Question
Q1 - Consider the United States and the countries it trades with the most (measured in trade volume): Canada, Mexico, China, and Japan. For simplicity,
Q1- Consider the United States and the countries it trades with the most (measured in trade volume): Canada, Mexico, China, and Japan. For simplicity, assume these are the only four countries with which the United States trades. Trade shares (trade weights) and U.S. nominal exchange rates for these four countries are as follows:
Country (Currency) | Share of Trade | $ per FX in 2015 | $ per FX in 2016 |
Canada (dollar) | 36% | 0.8271 | 0.6892 |
Mexico (Peso) | 28% | 0.0683 | 0.0538 |
China (yuan) | 20% | 0.1608 | 0.1522 |
Japan (yen) | 16% | 0.0080 | 0.0086 |
- Compute the percentage change from 2015 to 2016 in the four U.S. bilateral exchange rates (defined as U.S. dollars per unit of foreign exchange, or FX) in the table provided.
- Use the trade shares as weights to compute the percentage change in the nominal effective exchange rate for the United States between 2015 and 2016 (in U.S. dollars per foreign currency basket).
- Based on your answer to (b), what happened to the value of the U.S. dollar against this basket between 2015 and 2016? How does this compare with the change in the value of the U.S. dollar relative to the Mexican peso? Explain your answer.
Q2- Consider the fundamental equation of the asset approach to the exchange rate for two countries, China and Thailand. The current spot exchange rate is 4 Thai baht per Chinese yuan E baht/yuan = 4.
Analyze the following situations. For each, explain each of the following changes from the perspective of the Thai investor: expected rate of return on Thai deposits, expected rate of return on Chinese deposits, and the spot exchange rate. Illustrate in the FX diagram.
- The expected exchange rate increases Eebaht/yuan >4 and interest rates in both countries remain unchanged.
- The interest rate on Chinese and Thai deposits increases by the same amount and the expected exchange rate remains unchanged.
- The interest rate on Chinese deposits decreases, Thai interest rates remain un-changed, and the expected exchange rate is unchanged.
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