RQ_Solution_Ch_14 - ECMC61 Chapter 14 Review Questions...

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ECMC61 – Chapter 14 Review Questions Answer Key Question 1: Problems #6 Interest rate parity: Let USD ($) be domestic currency and pound sterling (£) be foreign currency. Suppose the dollar interest rate and the pound sterling interest rate are the same, 5% per year, R $ = R £ = 0.05: For IRP to hold, = 0. This implies . The current exchange rate, E, must equal the expected future exchange rate, E e , with equality of nominal interest rates, there can be no expected increase or decrease in the $/£ exchange rate in equilibrium. Suppose the expected future $/£ exchange rate, $1.52 per pound, remains constant as Britain’s interest rate rises to 10% per year. If the U.S. interest rate also remains constant at 5%, the new equilibrium $/£ exchange rate is: Given the above information, IRP implies . For IRP to hold, . The expected rate of appreciation of the dollar is 5% per year. Solve for E $/£ , E $/£ = 1.52/0.95 = 1.6. Question 2: Problems #7 If market traders learn that the interest rate on dollar will decrease in the near future: They expect the U.S. dollar to depreciate because investing in U.S. dollar deposit is not as attractive as before. The dollar is expected to depreciate against euro, i.e.,
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This note was uploaded on 12/21/2011 for the course ECONOMICS ECMC61 taught by Professor Dr.irisau during the Fall '11 term at University of Toronto.

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RQ_Solution_Ch_14 - ECMC61 Chapter 14 Review Questions...

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