International Economics: Exchange Rates

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Questions and Answers

If the exchange rate E$/€ is 1.1045, what is the cross rate Ekr/$?

6.5890/1.1045

6.5890*1.1045

6.7661*1.1045

6.7661/1.1045 (correct)

If an arbitrage opportunity exists, which of the following is true?

There is a difference in the exchange rates across countries.

The exchange rates are equalized across countries.

There is no opportunity to make a profit.

There is a profit opportunity by buying and selling currencies. (correct)

What is the covered interest parity condition formula?

F$/€ = E$/€ * (1 + i$) / (1 + i€) (correct)

F$/€ = E$/€ - (i$ - i€)

F$/€ = E$/€ + (i$ - i€)

F$/€ = E$/€ * (1 - i$) / (1 - i€)

Which of the following is NOT a function of a vehicle currency?

Setting monetary policy Signup and view all the answers

What is the forward exchange rate F$/€ if E$/€ = 1.1045 and the one-year interest rate in the US is 2% and in the Eurozone is 1%?

1.1045 * (1 + 0.02) / (1 + 0.01) Signup and view all the answers

If the exchange rate E$/€ is 1.1045 and the exchange rate Ekr/€ is 7.4731, what is the cross rate Ekr/$?

7.4731/1.1045 Signup and view all the answers

What happens to home exports when the home country's exchange rate depreciates?

They become less expensive as imports to foreigners Signup and view all the answers

What is the purpose of triadic arbitrage?

To earn a profit by exploiting differences in exchange rates across countries. Signup and view all the answers

What is the uncovered interest parity condition formula?

i$ = i€ + (E$/€ - F$/€)/E$/€ Signup and view all the answers

Which type of exchange rate regime allows for frequent depreciations and appreciations?

Floating exchange rate regime Signup and view all the answers

What is required for a fixed exchange rate to remain in place for a long period?

Government intervention in the foreign exchange market Signup and view all the answers

What is the effect of an appreciation of the home country's exchange rate on foreign exports?

They become less expensive as imports to home residents Signup and view all the answers

Which of the following is an example of a fixed exchange rate?

The exchange rate between the US dollar and the Chinese yuan Signup and view all the answers

What happens to the price of home exports when the exchange rate appreciates?

They become more expensive as imports to foreigners Signup and view all the answers

What is the main difference between a fixed and a floating exchange rate regime?

The level of government intervention in the foreign exchange market Signup and view all the answers

What is the effect of a depreciation of the home country's exchange rate on foreign exports?

They become more expensive as imports to home residents Signup and view all the answers

What is the correct interpretation of the calculation ΔE$/€,t / E$/€,t = -2.47%?

The dollar appreciated against the euro by 2.47%. Signup and view all the answers

If the euro value of the dollar increases by 2.53%, what is the correct interpretation?

The euro depreciated against the dollar. Signup and view all the answers

What is the effective exchange rate?

A weighted average of exchange rates with multiple countries. Signup and view all the answers

Suppose the dollar appreciates against the euro by 5% and depreciates against the yen by 10%. What is the correct interpretation of the effective exchange rate?

The dollar has appreciated against the euro but depreciated against the yen. Signup and view all the answers

What is the formula to calculate the percentage change in the dollar value of the euro?

ΔE$/€,t / E$/€,t Signup and view all the answers

A country's currency appreciates against one country's currency and depreciates against another country's currency. What can be said about the effective exchange rate?

The effective exchange rate may appreciate or depreciate. Signup and view all the answers

What is the purpose of aggregating bilateral exchange rates using trade weights?

To calculate the effective exchange rate. Signup and view all the answers

If the dollar appreciates against the euro and depreciates against the yen, what is the correct interpretation?

The dollar has become stronger against the euro but weaker against the yen. Signup and view all the answers

Study Notes

Exchange Rate Essentials

Exchange rate notation: E1/2 denotes the exchange rate of country 1 in units of country 1's currency per unit of country 2's currency.
Example: E$/€ denotes the US exchange rate with the Eurozone, meaning US dollars per euro.

Exchange Rate Quotations

Table 2(13)-1 shows major exchange rates as they might appear in the financial media.
Columns (1) to (3) show rates on November 15, 2019, and columns (4) to (6) show rates on November 15, 2018.
Example: One US dollar was worth 1.3230 Canadian dollars, 6.7661 Danish krone, 0.9054 euros, and so on.

Exchange Rate Changes and Relative Prices

Changes in the exchange rate cause changes in the relative prices of goods produced in the home and foreign countries.
When the home country's exchange rate depreciates, home exports become less expensive as imports to foreigners, and foreign exports become more expensive as imports to home residents.
When the home country's exchange rate appreciates, home exports become more expensive as imports to foreigners, and foreign exports become less expensive as imports to home residents.

Exchange Rate Regimes

There are two major types of exchange rate regimes: fixed (or pegged) and floating.
A fixed exchange rate fluctuates in a narrow range (or not at all) against some base currency over a sustained period.
A floating exchange rate fluctuates in a wider range, and the government makes no attempt to fix it against any base currency.

Appreciations and Depreciations

To determine the size of an appreciation or depreciation, compute the proportional change.
Example: The dollar appreciated against the euro by 2.47% from 2018 to 2019.
Example: The euro depreciated against the dollar by 2.53% from 2018 to 2019.

Multilateral Exchange Rates

Economists calculate multilateral exchange rate changes by aggregating bilateral exchange rates using trade weights to construct an average for each currency in the basket.
The resulting measure is called the change in the effective exchange rate.
Example: Home's currency appreciates 10% against country 1 but depreciates 30% against country 2, so the effective exchange rate change is calculated using trade weights.

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Description

Understand the notation and concepts of exchange rates between countries, including exchange rate quotations and currency units.