1. ECO 473 Foreign Exchange Markets Answer Key
Spring 2019 – Dr. D. Foster

2. Foreign Exchange Worksheet Problems
Above are the major exchange rates (maybe copied from XE.com) for 4/1/ They are - U.S. Dollar (USD), Euro (EUR), British Pound (GBP), Japanese Yen (JPY), Indian Rupee (INR), Australian Dollar (AUD) and Canadian Dollar (CAD). There are two lines for each pair of currencies. The top line shows the amount of that column currency that you can buy with one unit of the row currency (e.g. one U.S. dollar buys Indian rupees; or you can also say that it takes rupees to buy one dollar). The second line shows this the other way around (e.g. one Indian rupee buys U.S. dollars; or it costs $ to buy one rupee). Since all four of the row currencies are also included in the column currencies, part of the table is repetitive.

3. 1a. Since April of 2015 there has been an increase in Canadian preference for European goods, causing the exchange rate to change by 7% to the value(s) shown above. Draw the graph of the foreign exchange market from the Canadian perspective showing what has happened between 2015 and 2019.
Can $/€ S€
1a. Canadian perspective. If there is an increased preference for European goods, Canadians will have to acquire more Euros, so the demand for Euros rises. This will raise the exchange rate, depreciating the Canadian dollar.
Since the Can $ has depreciated by 7%, and it now takes C$ to buy a Euro, then it must have been $ in April of 2015.
( )/(1.07) = D€
1.488
1.592
D’€ €

4. Or, you can get a slightly different value:
1b. Repeat exercise #1a, except show this from the European perspective.
1b. European perspective. If the Canadians are demanding more Euros, then they must be supplying more dollars (in order to buy more European goods). It is the “flip view” of the market presented in #1a. So, the supply of dollars increases, shifting to the right, driving down the exchange rate (from the European perspective).
Since these values are the inverse of the ones used in #1, we can solve for the previous exchange rate directly:
1/ =
€/Can $
.6722 S$
S’$
.6282 D$
Can $
Or, you can get a slightly different value:
(.62819)/(.93) = .6755

5. 2a. Since October of 2014 Britain has experience a rate of inflation that is 3% more than that in the U.S. If the “relative purchasing power parity” holds, show how the exchange rate has changed from 2014 to 2019 from the British perspective.
2a. British perspective. If the inflation rate in the U.K. is 3% higher than in the U.S., the relative purchasing power parity condition states that the exchange rate ($/₤) will change by the difference in the inflation rates, or by -3% in this case.
%ΔE = πUS - πUK
So, while we don’t know the individual rates of inflation, we know the result. If E is falling, then the $ is appreciating.
The previous exchange rate must have been ₤ per $:
(.706)/(1.03) = .6854
£/$ S$
.685 D$
.706
D’$ $
Why is this happening? Since the U.K. is experiencing more inflation, their goods are getting more expensive, and ours are cheaper. Consequently, they would like to buy more of our cheaper goods, for which they’ll need dollars. So, the demand for $ rises. OR, . . .

6. 2a. con’t.
£/$
S’$ S$
.706
.685
D’$ D$ $
OR, We can show this as a combination of rising demand for $ and a falling supply of $ - The British want more $ to buy cheaper American goods while Americans want to offer fewer $ because British goods are now more expensive.

7. 2b. Repeat exercise #2a, except show this from the U.S. perspective.
2b. U.S. perspective. If the British are demanding more dollars (because our goods are relatively cheaper), then they must be supplying more pounds. Again – this must be true!
The past exchange rate must be the inverse of the value from #3:
1/(.68543) = $1.4589 S£
1.459
$/£
S’£
1.42 D£
OR, you could motivate this outcome by noting that the demand for pounds is decreasing, because their goods are more expensive and we don’t want to buy as much. Or, some combination of these two reasons. Regardless, the exchange rate (U.S. perspective) is falling.

8. 3a. In early April of 2019 the Japanese will begin imposing tariffs on goods shipped there from Australia. Consequently the AUD is expected to depreciate by 6% over the next two years. Show what we expect to be happening in the foreign exchange market from 2019 to 2021 from the Australian perspective.
AUS$/¥
S’¥ S¥
3a. Australian perspective. If the Japanese tax Australian goods, that will make them more expensive, and less will be purchased, thus lowering the demand for Australian currency. Since the Japanese are demanding less AUS$, they must be supplying less yen.
Since the AUS$ will be depreciating by 6%, the new exchange rate is expected to be:
(.01233)*(1.06) =
.01307
.0123 D¥

9. 3b. Repeat exercise #3a, except show this from the Japanese perspective.
¥/AUS$
SAUS$
3b. Japanese perspective. If the Japanese tax Australian goods, that will make them more expensive, and less will be purchased, thus lowering the demand for Australian currency.
Since the AUS$ is depreciating by 6%, the yen is appreciating by 6%. We can solve for the yen price of AUS$ directly:
1/ = 76.51
81.09
76.51
DAUS$
D’AUS$
AUS$

10. ECO 473 Foreign Exchange Markets Answer Key
Spring 2019 – Dr. D. Foster