International Macroeconomics 3rd Edition Feenstra Solutions Manual

International Macroeconomics 3rd

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International Macroeconomics 3rd Edition Feenstra Solutions Manual

2 13

Introduction to Exchange Rates

and the Foreign Exchange Market

1. Refer to the exchange rates given in the following table:

June 25, 2010 June 25, 2009

Country (currency) FX per $ FX per £ FX per € FX per $

Australia (dollar) 1.152 1.721 1.417 1.225

Canada (dollar) 1.037 1.559 1.283 1.084
Denmark (krone) 6.036 9.045 7.443 5.238
Euro 0.811 1.215 1.000 0.703
Hong Kong (dollar) 7.779 11.643 9.583 7.750
India (rupee) 46.36 69.476 57.179 48.16
Japan (yen) 89.35 134.048 110.308 94.86
Mexico (peso) 12.697 18.993 15.631 13.22
Sweden (krona) 7.74 11.632 9.577 7.460
United Kingdom (pound) 0.667 1.000 0.822 0.609
United States (dollar) 1.000 1.496 1.232 1.000
Source: U.S. Federal Reserve Board of Governors, H.10 release: Foreign Exchange Rates.

Based on the table provided, answer the following questions:

a. Compute the U.S. dollar–yen exchange rate E$/¥ and the U.S. dollar–
Canadian dollar exchange rate E$/C$ on June 25, 2010, and June 25, 2009.
Answer:
June 25, 2009: E$/¥ = 1/(94.86) = $0.0105/¥
June 25, 2010: E$/¥ = 1/(89.35) = $0.0112/¥
June 25, 2009: E$/C$ = 1/(1.084) = $0.9225/C$
June 25, 2010: E$/C$ = 1/(1.037) = $0.9643/C$

b. What happened to the value of the U.S. dollar relative to the Japanese yen and
Canadian dollar between June 25, 2009, and June 25, 2010? Compute the per-
centage change in the value of the U.S. dollar relative to each currency using the
U.S. dollar-foreign currency exchange rates you computed in (a).
Answer: Between June 25, 2009 and 2010, both the Canadian dollar and the
Japanese yen appreciated relative to the U.S. dollar. The percentage appreciation
in the foreign currency relative to the U.S. dollar is:
%
E$/¥  ($0.0112 – $0.0105)/$0.0105 = 6.17%
%
E$/C$  ($0.9643 – $0.9225)/$0.9225 = 4.53%

S-5

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S-6 Solutions ■ Chapter 2(13) Introduction to Exchange Rates & the Foreign Exchange Market

c. Using the information in the table for June 25, 2010, compute the Danish
krone–Canadian dollar exchange rate Ekrone/C$.
Answer: Ekrone/C$ = (6.036 kr/$)/(1.037 C$/$) = 5.8206 kr/C$.
d. Visit the website of the Board of Governors of the Federal Reserve System at
http://www.federalreserve.gov/. Click on “Economic Research and Data” and
then “Statistics: Releases and Historical Data.” Download the H.10 release For-
eign Exchange Rates (weekly data available). What has happened to the value of
the U.S. dollar relative to the Canadian dollar, Japanese yen, and Danish krone
since June 25, 2010?
Answer: Answers will depend on the latest data update.
Based on the foreign exchange rates (H.10) released on September 16, 2013, the
exchange rate for the Canadian dollar, yen, and krone was 1.03, 99.38, and 5.62,
respectively. Thus, while the Canadian dollar–U.S. dollar exchange rate has re-
mained about the same, the yen has depreciated by about 11.22% and the krone
has appreciated by about 6.95%.
e. Using the information from (d), what has happened to the value of the U.S. dol-
lar relative to the British pound and the euro? Note: The H.10 release quotes
these exchange rates as U.S. dollars per unit of foreign currency in line with
long-standing market conventions.
Answer: Answers will depend on the latest data update.
Based on the foreign exchange rates (H.10) released on September 16, 2013, the
U.K. pound–U.S. dollar and euro–U.S. dollar rates were 0.63 and 0.753, respec-
tively. Thus, relative to the U.S. dollar, the pound appreciated by 5.48% and the
euro appreciated by 7.12%.
2. Consider the United States and the countries it trades with the most (measured in
trade volume): Canada, Mexico, China, and Japan. For simplicity, assume these are the
only four countries with which the United States trades. Trade shares and exchange
rates for these four countries are as follows:
Country (currency) Share of Trade $ per FX in 2009 $ per FX in 2010

Canada (dollar) 36% 0.9225 0.9643

Mexico (peso) 28% 0.0756 0.0788
China (yuan) 20% 0.1464 0.1473
Japan (yen) 16% 0.0105 0.0112

a. Compute the percentage change from 2009 to 2010 in the four U.S. bilateral ex-
change rates (defined as U.S. dollars per unit of foreign exchange, or FX) in the
table provided.
Answer:
%D E$/C$ = (0.9643 – 0.9225)/0.9225 = 4.53%
%D E$/pesos = (0.0788 – 0.0756)/0.0756 = 4.23%
%D E$/yuan = (0.1473 – 0.1464)/0.1464 = 0.61%
%D E$/¥ = (0.0112 – 0.0105/0.0105 = 6.67%
b. Use the trade shares as weights to compute the percentage change in the nomi-
nal effective exchange rate for the United States between 2009 and 2010 (in U.S.
dollars per foreign currency basket).
Answer: The trade-weighted percentage change in the exchange rate is:
%D E = 0.36(%D E$/C$) + 0.28(%D E$/pesos) + 0.20(%D E$/yuan) +0.16(%D E$/¥)
%D E = 0.36(4.53%) + 0.28(4.23%) + 0.20(0.61%) + 0.16(6.67%) = 4.01%
 Solutions ■ Chapter 2(13) Introduction to Exchange Rates & the Foreign Exchange Market S-7

c. Based on your answer to (b), what happened to the value of the U.S. dollar against
this basket between 2009 and 2010? How does this compare with the change in the
value of the U.S. dollar relative to the Mexican peso? Explain your answer.
Answer: The dollar depreciated by 4.01% against the basket of currencies.Vis-à-vis
the peso, the dollar depreciated by 4.23%. The average depreciation is smaller be-
cause the dollar depreciated by only 0.61% against China with a 20% trade share.
3. Go to the website for Federal Reserve Economic Data (FRED): http://research.st-
louisfed.org/fred2/. Locate the monthly exchange rate data for the following:
Look at the graphs and make your own judgment as to whether each currency was
fixed (peg or band), crawling (peg or band), or floating relative to the U.S. dollar dur-
ing each time frame given.
a. Canada (dollar), 1980–2012
Answer: Floating exchange rate
b. China (yuan), 1999–2004, 2005–2009, and 2009–2010
Answer: 1999–2004: Fixed exchange rate. 2005–2010: Gradual appreciation vis-
à-vis the dollar. Again fixed for 2009–2010
c. Mexico (peso), 1993–1995 and 1995–2012
Answer: 1993–1995: crawl; 1995–2012: floating (with some evidence of a man-
aged float)
d. Thailand (baht), 1986–1997 and 1997–2012
Answer: 1986–1997: fixed exchange rate; 1997–2012: floating
e. Venezuela (bolivar), 2003–2012
Answer: Fixed exchange rate (with occasional adjustments)
4. Describe the different ways in which the government may intervene in the forex
market.Why does the government have the ability to intervene in this way, while pri-
vate actors do not?
Answer: The government may participate in the forex market in a number of ways:
capital controls, establishing an official market (with fixed rates) for forex transactions,
and forex intervention by buying and selling currencies in the forex markets. The
government has the ability to intervene in a way that private actors do not because
through its central bank it has unlimited stock of its own currency and usually a large
stock of foreign reserves. Its intervention is guided by policy rather than merely mak-
ing profits on currency trade, which is the case with the private sector.
5. Suppose quotes for the dollar–euro exchange rate, E$/€, are as follows: in New York,
$1.50 per euro; and in Tokyo, $1.55 per euro. Describe how investors use arbitrage to
take advantage of the difference in exchange rates. Explain how this process will af-
fect the dollar price of the euro in New York and Tokyo.
Answer: Investors will buy euros in New York at a price of $1.50 each because this
is relatively cheaper than the price in Tokyo. They will then sell these euros in Tokyo
at a price of $1.55, earning a $0.05 profit on each euro. With the influx of buyers in-
New York, the price of euros in New York will increase. With the influx of traders
selling euros in Toyko, the price of euros in Tokyo will decrease. This price adjustment
continues until the exchange rates are equal in both markets.
6. Consider a Dutch investor with 1,000 euros to place in a bank deposit in either the
Netherlands or Great Britain. The (one-year) interest rate on bank deposits is 2% in
Britain and 4.04% in the Netherlands. The (one-year) forward euro–pound exchange
rate is 1.575 euros per pound and the spot rate is 1.5 euros per pound. Answer the
following questions, using the exact equations for UIP and CIP as necessary.
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