Solutions 1

Solutions 1 - FIN 330 Homework 1: Exchange Rates 1) Suppose...

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1 FIN 330 Homework 1: Exchange Rates 1) Suppose prices start rising in the United States relative to prices in Japan. What would we expect to see happen to the dollar:yen exchange rate? Explain. As U.S. prices start rising relative to Japanese prices, both American and Japanese consumers will start substituting Japanese for U.S. goods, leading to increases in both the supply of U.S. dollars and the demand for Japanese yen. The result will be a depreciation of the dollar. 2) Comment on the following headlines in the Wall Street Journal:- a) “Dollar Surges as Coup in Soviet Union Revives Unit’s Appeal as Safe Haven” (August 20, 1991) With the reduction in world tension occasioned by the decline in Communism's appeal in the Soviet Union, investors had less need for the U.S. dollar as a safe haven. The Soviet coup brought back the threat of Soviet militarism and led investors to desire once again to hold an increased share of their wealth in dollars. This increased demand for dollars led to the dollar's surge in value. b) “Dollar Plummets on Soviet Coup Failure” (August 22, 1991) As the threat of Soviet militarism once again faded with the failure of the Soviet coup, investors refused to continue paying the safe-haven premium they had previously been willing to pay. As investors shifted their demand from dollars to other currencies, the dollar reversed its previous runup. c) “Dollar Falls Across the Board as Fed Cuts Discount Rate to 6.5% from 7% (September 19, 1990) One possibility is that the Fed's cut in the discount rate reduced real interest rates in the United States, reducing the attractiveness of dollar-denominated financial assets relative to assets denominated in foreign currencies. As investors shifted to non-U.S. assets, they had to first sell
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Solutions 1 - FIN 330 Homework 1: Exchange Rates 1) Suppose...

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