International Finance Tutorial TUTORIAL TRUE-FALSE QUIZ If the U.S intervenes in the foreign exchange market by buying U.S dollars with Japanese yen, then the U.S dollar should appreciate against the Japanese yen a True Correct This would increase the demand for U.S dollars and increase the supply of Japanese yen, which should make U.S dollar appreciate versus the Japanese yen If the U.S government places a high tax on interest income earned on foreign investments, it would most likely encourage the exchange of U.S dollars for other currencies a False Correct This would most likely discourage the exchange of dollars for other currencies, as the tax would render foreign investments less attractive Currency speculators can be especially influential on the exchange rate movements of emerging markets because those markets have a smaller amount of foreign exchange trading a True Correct The smaller amount of trading would magnify actions taken by currency speculators A higher foreign interest rate tends to place downward pressure on the foreign currency and therefore can have an unfavorable affect on expected dollar cash flows a False Correct The higher foreign interest rate should place upward pressure on the foreign currency due to increased demand and therefore have a favorable affect on expected dollar cash flows If two countries engage in a large volume of international trade but very small international capital flows, relative inflation rates would likely be more influential than relative interest rates a True Correct The sensitivity of an exchange rate to these factors is dependent on the volume of international transactions between the two countries If the two countries engage in a large volume of international trade but very small international capital flows, the relative inflation rates would likely be more influential However, if the two countries engage in a large volume of capital flows, interest rate fluctuations may be most influential b False Incorrect MULTIPLE CHOICE QUIZ Assume the spot rate of the euro (€) is $0.90 The expected spot rate one year from now is assumed to be $0.85 This percentage change reflects a: a 5.56% appreciation of the euro Incorrect Percentage change in foreign currency value = (S - S t-1)/St-1 (negative results are depreciation, positive results are appreciation) b 5.56% depreciation of the euro Correct Percentage change in foreign currency value = (S - St-1)/St-1 = ($0.85 - $0.90) / $0.90 = -0.0556 = 5.56% depreciation (negative results are depreciation, positive results are appreciation) c 5.88% appreciation of the euro Incorrect Percentage change in foreign currency value = (S - S t-1)/St-1 (negative results are depreciation, positive results are appreciation) International Finance Tutorial d 5.88% depreciation of the euro Incorrect Percentage change in foreign currency value = (S - S t-1)/St-1 (negative results are depreciation, positive results are appreciation) The current spot rate of the British pound (£) is $1.45 One year from now, the spot rate of the British pound is $1.51 This percentage change reflects a: a 4.14% appreciation of the U.S dollar Incorrect Percentage change in foreign currency value = (S - S t-1)/St-1 (negative results are depreciation, positive results are appreciation) This formula will give the change in the British pound, not the U.S dollar b 4.14% depreciation of the British pound Incorrect Percentage change in foreign currency value = (S - S t-1)/St-1 (negative results are depreciation, positive results are appreciation) c 4.14% appreciation of the British pound Correct Percentage change in foreign currency value = (S - St-1)/St-1 = ($1.51 - $1.45)/$1.45 = 0.0414 = 4.14% appreciation (negative results are depreciation, positive results are appreciation) d 3.97% appreciation of the British pound Incorrect Percentage change in foreign currency value = (S - S t-1)/St-1 (negative results are depreciation, positive results are appreciation) Suppose the inflation rate in Australia goes up relative to the U.S inflation rate What effect will that have on the supply, demand, and equilibrium exchange rate of the Australian dollar? a the supply of Australian dollars will go up, the demand for Australian dollars will go down, and the Australian dollar will depreciate Correct An increase in Australian inflation relative to U.S inflation will cause the demand for Australian dollars to go down because Americans will want to buy fewer Australian goods This will lead to an increase in the supply of Australian dollars The result will be a depreciation in the value of the Australian dollar relative to the U.S dollar b the supply of Australian dollars will go up, the demand for Australian dollars will go down, and the Australian dollar will appreciate Incorrect An increase in Australian inflation relative to U.S inflation will cause the demand for Australian dollars to go down because Americans will want to buy fewer Australian goods This will lead to an increase in the supply of Australian dollars The result will be a depreciation in the value of the Australian dollar relative to the U.S dollar c the supply of Australian dollars will go down, the demand for Australian dollars will go up, and the Australian dollar will depreciate Incorrect An increase in Australian inflation relative to U.S inflation will cause the demand for Australian dollars to go down because Americans will want to buy fewer Australian goods This will lead to an increase in the supply of Australian dollars The result will be a depreciation in the value of the Australian dollar relative to the U.S dollar d the supply of Australian dollars will go down, the demand for Australian dollars will go up, and the Australian dollar will appreciate Incorrect An increase in Australian inflation relative to U.S inflation will cause the demand for Australian dollars to go down because Americans will want to buy fewer Australian goods This will lead to an increase in the supply of Australian dollars The result will be a depreciation in the value of the Australian dollar relative to the U.S dollar Suppose interest rates in Europe increase relative to U.S interest rates What effect will that have on the supply, demand, and equilibrium exchange rate of the euro (€)? a the supply of euros will go up, the demand for euros will go down, and the euro will depreciate Incorrect Interest rate increases in Europe relative to the U.S will cause demand for euros to go up because people will want to invest in European securities This will lead to a International Finance Tutorial decrease in the supply of euros because people will want to stay in that currency The result will be an appreciation in the value of the euro relative to the U.S dollar b the supply of euros will go up, the demand for euros will go down, and the euro will appreciate Incorrect Interest rate increases in Europe relative to the U.S will cause demand for euros to go up because people will want to invest in European securities This will lead to a decrease in the supply of euros because people will want to stay in that currency The result will be an appreciation in the value of the euro relative to the U.S dollar c the supply of euros will go down, the demand for euros will go up, and the euro will depreciate Incorrect Interest rate increases in Europe relative to the U.S will cause demand for euros to go up because people will want to invest in European securities This will lead to a decrease in the supply of euros because people will want to stay in that currency The result will be an appreciation in the value of the euro relative to the U.S dollar d the supply of euros will go down, the demand for euros will go up, and the euro will appreciate Correct Interest rate increases in Europe relative to the U.S will cause demand for euros to go up because people will want to invest in European securities This will lead to a decrease in the supply of euros because people will want to stay in that currency The result will be an appreciation in the value of the euro relative to the U.S dollar Suppose income levels in Australia go up relative to the U.S levels What effect will that have on the supply, demand, and equilibrium price of U.S dollars? a the supply of U.S dollars will go up, the demand for U.S dollars will go down, and the U.S dollar will depreciate Incorrect Income increases in Australia relative to the U.S will cause demand for U.S dollars to go up because Australians will have more money to buy imports This will not change the supply of U.S dollars The result of the demand shift will be an appreciation in the value of the U.S dollar b the supply of U.S dollars will go up, the demand for U.S dollars will go down, and the U.S dollar will appreciate Incorrect Income increases in Australia relative to the U.S will cause demand for U.S dollars to go up because Australians will have more money to buy imports This will not change the supply of U.S dollars The result of the demand shift will be an appreciation in the value of the U.S dollar c the supply of U.S dollars will not change, the demand for U.S dollars will go up, and the U.S dollar will depreciate Incorrect Income increases in Australia relative to the U.S will cause demand for U.S dollars to go up because Australians will have more money to buy imports This will not change the supply of U.S dollars The result of the demand shift will be an appreciation in the value of the U.S dollar d the supply of U.S dollars will not change, the demand for U.S dollars will go up, and the U.S dollar will appreciate Correct Income increases in Australia relative to the U.S will cause demand for U.S dollars to go up because Australians will have more money to buy imports This will not change the supply of U.S dollars The result of the demand shift will be an appreciation in the value of the U.S dollar If a bank thinks the British pound is overvalued, it should which of the following? a buy more of the pound before it depreciates Incorrect Since the bank expects the pound to decrease in value, it would want to sell it now before it depreciates b buy more of the pound before it appreciates Incorrect Since the bank expects the pound to decrease in value, it would want to sell it now before it depreciates International Finance Tutorial c sell the pound before it depreciates Correct Since the bank expects the pound to decrease in value, it would want to sell it now before it depreciates d sell the pound before it appreciates Incorrect Since the bank expects the pound to decrease in value, it would want to sell it now before it depreciates e none of above Incorrect Answer c is the correct answer Assume the U.S and Argentina have high levels of trade flows but low levels of capital flows Which of the following statements is true regarding exchange rate determination? a inflation differentials are very important Incorrect Although inflation differentials are important, this is not the best answer b interest rate differentials are very important Incorrect Interest rate differentials are very important when there are high levels of capital flows, but have little impact on trade flows c income differentials are very important Incorrect Although income differentials are very important, this is not the best answer d both a and c Correct Inflation and income differentials are very important when there are high levels of trade flows, but have little impact on capital flows e all of the above Incorrect Answer d is the correct answer Which of the following is not a factor that affects exchange rates? a relative inflation rates Incorrect Relative inflation rates affect exchange rates Changes in relative inflation rates can affect international trade activity, which influences the demand and supply of currencies, and therefore influences exchange rates b relative income levels Incorrect Relative income levels affect exchange rates Since income can affect the amount of imports demanded, it can affect exchange rates c relative interest rates Incorrect Relative interest rates affect exchange rates Changes in relative interest rates affect investment in foreign securities, which influences the demand and supply of currencies and therefore influences exchange rates d government controls Incorrect Government controls affect exchange rates The governments of foreign countries can influence the equilibrium exchange rate in many ways, including the imposition of foreign exchange barriers e all of the above are factors that affect exchange rates Correct Relative inflation rates, income levels, and interest rates can all affect exchange rates Furthermore, government controls and expectations can affect exchange rates PROBLEMS If you expect the exchange rate of USD to appreciate from its present level of VND 16,000 to VND16,080 in 30 days, what should you to earn speculative profit? Calculate the profit if you can borrow million units of a currency to start USD interest rate 4.50 - 4.75% VND interest rate 8.0 - 9.0% Chapter 4: Question 3, Self-Test on page 112 of Madura Chapter 4: Question 19 on page 114 of Madura International Finance Tutorial 19 Aggregate Effects on Exchange Rates Assume that the United States invests heavily in government and corporate securities of Country K In addition, residents of Country K invest heavily in the United States Approximately $10 billion worth of investment transactions occur between these two countries each year The total dollar value of trade transactions per year is about $8 million This information is expected to also hold in the future Because your firm exports goods to Country K, your job as international cash manager requires you to forecast the value of Country K’s currency (the “krank”) with respect to the dollar Explain how each of the following conditions will affect the value of the krank, holding other things equal Then, aggregate all of these impacts to develop an overall forecast of the krank’s movement against the dollar a U.S inflation has suddenly increased substantially, while Country K’s inflation remains low ANSWER: Increased U.S demand for the krank Decreased supply of kranks for sale Upward pressure in the krank’s value b U.S interest rates have increased substantially, while Country K’s interest rates remain low Investors of both countries are attracted to high interest rates ANSWER: Decreased U.S demand for the krank Increased supply of kranks for sale Downward pressure on the krank’s value c The U.S income level increased substantially, while Country K’s income level has remained unchanged ANSWER: Increased U.S demand for the krank Upward pressure on the krank’s value d The U.S is expected to impose a small tariff on goods imported from Country K ANSWER: The tariff will cause a decrease in the United States’ desire for Country K’s goods, and will therefore reduce the demand for kranks for sale Downward pressure on the krank’s value e Combine all expected impacts to develop an overall forecast ANSWER: Two of the scenarios described above place upward pressure on the value of the krank However, these scenarios are related to trade, and trade flows are relatively minor between the U.S and Country K The interest rate scenario places downward pressure on the krank’s value Since the interest rates affect capital flows and capital flows dominate trade flows between the U.S and Country K, the interest rate scenario should overwhelm all other scenarios Thus, when considering the importance of implications of all scenarios, the krank is expected to depreciate Small Business Dilemma Assessment by the Sports Exports Company of Factors That Affect the British Pound’s Value Given Jim’s expectations, forecast whether the pound will appreciate or depreciate against the dollar over time ANSWER: The pound should depreciate because the British inflation is expected to be higher than the U.S inflation This could cause a shift in trade flows that would place downward pressure on the pound’s value The interest rate movements of both countries are expected to be similar for both countries Therefore, there should not be any adjustment in the capital flows between the two countries Given Jim’s expectations, will the Sports Exports Company be favorably or unfavorably affected by the future changes in the value of the pound? ANSWER: The Sports Exports Company will be unfavorably affected, because depreciation in the British pound will cause the pound receivables to convert into fewer dollars International Finance Tutorial ... Correct Percentage change in foreign currency value = (S - St-1)/St-1 = ($1.51 - $1 .45 )/$1 .45 = 0. 041 4 = 4. 14% appreciation (negative results are depreciation, positive results are appreciation)... interest rate 4. 50 - 4. 75% VND interest rate 8.0 - 9.0% Chapter 4: Question 3, Self-Test on page 112 of Madura Chapter 4: Question 19 on page 1 14 of Madura International Finance Tutorial 19 Aggregate... b 4. 14% depreciation of the British pound Incorrect Percentage change in foreign currency value = (S - S t-1)/St-1 (negative results are depreciation, positive results are appreciation) c 4. 14%