problems 10,14,18,19,21,24,35
Higher expected inflation in Canada suggests that the Canadian
dollar (CAD) may depreciate relative to the U.S. dollar (USD) over
time. This is because higher inflation erodes the purchasing power
of a currency, leading to a decrease in its value compared to
currencies with lower inflation rates
According to the Purchasing Power Parity (PPP) theory, exchange
rates adjust to reflect differences in inflation rates between
countries. If U.S. investors invest in Mexico, they would initially
receive a high nominal return due to the high interest rate in
Mexico. However, the higher expected inflation in Mexico would
likely lead to a depreciation of the Mexican peso relative to the U.S.
dollar.
To calculate the expected nominal return for U.S. investors, we need
to consider both the interest rate differential and the expected
change in the exchange rate due to inflation. If the Mexican peso
depreciates by approximately 40% (the inflation differential), the
high nominal return from the Mexican interest rate would be offset
by the loss in value of the peso.
New Spot Rate=1.73×(1+(1+2%)/(1+7%)-1)=1.73×(–.0467)=1.649.
The force that causes the spot rate to change according to the IFE is
the difference in nominal interest rates between the two countries.
Investors seek higher returns, and if one country offers a higher
nominal interest rate, its currency is expected to depreciate to
offset the higher returns, maintaining equilibrium in real returns
across countries.
a. High inflation in Russia has severely pressured the value of the Russian ruble by
eroding its purchasing power, creating economic uncertainty, and decreasing investor
confidence. Despite high nominal interest rates, the real interest rates can be negative
due to inflation exceeding these rates, discouraging savings and investments in ruble-
denominated assets. Additionally, expectations of further depreciation lead people and
businesses to convert rubles into more stable foreign currencies, increasing the supply
of rubles in the foreign exchange market and driving down its value. This cycle of
high inflation and currency depreciation creates a challenging environment for
economic stability.
b. Yes, the effect of high Russian inflation on the decline in the
ruble's value supports the Purchasing Power Parity (PPP) theory.
According to PPP, the exchange rate between two countries should
adjust to reflect differences in their inflation rates. High inflation in
Russia erodes the purchasing power of the ruble, leading to its
depreciation relative to currencies of countries with lower inflation
rates, such as the U.S. dollar. However, the relationship between
inflation and currency value can be distorted by political conditions
in Russia. Political instability, economic sanctions, and government
interventions can exacerbate the ruble's depreciation beyond what
PPP would predict. For instance, sanctions imposed by Western
countries have restricted Russia's access to international markets
and financial systems, further weakening the ruble. Additionally,
political decisions, such as capital controls and state interventions in
the economy, can create uncertainty and reduce investor
confidence, leading to more significant currency fluctuations
c. From the perspective of Russian consumers, the prices of Russian
goods are unlikely to be equal to the prices of U.S. goods after
considering exchange rates. The high inflation rate in Russia
significantly reduces the purchasing power of the ruble, making U.S.
goods more expensive when converted to rubles. Additionally, local
market conditions, such as tariffs and supply chain issues, further
increase the cost of imported goods. Therefore, despite the
exchange rate adjustments, the real cost of U.S. goods remains
higher for Russian consumers compared to locally produced items.
d. The effects of high Russian inflation and the decline in the ruble
do not fully offset each other for U.S. importers. High inflation in
Russia increases the cost of producing goods, which can lead to
higher prices for Russian exports. However, the decline in the
ruble's value makes Russian goods cheaper in terms of U.S. dollars.
While the depreciation of the ruble can partially mitigate the impact
of higher production costs, it does not completely offset them. U.S.
importers may benefit from lower prices due to the weaker ruble,
but they could still face higher costs if Russian inflation significantly
raises the prices of goods before they are exported
a. Expected Change in Exchange Rate= (1+0.03)/(1+0.05)−1=−0.019
b. Expected Spot Rate=1.10×(1−0.019)=1.079
Initial Investment: $100,000 converted to euros at $1.10 per euro:
Euros=100,000/1.10=90,909.09euros
Investment Growth in Germany: 90,909.09 euros invested at 5%
interest:
Euros after one year = 90,909.09×1.05 = 95,454.55 euros
Conversion Back to USD: 95,454.55 euros converted back to USD at
$1.00 per euro:
USD after one year=95,454.55×1.00=95,454.55 USD
Percentage Return:
Percentage Return= (95,454.55−100,000)/100,000×100=−4.55%
c. USD after one year=95,454.55×1.08=103,090.91 USD
Percentage Return= (103,090.91−100,000)/100,000×100=3.09%
d. USD after one year=100,000×1.03=103,000 USD
Required Spot Rate= 95,454.55/103,000=$1.084
So, the spot rate of the euro must be at least $1.084 in one year for
Beth's strategy to be successful.
U.S. Inflation Rate = 7% = 0.07
Mexican Inflation Rate = 3% = 0.03
Percentage Change=(1+0.07)/(1+0.03)−1 = 0.038835 or 3.8835%
Future Spot Rate=0.10×(1+0.038835) = 0.1038835 USD/MXN
Amount in USD = 20,000,000×0.1038835 = 2,077,670USD
