Suppose the Domestic Currency Appreciates then the Forward Exchange Rate: Ecology Assignment, CU, Canada

University Carleton University (CU) Canada
Subject Ecology

Part A. Multiple Choice:

  1. Suppose the domestic currency appreciates then the forward exchange rate should a. depreciate b. appreciate. c. remain unchanged
  2. Suppose the foreign government imposes a tariff on domestic exports. Then the supply-demand model of exchange rates predicts a. depreciation of the foreign currency. b. domestic depreciation and an increase in X − M. c. domestic depreciation and a decrease in X − M.
  3. Suppose there is a fixed exchange rate and foreign investors believe many domestic firms will develop new products. Then the supply-demand model of exchange rates predicts a. a fall in domestic central bank reserves of foreign currency and a fall in X − M. b. a rise in domestic central bank reserves of foreign currency. c. a jump in foreign interest rates.
  4. If investors become convinced the foreign government will default on its debt, with a floating exchange rate the Fleming-Mundell model predicts a. a rise in domestic GDP and an increase in domestic net exports. b. aa rise in domestic GDP and foreign investment spending. c. a fall in both domestic GDP and investment. 1
  5. Suppose the foreign economy has inflation much higher than the domestic economy than with a floating exchange rate the supply-demand model of exchange rates predicts a. depreciation of the domestic currency and a rising trade balance. b. high domestic inflation c. appreciation of the domestic currency.

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Part B. Numerical Problems:

1. Suppose the Canadian dollar-U.S.dollar rate is 1.20 Canadian dollars (CAD) per U.S. dollar (USD). The Euro-USD rate is 1.1564 euros per U.S. dollar. The Euro-CAD rate is 0.9824 euros per Canadian dollar.

a. Calculate the cross rate between Canadian dollars (CAD) and U.S. dollars (USD) using the euro as an intermediate currency.

b. Suppose an investor has 800,000 CAD. Calculate profits from triangular arbitrage which uses the cross rate between CAD and USD.

  1. Consider the following spot rates for converting U.S. dollars (USD) and Canadian dollars (CAD). Toronto: bid=1.354 CAD per USD. ask= 1.363 CAD per USD. New York: bid=0.714 USD per CAD. ask= 0.724 USD per CAD. (10) Consider converting 400,000 USD to CAD in New York and then converting the resulting amount of CAD back to USD in Toronto. Determine if there are there arbitrage opportunities from this trade.

Part C: Theoretical Problems

1. Analyze the effect of the following independent shocks on domestic Y and i in the Fleming-Mundell model.

a. The domestic economy experiences a fall in wages. The exchange rate is fixed and capital is imperfectly mobile. State the effect on domestic central bank reserves of foreign currency.

b. Domestic money demand falls. The exchange rate is floating and capital is perfectly mobile.

c. Foreign commercial banks decide to hold a higher fraction of each deposit on reserve. The exchange rate is fixed and capital is perfectly mobile.

d. The foreign government lowers its spending. The exchange rate is fixed and capital is perfectly mobile.

e. Suppose the domestic economy is initially above Yn. A diagram determines whether a fixed or floating exchange rate is superior for the shock in (d). Also, state your finding in a sentence.

f. Domestic firms believe domestic consumption spending will fall. The exchange rate is floating and capital is imperfectly mobile. State the final effect on domestic investment.

2. Show the effects of the following independent shocks on the exchange rate in the foreign exchange market diagram. Assume the exchange rate is floating.

a. The domestic government finances major urban development in one of its inner cities by borrowing a vast amount from foreign investors.

b. For the shock in (a) state the effects on foreign net exports.

c. Floods destroy a large amount of domestic capital stock.

d. Investors expect domestic interest rates to rise.

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