(PDF) The Impact of Exchange Rates on French Wine Exports

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Homework Assignment 6Chapter 15 – Questions1.When the Euro appreciates, are you more likely to drink California or Frenchwine?You are more likely to drink California wine because the euroappreciation makes French wine relatively more expensive thanCalifornia wine.2.“A country is always worse off when its currency is weak (falls in value).” Isthe statement true, false or uncertain? Explain your answer.False. Although a weak currency has the negative effect of making itmore expensive to buy foreign goods or to travel abroad, it may helpdomestic industry. Domestic goods become cheaper relative to foreigngoods, and the demand for domestically produced goods increases.The resulting higher sales of domestic products may lead to higheremployment, a beneficial effect on the economy.3.In a newspaper, chose one exchange rate from each of the regions listed inFollowing the Financial News box on p347. Which of these currencies haveappreciated, and which have depreciated since June 23, 2010?4.If the Japanese price level rises by 5% relative to the price level in the UnitedStates, what does the theory of purchasing power parity predict will happento the value of the Japanese Yen in terms of US dollars?It predicts that the value of the yen will fall 5% in terms of dollars.5.If the demand for a country’s exports falls at the same time that tariffs onimports are raised, will the country’s currency tend to appreciate ordepreciate in the long run?In the long run, the fall in the demand for a country’s exports leads toa depreciation of its currency, but the higher tariffs lead to anappreciation. Therefore, the effect on the exchange rate is uncertain.6.In the mid-to-late 1970’s, the yen appreciated relative to the dollar eventhough Japan’s inflation rate was higher than America’s. How can this beexplained by an improvement in the productivity of Japanese industryrelative to American industry?Even though the Japanese price level rose relative to the American,the yen appreciated because the increase in Japanese productivityrelative to American productivity made it possible for the Japanese tocontinue to sell their goods at a profit due to the high value of the yen.Predicting the future7.The president of the United States announces that he will reduce inflationwith a new anti-inflation program. If the public believes him, predict whatwill happen to the exchange rate for the U.S. dollar vs. other currencies.The dollar will appreciate. Because expected U.S. inflation falls as aresult of the announcement, therewill be an expected appreciation ofthe dollar and so the expected return on dollar assets will rise. As a
result, the demand curve will shift to the right and the equilibriumvalue of the dollar will rise.8.If the Bank of England prints money to reduce unemployment, what willhappen to the value of the pound in the short run and the long run?The pound depreciates but overshoots, declining by more in the shortrun than in the long run. ConsiderBritain to be the domestic country.The rise in the money supply leads to a higher domestic price levelinthe long run, which leads to a lower expected future exchange rate. Inaddition, the rise in the money supply lowers the domestic interestrate on pound assets. Both of these changes lower the expectedreturnon pound assets at any given exchange rate, shifting the demand curveto the left. The short-run outcome is a lower value of the pound.However, in the long run, the domestic interest rate returns to itsprevious value, and the demand curve shifts back to the rightsomewhat. The exchange rate rises to some extent, but still remainsbelow its initial level.9.If the Indian government unexpectedly announces that it will be imposinghigher tariffs on foreign goods one year from now, what will happen to thevalue of the Indian rupee today?The Indian rupee will appreciate. The announcement of tariffs willraise the expected future exchange rate for the rupee and so increasethe expected appreciation of the rupee. This means that the demandfor rupee-denominated assets will increase, shifting the demand curveto the right, and the rupee exchange rate therefore rises.10.If nominal interest rates in the US rise but real interest rates fall, predictwhat will happen to the US exchange rate.The dollar will depreciate. A rise in nominal interest rates but adecline in the real rate implies a rise in expected inflation thatproduces an expected depreciation of the dollar that is larger than theincrease in the domestic interest rate. As a result, the expected returnon dollar assets falls at any exchange rate, shifting the demand curveto the left and leading to a fall in the exchange rate.11.If American auto companies make a breakthrough in automobile technologyand are able to produce a car that gets 60 miles to the gallon, what willhappen to the US exchange rate?The dollar will appreciate. The increase in U.S. productivity raises theexpected future exchange rate and thus raises the expected return ondollar assets at any exchange rate. The resulting rightward shift of thedemand curve leads to a rise in the equilibrium exchange rate.12.If Mexicans go on a spending spree and buy twice as much French perfume,Japanese TVs, English sweaters, Swiss watches and Italian wine, what willhappen to the value of the Mexican Peso.The peso will depreciate. Consider Mexico to be the domestic country.An increased demand for imports would lower the expected futureexchange rate and result in a lower expected appreciation of the peso.The resulting lower expected return on peso assets at any given
exchange rate would then shift the demand curve to the left, leading toa fall in the peso exchange rate.13.If expected inflation drops in Europe so that interest rates fall there, predictwhat will happen to the exchange rate for the US dollar vs. the Euro.The dollar will depreciate. The drop of expected inflation in Europe,which leads to a decline in the foreign interest rate (which is smallerthan the drop in expected inflation), leads to a decline in the relativeexpected return on dollar assets, because the expected euroappreciation is greater than the decline in the foreign interest rate.The result of the decline in the relative expected return on dollarassets, a leftward shift of the demand curve, and the equilibrium U.S.exchange rate falls.14.If the European Central Bank decides to contract the money supply to fightinflation, what will happen to the value of the US dollar vs. the Euro?The contraction of the European money supply will increaseEuropean interest rates and raise the future value of the euro, both ofwhich will decrease the relative expected return on dollar assets. Thedemand curve will then shift to the left, and the dollar will depreciate.15.If there is a strike in France, making it harder to buy French goods, what willhappen to the value of the Euro?Consider France to be the domestic country. Because it is harder toget French goods, people will buy more foreign goods and the value ofthe euro in the future will fall. The expected depreciation of the eurolowers the expected return on euro assets at any exchange rate, so thedemand curve shifts to the left and the value of the euro will fall.Chapter 15 – Quantitative Problems1.A German sports car is selling for 70,000 euros. What is the dollar price inthe United States for the German car if the exchange rate is 0.90 euros perdollar?70,000 euros($1/0.90 euros)$77,777.77.2.An investor in England purchased a 91-day T-bill for $987.65. At that time,the exchange rate was $1.75 per pound. At maturity, the exchange rate was$1.83 per pound. What was the investor’s holding period return in pounds?The bond cost $987.65/$1.75 = £564.37.At maturity, the $1,000 is worth $1,000/$1.83 = £546.45.The holding period return is (546.45 − 564.37)/564.37 = −0.0317.3.An investor in Canada purchased 100 shares of IBM on January 1 at $93.00per share. IBM paid an annual dividend of $0.72 on December 31st. Thestock was sold that day as well for $100.25. The exchange rate was $0.68 perCanadian Dollar on January 1 and $0.71 per Canadian dollar on December 31.What is the investor’s total return in Canadian dollars?The price of each share is $93.00/$0.68 = 136.76 Canadian dollars.The dividend is $0.72/$0.71 = 1.014 Canadian dollarsThe sale price is $100.25/$0.71 = 141.20 Canadian dollarsThe return = (141.20 + 1.014 − 136.76)/136.76 = 0.03988
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