Deck 13: Economic Interdependence

Question 1

Based on the data in Table 1, did the dollar depreciate or appreciate against the pound, the Canadian dollar, the franc, the yen, and the mark between 1970 and 1980? Between 1980 and 1990? Between 1990 and 2000? Between 2000 and 2011?
Table 1 Exchange Rates Since 1970

Answer 1

From the below table, obtain the values of each country with respect to the year:
Canadian dollar
French franc / U.S. dollar
Yen/ pound
Dollar / mark

Question 2

Table 1 shows the exchange rates of various currencies versus the dollar. Use the information in the table to show how you could have profi ted by trading currencies if the exchange rate be-tween French francs and German marks was 3 francs per mark on January 1, 1990. Suppose that you began with 10,000 marks. Show what trades you could have made buying or selling francs, marks, and dollars to generate a profi t and how much money you could make.
Table 1 Exchange Rates Since 1970

Answer 2

As per the information we have,
On January 1, 1990 -
As per the given table below
In 1990,
Here we can see that if we trade with French franc, it is profited.

Question 3

Suppose that you are an investor who is considering buying a one-year U.S. government bond that has a 5 percent interest rate or a one-year Japanese government bond with a 1 percent interest rate. The exchange rate today is 110 yen per dollar, and you expect the exchange rate to be 105 yen per dollar one year from now
a Which bond would you purchase? Why?
b Suppose that the exchange rate today is 107 yen instead of 110 yen. Would you change your decision about which bond to buy?
c Suppose that the exchange rate is 110 yen today, and you think that there is a 20 percent chance that the exchange rate will be 100 yen in one year and an 80 percent chance that the exchange rate will be 108 yen in one year. Would you change your decision about which bond to buy?

Answer 3

Suppose that you are an investor who is considered buying a one-year U.S. government bond that has a 5 percent interest rate or a one year Japanese government bond with 1 percent interest rate. The exchange rate today is 110 yen per dollar, and you expect the exchange rate to be 105 yen per dollar one year from now.
a)
The bond I purchase today will be decided based on the following analysis:
If we are ready to invest 1000 dollars
To buy the Japanese bond, we would exchange $ 10,000 for 1,000,000 Yen and then buy the bond with this Yen.
At the end of the year, we will get principle
If the exchange rate is 110 Yen / Dollar
If the exchange rate after one year is 105 Yen / Dollar
It is better to purchase U.S. Government bond only , as we are getting 10500 dollars (10000 + 500) here and when as if it is Japanese we are getting Loss = 9181 dollars.
b)
No , because we incur a loss even it is 107 or 110 Yen.
c)
There is no change of changing the idea not to purchase Japanese bond because there are only 20% chances for the exchange rate to come down to 100 Yen.

Question 4

Suppose that the exchange rate adjusts so that interest-rate parity holds. Suppose also that the interest rate on a one-year German bond is 7 percent and the interest rate on a one-year U.S. bond is 4 percent.
a Suppose that you expect the exchange rate in one year to be 1.2 dollars per euro. What is the exchange rate today?
b Suppose that relative purchasing-power parity holds and that the infl ation rate in Germany is expected to be 2 percent over the next year. What is the expected infl ation rate in the United States?

Question 5

Because business cycles across countries have become less correlated recently, should we expect synchronized or unsynchronized business cycles across countries in the future?

Question 6

Some U.S. presidents have pursued a strong dollar policy, taking actions that cause the dollar to appreciate against other currencies. Other presidents have cared less about the value of the dollar, allowing it to depreciate against other currencies. What are the benefi ts and costs to a nation of appreciation and depreciation?

Question 7

Why does an oil price shock cause the business cycles of different countries to be synchronized?

Question 8

Suppose that you were a politician in a small country that owed millions of dollars (in dollardenominated loans) to U.S. banks that had lent your country money for investment over the past decade. Most of the investments failed because they went to political cronies rather than to legitimate business fi rms. Now foreign investors are getting nervous and starting to pull their money out, causing your country's exchange rate to depreciate. What actions should you consider taking to save your country's economy? Will it help to pass a law forbidding foreign investment?

Question 9

Why did the business cycles of major industrial countries become unsynchronized in the 1990s?

Question 10

What mechanisms lead to the international transmission of economic shocks? Explain the basic means by which the transmission occurs.

Question 11

What is the difference between the law of one price and purchasing-power parity?

Question 12

Why do investors care about what happens to the exchange rate?

Question 13

What is the difference between the nominal exchange rate and the real exchange rate?

Question 14

How does absolute purchasing-power parity differ from relative purchasing-power parity?

Question 15

What is interest-rate parity?

Question 16

What is the relationship between a country's savings, its government budget defi cit, its domestic investment in physical capital, and its foreign investment?

Question 17

What were the main causes of the Asian fi nancial crisis in 1997? What role did exchange rates play in the crisis?