ECMA06_Tutorial_11_Solution - ECMA06 Tutorial #11 Answer...

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Question 1 Part (a) Demand for Canadian dollars (C$) in the foreign exchange market – it arises when foreigners purchases stuffs from us because foreigners living outside Canada tens not to have C$ and when we sell stuffs to them we want them to pay us in C$. Exports of goods and services Foreign purchases of domestic assets The total demand for C$ = $110 + $80 = $190 Supply of C$ in the foreign exchange market – it arises when Canadians purchases stuffs from foreigners because we tend not to hold foreign currencies for our daily transactions and when we buy stuffs from foreigners they want them to pay them in their currencies so that they can use our payments immediately. Thus, Canadians need to covert C$ into foreign currencies when we imports stuffs. Imports of goods and services Domestic purchases of foreign assets The total supply of C$ = $120 + $70 = $190 Given the total demand for C$ = the total supply of C$, the foreign exchange market is in equilibrium (i.e., in balance) and there is no pressure for the exchange rate to change. Part (b) Suppose C$ appreciates (i.e., it takes more foreign currencies to exchange 1C$): The goods market: Appreciation of C$ makes Canadian goods and services become more expensive for foreigners while foreign goods and services less expensive to Canadians. Exports of goods and services while imports of goods and services . The capital market: The capital market tends not to be affected by the change in exchange rate. It is true that the appreciation of C$ makes the purchases of foreign assets cheaper, but at the same time make the returns of holding these assets less valuable (there will be capital loss of holding foreign-currency denominated assets because when we convert the foreign currencies received when the investment matures, we receive fewer C$ than before). Therefore, the overall rate of return on foreign assets remains unchanged. The appreciation of C$ makes the purchases of Canadian assets more expensive, but at the same time make the returns of holding these assets more valuable (there will be capital gain of holding C$ denominated assets because when foreigners convert the C$ received when the investment matures, they receive more C$ than before). Therefore, the overall rate of return on Canadian assets remains unchanged. Note: you will learn more about this in upper level economics class.
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This note was uploaded on 12/21/2011 for the course ECONOMICS ECMA06 taught by Professor Dr.atamazaheri during the Spring '10 term at University of Toronto- Toronto.

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ECMA06_Tutorial_11_Solution - ECMA06 Tutorial #11 Answer...

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