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Answers to End of Chapter 4s Questions

7. Interest rate movements affect exchange rates. Speculators can use anticipated interest rate movements to forecast exchange rate movements. They may decide to purchase securities in particular countries because of their expectations about currency movements, since their yield will be affected by changes in a currencys value. These purchases of securities require an exchange of currencies, which can immediately affect the equilibrium value of exchange rates. If a forecast of interest rates by a respected economist was already anticipated by market participants or is not different from investors original expectations, an announced forecast does not provide new information. Thus, there would be no reaction by investors to such an announcement, and exchange rates would not be affected. 8. The euros value could change because of the balance of trade, which reflects more .S. demand for !uropean goods than the !uropean demand for .S. goods. The capital flows between the .S. and !urope will also affect the .S. demand for euros and the supply of euros for sale "to be exchanged for dollars#. 10. a. The trade deficit announcement may provide a reasonable forecast of future trade deficits and therefore has implications about supply and demand conditions in the foreign exchange market. $or example, if the trade deficit was larger than anticipated, and is expected to continue, this implies that the .S. demand for foreign currencies may be larger than initially anticipated. Thus, the dollar would be expected to weaken. Some speculators may take a position in foreign currencies immediately and could cause an immediate decline in the dollar. b. If the market correctly anticipated the trade deficit figure, then any news contained in the announcement has already been accounted for in the market. The market should only respond to an announcement about the trade deficit if the announcement contains new information. 11. The euros value changes in response to the flow of funds between the .S. and the countries using the euro or their currency. The pounds value changes in response to the flow of funds between the .S. and the .%. &'nswer is based on intuition, is not directly from the text.( 12. The large amount of )ussian imports and lack of )ussian exports placed downward pressure on the )ussian currency. The high inflation rate in )ussia also placed downward pressure on the )ussian currency. 14. ' relative decline in 'sian economic growth will reduce 'sian demand for .S. products, which places upward pressure on 'sian currencies. *owever, given the change in interest rates, 'sian corporations with excess cash may now invest in the .S. or other countries, thereby increasing the demand for .S. dollars. Thus, a decline in 'sian interest rates will place downward pressure on the value of the 'sian currencies. The overall impact depends on the magnitude of the forces +ust described.

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16. The weak .S. economy would result in a reduced demand for foreign products, which results in a decline in the demand for foreign currencies, and therefore places downward pressure on currencies relative to the dollar "upward pressure on the dollars value#. The lower .S. interest rates should reduce the capital flows to the .S., which place downward pressure on the value of the dollar. 18. a. The high inflation in 3exico places continual downward pressure on the value of the peso. b. The high interest rates in 3exico result from expectations of high inflation. That is, the real interest rate in 3exico may not be any higher than the .S. real interest rate. 6iven the high inflationary expectations, .S. investors recogni7e the potential weakness of the peso, which could more than offset the high interest rate "when they convert the pesos back to dollars at the end of the investment period#. Therefore, the high 3exican interest rates do not encourage .S. investment in 3exican securities, and do not help to strengthen the value of the peso. c. The bid8ask spread is wider because the banks that provide foreign exchange services are sub+ect to more risk when they maintain currencies such as the peso that could decline abruptly at any time. ' wider bid8ask spread adversely affects the .S. firm that does business in 3exico because it increases the transactions costs associated with conversion of dollars to pesos, or pesos to dollars. 20. a. 4lue -emon 4ank can capitali7e on its expectations about pesos "39,# as follows2 5. 4orrow 39,:0 million /. ;onvert the 39,:0 million to dollars2 39,:0,000,000 < =.51 > =50,100,000 ?. @end the dollars through the interbank market at A.0B annuali7ed over a 50Cday period. The amount accumulated in 50 days is2 =50,100,000 < &5 D "AB < 508?E0#( > =50,100,000 < &5.00////( > =50,1/?,??? .. )epay the peso loan. The repayment amount on the peso loan is2 39,:0,000,000 < &5 D "A.:B < 508?E0#( > :0,000,000 < &5.00/.5:(>39,:0,5EF,5E: 1. 4ased on the expected spot rate of =.5., the amount of dollars needed to repay the peso loan is2 39,:0,5EF,5E: < =.5. > =F,A/?,EA? E. 'fter repaying the loan, 4lue -emon 4ank will have a speculative profit "if its forecasted exchange rate is accurate# of2 =50,1/?,??? G =F,A/?,EA? > =EFF,E10

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b. 4lue -emon 4ank can capitali7e on its expectations as follows2 5. 4orrow =50 million /. ;onvert the =50 million to pesos "39,#2 =50,000,0008=.51 > 39,EE,EEE,EE: ?. @end the pesos through the interbank market at A.1B annuali7ed over a ?0Cday period. The amount accumulated in ?0 days is2 39,EE,EEE,EE: < &5 D "A.1B < ?08?E0#( > EE,EEE,EE: < &5.00:0A?( > 39,E:,5?A,AAF .. )epay the dollar loan. The repayment amount on the dollar loan is2 =50,000,000 < &5 D "A.?B < ?08?E0#( > =50,000,000 < &5.00EF5:( > =50,0EF,5:0 1. ;onvert the pesos to dollars to repay the loan. The amount of dollars to be received in ?0 days "based on the expected spot rate of =.5:# is2 39,E:,5?A,AAF < =.5: > =55,.5?,E55 E. The profits are determined by estimating the dollars available after repaying the loan2 =55,.5?,E55 G =50,0EF,5:0 > =5,?..,..5 29. Hld rates last year Spot rate of kronor > "5.008:# > =.5./A1: Spot rate of 7loty > =..0 Spot rate of 7loty in kronor > ..8.5./A1: > /.A Iew rates after 5 year Spot rate of kronor > "5.008A# > =.5/1 Spot rate of 7loty > =... Spot rate of 7loty in kronor > ...8.5/1 > ?.1/ This indicates that the cross exchange rate of 7loty in kronor has appreciated B of appreciation > "?.1/C/.A#8/.A > /1.:5B

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