2010_Fall_Exam1

2010_Fall_Exam1 - TOWSON UNIVERSITY COLLEGE OF BUSINESS AND...

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TOWSON UNIVERSITY COLLEGE OF BUSINESS AND ECONOMICS FIN435.001 Dr. M. Rhee Fall 2010 1. Describe how the changes in the following macroeconomic variables effect the exchange rates? (provide logical rationale and use diagrams ) a) higher interest rate in Germany Higher interest rate in Germany → Increased investments in Germany to get a higher return on investment → Demand for € increases → Demand curve for € shifts out → ($) price of € (called an exchange rate) increases → Stronger € and weaker $ b) Comment on the statement, “a stronger economy has a stronger currency” Is that true? Why and why not? Stronger German economy can have an impact on the exchange rate in two different ways; one is through a consumption channel and the other is an investment channel. It may depend on which side has stronger impact on the exchange rate. However, “a stronger economy has a stronger currency” is empirically true because the investment side has been dominating the consumption side empirically. (i) Consumption Side → German income increases → Demand for U.S. products (as well as German products) increases → Demand for US$ increases = Supply of € increases → € supply curve shifts out → ($) price of € (called an exchange rate) decreases → Stronger $ and weaker € (ii) Investment Side → Investment in Germany increases to get a higher return from the stronger German Economy → Demand for € increases → Demand curve for € shifts out Q ( ) $/ S ( ) D ( ) D’ ( ) S 0 S 1 Q ( ) $/ S ( ) D ( ) D’ ( ) S 0 S 1 Q ( ) $/ S ( ) D’ ( ) D ( ) S 0 S 1
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→ ($) price of € (called an exchange rate) increases → Stronger € and weaker $ Empirically, investment side dominates. Strong economy results in the stronger currency
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2010_Fall_Exam1 - TOWSON UNIVERSITY COLLEGE OF BUSINESS AND...

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