Question

13) Complete the following computations involving exchange rates.

1. Suppose that the British pound trades for $2 and for 1.50 euros. What is the price in dollars of a German Shepherd dog purchased in Germany for 1000 euros?

2. Just to make sure that you got this down (intuition will be a lot harder here): Suppose that $1 trades for .76 euros. 1 Canadian dollar trades for .64 British pounds, and 1 euro trades for 1.31 Canadian dollars. What is the price in U.S. dollars of a Wayne Rooney jersey that costs 45 pounds in Manchester, England?

3. Under normal conditions, we assume that exchange rates must be the same globally. This would mean that $1 = 1 British Pound in New York and in London. Suppose this was not the case. Suppose that you have $10, and it is free to make currency exchanges. If the exchange rate is $1 = 1 British Pound in New York and $1 = .75 British Pounds in London, what should you do? Explain.

Answer 1

Question 13

(a)

1 British pound = $2

1 British pound = 1.50 euros

Price of a German shepherd dog in Germany = 1,000 euros

Converting price into British pounds

1.50 euros = 1 British pounds

1 euro = (1/1.50) British pounds

1,000 euros = (1/1.50) * 1,000 = 666.67 British pounds

Converting British pounds into US dollars

1 British pound = $2

666.67 British pounds = [2 * 666.67] = $1,333.34

Thus,

The price in dollars of the German shepherd dog is $1,333.34.

(b)

Cost of jersey = 45 pounds

Converting pounds into Canadian dollars

0.64 pounds = 1 Canadian dollar

1 pound = (1/0.64) Canadian dollars

45 pounds = (1/0.64) * 45 = 70.31 Canadian dollars

The cost of jersey in Canadian dollars is 70.31

Converting Canadian dollars into euros

1.31 Canadian dollars = 1 euro

1 Canadian dollar = (1/1.31) euro

70.31 Canadian dollar = (1/1.31) * 70.31 = 53.67 euros

The cost of jersey in euros is 53.67 euros

Converting euros into dollar

0.76 euros = $1

1 euro = $(1/0.76)

53.76 euros = (1/0.76) * 53.76 = $70.62

Thus,

The price in US dollars of a Wayne Rooney jersey is $70.62.

(c)

Amount = $10

Exchange rate in New York

$1 = 1 British pound

So, we will exchange $10 for British pound in New York.

$1 = 1 British pound

$10 = 10 British Pounds

Now, we will sell these British Pounds for US dollars in London.

Exchange rate in London is as follows -

0.75 British pounds = $1

1 BP = $(1/0.75)

10 BP = (1/0.75) * 10 = $13.33

So,

After exchange, we have $13.33

Thus,

Converting $10 into British pound in New York and then converting these pounds back in to dollars in London gives us a profit of ($13.33 - $10) $3.33.