1. If the price level recently increased by 3% in England while falling 2% in th
ID: 1161905 • Letter: 1
Question
1. If the price level recently increased by 3% in England while falling 2% in the United States, how much must the exchange rate change if PPP holds? Assume that theeurrent exchange rate EUSD/GBP) is 1.8 (a) 1.62 (b) 1.71 (c) 1.85 (d) 2.01 2. Suppose the average interest rate on euro bonds is 4%, and the average interest rate on U.S. dollar bonds is 6%, which should the investor choose? (a) neither, because bonds have high default rates. (b) both, an investor will choose some euro bonds and some U.S. bonds to diversify. (c) the euro bond, because their economies are usually more stable. (d) It is not possible to answer without information on exchange rates. 3. If the U.S. interest rate is 4% per year and the U.K. interest rate is 9% 1 per year, which of the following statements is TRUE? (a) The dollar will depreciate 13% in one year (b) The pound will depreciate 13% in one year (c) The pound will appreciate 5% in one year (d) The dollar will appreciate 5% in one year 4. Consider the sales of McDonald's Big Mac in the United States and Japan, identify the option that shows whether the law of one price will hold or not, and state whether the relative price, s FOREIGN, is greater than, less than, or equal to 1 and the reason behind it (a) dsiFOREIG1 bcause the LOOP assumptions are met in this case. (b) s/FOREIGN because the LOOP assumptions are not met in this case given that there are non-tradable elements n the production of the Big Mac, such as labor and rent (c) qUS/FOREIGN 1 because the LOOP assumptions are met in this case. (d) YUS FOREIGN #1 because the LOOP assumptions are not met in this case given that there are non-tradable elements in the production of the Big Mac, such as labor and rentExplanation / Answer
Solution 1) Exchange rate USD/GBP = 1.80
Prices Level Changes = 5%(3+2)
Change in Exchange Rate = 1.80 x 5% = $0.09/GBP
New Exchange Rate would be 1.80 - 0.09 = $1.71/GBP
Solution 2) c) Euro bonds because stable economy eliminates the risk of foreign exchange risk.
Solution 3) d) The dollar will appreciate 5% in one year.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.