Use the FX market diagram to answer the following question. Consider the relatio

Question

Use the FX market diagram to answer the following question. Consider the relationship between the Mexican peso and the Canadian dollar (C$). Let the exchange rate be deÖned as Mexican pesos per Canadian dollar, Epesos=C$. For each of the following cases, illustrate the e§ects on the FX market using graphs and state how the following variables change: interest rates in Mexico (ipeso) and Canada (iC$), the spot exchange rate (Epesos=C$), and the expected rate of return on Canadian and Mexican deposits (from the perspective of a Mexican investor). Unless otherwise noted, you may assume that the expected exchange rate is unchanged. (a) Canadaís interest rate increases. (b) Investors in the market anticipate an appreciation in the peso. (c) Mexicoís interest rate decreases. (d) Canada and Mexico decrease interest rates by the same amount.

Explanation / Answer

A. MXN per CAD will increase as MXN has appretiated and become stronger, CAD interest rated gave increased. Country whose interest are high are expected to depretiate forward.

B. MXN per CAD will increase, return on maxican deposin will increase.

C. No change in exchange rate.

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