ECON7520 Exchange rates and foreign exchange market: An asset approach
Exchange rates and foreign exchange market: An asset approach
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ECON7520 – Tutorial 2 Questions
Topic 2: Exchange rates and foreign exchange market: An asset approach
Based on lecture 2 and chapter 14 of Krugman, P., Obstfeld, M. and Melitz, M. (2018)
International Economics: Theory and Policy, Global Edition, (11th Edition), Pearson Higher
Education USA.
Part A. MCQs
1. If the domestic and the foreign interest rates are 12% and 10% respectively, then according
to interest rate parity condition __________.
(a) foreign currency is expected to appreciate by 4%
(b) foreign currency is expected to appreciate by 2%
(c) foreign currency is expected to depreciate by 4%
(d) foreign currency is expected to depreciate by 2%
2. If the US interest rate is 4% per year and the UK interest rate is 9% per year, which of the
following is true according to interest rate parity condition?
(a) The dollar will depreciate 5% in one year.
(b) The pound will appreciate 9% in one year.
(c) The pound will depreciate 5% in one year.
(d) The dollar will appreciate 9% in one year.
3. A currency forward contract is described as __________.
(a) agreeing today to buy or sell specified amount of a currency at a later date at a price set in
the future
(b) agreeing today to buy or sell specified amount of a currency today at its current price
(c) agreeing today to buy or sell specified amount of currency at a later date at a price set
today
(d) None of the above
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4. If a firm based in Germany wishes to avoid the risk of exchange rate movements, and is
due to receive $70,000 in 60 days, it could _________.
(a) enter into a 60-day forward sale of US dollars for euros
(b) enter into a 60-day forward purchase of US dollars for euros
(c) sell US dollars 60 days from now at the spot rate
(d) purchase US dollars 60 days from now at the spot rate
5. Suppose interest rates in the US are 5% when the spot exchange rate is $0.75 per euro and
the interest rate in France is 8% per year. What must the one-year forward exchange rate
approximately be?
(a) $0.73 per euro.
(b) $0.75 per euro.
(c) $0.81 per euro.
(d) $0.77 per euro.
6. Assume that the current exchange rate between US dollar and UK pound is 2 (i.e. 2 dollars
per pound). If interest parity holds, and the US interest rate is 8% while the UK interest rate is
6%, the expected exchange rate in one year is _______.
(a) 1.98
(b) 1.99
(c) 2.01
(d) 2.04
7. When a country’s currency depreciates _____________.
(a) exports will be cheaper and imports become more expensive
(b) exports will be expensive and imports become cheaper
(c) both imports and exports become more expensive
(b) both imports and exports become cheaper
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8. An appreciation of a country’s currency ___________.
(a) decreases the relative price of its exports and lowers the relative price of its imports
(b) lowers the relative price of its exports and raises the relative price of its imports
(c) raises the relative price of its exports and lowers the relative price of its imports
(d) raises the relative price of its exports and raises the relative price of its imports
9. Which of the following statement is most accurate?
(a) An appreciation of a country’s currency makes its goods more expensive.
(b) A depreciation of a country’s currency makes its goods more expensive for foreigners.
(c) A depreciation of a country’s currency makes its goods cheaper.
(d) A depreciation of a country’s currency makes its goods cheaper for foreigners.
10. A(n) __________ of a nation’s currency will cause imports _________ and exports to
______, all other things held constant.
(a) appreciation; increase; increase
(b) depreciation; decrease; decrease
(c) depreciation; decrease; increase
(d) depreciation; increases; decrease
11. A foreign exchange swap is a ____________.
(a) spot sale of a currency
(b) forward repurchase of a currency
(c) spot sale of a currency combined with a forward repurchase of the currency
(d) spot sale of a currency combined with a forward sale of the currency
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12. What is the expected dollar rate of return on euro deposits if today’s exchange rate is
$1.167 per euro, next year’s expected exchange rate is $1.10 per euro, the dollar interest rate
is 10% and the euro interest rate is 5%?
(a) 11%
(b) -1%
(c) 0%
(d) 10%
13. The dollar rate of return on euro deposits is __________.
(a) approximately the euro interest rate plus the rate of depreciation of the dollar against the
euro
(b) approximately the euro interest rate minus the rate of depreciation of the dollar against the
euro
(c) the rate of appreciation of the dollar against the euro
(d) approximately the dollar interest rate plus the rate of depreciation of the dollar against the
euro
14. The price specified on an option that the holder can buy or sell a specified amount of
foreign currency is called _________.
(a) premium
(b) call
(c) strike rate
(d) put
15. A put option gives the owner the right __________.
(a) and the obligation to buy one currency with another currency at a given price
(b) and the obligation to sell one currency with another currency at a given price
(c) but not the obligation to buy one currency with another currency at a given price
(d) but not the obligation to sell one currency with another currency at a given price
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Part B. Short answer/problem solving questions
1. Compute how many dollars it would cost to buy an Edinburgh Woolen Mill sweater
costing 50 British pounds for the following exchange rates.
Exchange rate (number of dollars
per one British pound)
Price of a sweater in
British pounds
Price in dollars
1.3 50
1.4 50
1.75 50
1.9 50
2. Compute how many British pounds it would cost to buy a pair of American designer jeans
costing $45.
Exchange rate (number of dollars
per one British pound)
Price of a pair of
American designer jeans
Price in British pounds
1.1 45
1.25 45
1.5 45
1.8 45
3. Find the exchange rate between the dollar and the British pound for the following cases.
Priced of a pair of American
designer jeans
Price in British pounds Exchange rate (number of
dollars per one British pound)