Question 1

Assume that a British investor buys a one-year U.S. Treasury bill that pays 6 percent annual interest. Given a yield of 4 percent on a comparable British Treasury bill, the U.S. dollar must depreciate 2 percent against the British pound during the year for interest rate parity to hold.

Accepted Answer

The answer of Assume that a British investor buys a...

Question 2

If the euro per dollar exchange rate changes from $1 = 0.8 euros to $1 = 0.7 euros, it implies that the euro has depreciated against the dollar.

Accepted Answer

The change in exchange rate actually implies that the dollar has appreciated and became stronger against the euro, not the other way around.

Question 3

Suppose a 10-mile taxi ride costs £6.50 in London and $10.00 in Los Angeles. If the exchange rate is £1 = $1.70 purchasing power parity holds.

Accepted Answer

Purchasing power parity means that goods and services should cost the same across different currencies after adjusting for exchange rates. However, the given prices of a 10-mile taxi ride in London and Los Angeles indicate that there is a price difference, which contradicts purchasing power parity. Additionally, the exchange rate of £1 = $1.70 does not factor into whether or not purchasing power parity holds.

Question 4

When the domestic currency depreciates, domestic goods become more expensive to foreign buyers.

Accepted Answer

When the domestic currency depreciates, it means that the domestic currency has lost value relative to foreign currencies. This makes domestic goods cheaper for foreign buyers, as they can now buy more with their currency.

Question 5

When a U.S. importer needs $20,000 to settle an invoice for 228,000 Uruguayan pesos, the price of 1 dollar is 11.4 Uruguayan pesos.

Accepted Answer

To convert Uruguayan pesos to US dollars, we need to divide the amount of pesos by the exchange rate of dollars per peso:
228,000 pesos ÷ 11.4 pesos/dollar = $20,000.

Question 6

Other things equal, an appreciation of the Algerian dinar in relation to the euro will act to increase Algerian demand for European goods and to decrease European demand for Algerian goods.

Accepted Answer

When the Algerian dinar appreciates in relation to the euro, it becomes more expensive for Europeans to purchase Algerian goods, which decreases European demand for Algerian goods. On the other hand, Algerians can now purchase European goods at a lower price, which increases their demand for European goods. Therefore, an appreciation of the Algerian dinar in relation to the euro will act to increase Algerian demand for European goods and to decrease European demand for Algerian goods.

Question 7

To ensure interest rate parity, a decrease in the interest rate on Euroyen relative to Eurodollar deposits will require a greater expected appreciation of the Japanese yen against the U.S. dollar.

Accepted Answer

The answer of To ensure interest rate parity, a decrease...

Question 8

Suppose the yen value of a $100,000 wheat import contract rises from ¥12,000,000 to ¥13,000,000 between the contract and the payment date. This implies that the yen value of 1 dollar has declined so that, other things equal, we can expect an increase in Japanese demand for U.S. goods.

Accepted Answer

An increase in the yen value of a dollar actually implies a strengthening of the yen, making U.S. goods relatively more expensive for Japanese buyers. This would likely lead to a decrease in Japanese demand for U.S. goods, rather than an increase.

Question 9

Other things equal, the higher the deviations from purchasing power, the lesser will be the arbitrage opportunities.

Accepted Answer

Higher deviations from purchasing power parity create more arbitrage opportunities as traders can profit from the price differences between two markets.

Question 10

If interest rates in Europe fall below interest rates in the United States, then, other things equal, the demand for euros will decrease.

Accepted Answer

When interest rates in Europe fall below interest rates in the United States, investors are likely to move their funds to the higher yielding US investments, causing a decrease in demand for euros.

Question 11

The dollar return on a foreign investment is less than the interest rate on the foreign asset, if the foreign currency depreciates against the U.S. dollar between the purchase date and the maturity date.

Accepted Answer

The dollar return on a foreign investment incorporates both the interest earned on the foreign asset and the gains or losses from changes in exchange rates. If the foreign currency depreciates against the U.S. dollar, the value of the interest earned in foreign currency terms, when converted back to dollars, will be less than anticipated, potentially making the total dollar return less than the interest rate on the foreign asset.

Question 12

Purchasing power parity holds when the exchange rate is equal to the product of the foreign price level and the domestic price level.

Accepted Answer

Purchasing power parity holds when the exchange rate between two currencies is equal to the ratio of the foreign price level to the domestic price level, not the product.

Quiz 21: Exchapterange Rates and Financial Links Between Countries