United States and into the United Kingdom

Other things equal, if exchange rates are flexible, and if U.S. consumers increase their demand for Japanese goods at the same time that Japanese consumers increase their demand for U.S. goods, then we would expect the dollar to

Given the following partially-completed table showing the quantity demanded of euros and the quantity supplied of dollars in exchange for the euros: exchange rate euros demanded dollars supplied \ 2.00=1 600 \ 1.50=1 \ 1,500 The missing values are __________.

In a setting of flexible exchange rates, suppose that the U.S. citizens decrease their import purchases from the United Kingdom at the same time that British citizens increase their purchases of stocks and bonds in the United States. The first action (the U.S. imports) by itself would lead to __________ of the dollar against the pound; the second action by itself would __________ of the dollar against the pound.