Minicase Determining the Effects of Changes in Exchange Rates, Purchasing Power Parity CONCEPTS IN THIS CASE exchange rate foreign exchange market spot versus forward transactions law of one price interest parity condition tariffs versus quotas purchasing power parity capital mobility As a new member of the international department at your company, you have been asked to conduct a review class on the foreign exchange market You remember something about this from your undergraduate classes, but you are not quite sure how to proceed The company library has older texts and other information, but you want to present more recent views on how to manage this important aspect of the company International sales produce almost 35% of all revenues and are expected to increase considerably in the future In fact, the only prospects for substantial growth will depend on the correct management of international markets and finances In setting up the review for others in your department, you decide to begin with fundamental definitions These definitions will be a part of the handout you will provide at the time of your presentation What are the definitions of the following foreign exchange terms? a Exchange rate b Foreign exchange market c Spot transactions d Forward transactions e Forward exchange rate f Appreciating currency g Depreciating currency h Law of one price i Interest parity condition j Monetary neutrality k Exchange rate overshooting l Effective exchange rate index m Tariffs n Quotas o Purchasing power parity p Capital mobility Explain why foreign exchange rates are important to your firm; how would changes in the exchange rate affect your firm's sales and net profits? Explain how a 20% increase in the price of Turkish pistachios would affect the cost of the same product in Canadian dollars under the theory of purchasing power parity (PPP) What factors does this theory leave out? In the long run, which four major factors affect the exchange rate? State whether each of the following changes causes the Canadian dollar to appreciate or to depreciate relative to foreign currencies q The price level in Canada rises r The price level in Canada falls s Canada imposes or increases a tariff t Canada imposes or reduces a quota u Demand for Canadian exports increases v Demand for Canadian exports decreases w Productivity in Canada increases x Productivity in Canada decreases Use the dollar and interest rates figure in your text to explain the need to distinguish between real and nominal interest rates when predicting exchange rate movements Assume that today is January 1, $1.00 = 5.80 francs, and the interest rate on dollar deposits is 8% y If the dollar appreciates relative to the franc by 2%, what will be the return on dollar deposits in terms of francs? z If the dollar depreciates relative to the franc by 1%, what will be the return on dollar deposits in terms of francs? aa If the expected exchange rate is $1.00 = 6.96 francs, what is the expected rate of appreciation for the dollar? bb If the dollar is expected to appreciate 5%, what interest rate on franc deposits is required if the concepts of interest-rate parity and capital mobility hold? Copyright © 2000–2001 Addison Wesley Longman, a division of Pearson Education Adaptation copyright © 2002 Pearson Education Canada ... affect the cost of the same product in Canadian dollars under the theory of purchasing power parity (PPP) What factors does this theory leave out? In the long run, which four major factors affect the. .. mobility Explain why foreign exchange rates are important to your firm; how would changes in the exchange rate affect your firm's sales and net profits? Explain how a 20% increase in the price of Turkish... increases x Productivity in Canada decreases Use the dollar and interest rates figure in your text to explain the need to distinguish between real and nominal interest rates when predicting exchange