Question

QUESTION 4

1. A eurozone citizen observes the spot rate between euros and pounds is currently £1.04/€. Assume the expected inflation rates over the course of the year in the eurozone and the UK are 3% and 2%, respectively. Suppose the spot rates for euros and pounds at the end of the year are as follows:

   $1.15/€, $1.11/£

   Which of the following statements is true according to relative PPP?

   		The euro appreciated in real terms.
   		The pound appreciated in real terms.
   		Neither the euro nor the pound appreciated in real terms.
   		Cannot be determined.

QUESTION 6

1. Use the following information to answer the next two questions.

   Investors expect inflation rates over the next twelve months in the US and Japan to be 8% and 3%, respectively.  The current exchange rates for the two currencies are as follows:

   C$.007/¥,   C$1.02/$

   Suppose that twelve months from now, the exchange rate between US dollars and yen is $.0071/¥.  According to relative PPP, what be theimpact of this new exchange rate on the US balance of trade?  (Assume the US is the home country and ignore any possible feedback loop.)Round intermediate steps to four decimals.

   		The US BOT will increase.
   		The US BOT will decrease.
   		The US BOT will not be affected.
   		Cannot be determined.

Answer 1

Answer 4:

The pound appreciated in real terms.

Explanation:

Current exchange rate:

£1.04/€

After one year:

$1.15/€, $1.11/£

1 € = $1.15 = 1.15/ 1.11 £ = 1.0360 £

This means British pound has appreciated.

When expected inflation rates over the course of the year in the Eurozone is 3% and the UK is 2%, UK pound will appreciate as compared to Euro since inflation rate in UK lower.

Hence option B is correct and other options A, C and D are incorrect.

Answer 6:

The US BOT will decrease

Explanation:

Given:

Exchange rate before

C$ 0.007 / Yen and C$ 1.02/ $

Hence:

US$ / Yen exchange rate will be:

$0.007/ 1.02 = $0.0069 per Yen

After twelve months:

Since Inflation in US is 8% and inflation if Japan is 3%, the US$ will depreciate.

The exchange rate is:

$0.0071/ Yen

As depreciated USD, will result in increase of imports into US as the imported goods will appear cheaper in US and will dampen US export sales as these will be costlier abroad.

As such depreciated US dollar will result in deterioration of US BOT.

Hence option B is correct and other options A, C and D are incorrect.