The price of a BMW is $33,000 in the United States and e28,000 in Germany. (a) Where would you buy? Why? (b) Assume one U.S. dollar buys e0.83. Is there any arbitrage opportunity? Where would you buy? Why? (c) Compute the no-arbitrage $ e exchange rate. At this exchange rate, where would you buy? 2. Between 2008 and 2017, the $ e exchange rate moved from $ e 1.48 to $ e 1.20. During this same period, the consumer price index (CPI) in the Euro Area rose from 89.81 to 102.31 and the U.S. CPI rose from 202.42 to 246.67. (a) Did PPP hold over the period? Could investors profit from arbitrage in the goods market? (b) If PPP had held over this period, what would the $ e exchange rate have been in 2017? (c) Was the U.S. dollar overvalued or undervalued against the euro over the period? By how much? 3. Suppose the Swiss franc is worth $0.99 at the beginning of the year. During the year, U.S. inflation is 5% and Swiss inflation is 3%. (a) Does PPP predict an appreciation or a depreciation of the Swiss franc over the year? Why? By how much approximately? (b) Does your answer change if you use PPP in its exact form? Compare the two numerical solutions. (c) Suppose the Swiss franc is worth $1.03 at the end of the year. i. Did the Swiss franc appreciate or depreciate against the U.S. dollar over the year? By how much? ii. Does your answer confirm or disprove the prediction of PPP in question a)? iii. Given your answer above, was the U.S. dollar overvalued or undervalued relative to the Swiss franc over the year? 4. Suppose that the price of the same basket of goods at time 0 is P C 0 = 100 in country C and P D 0 = 90 in country D, so that the exchange rate is S C D 0 = 100 90 . Inflation rates are expected to be 10% in country C and 21% in country D, over the foreseeable future. (a) Does PPP approximately predict an appreciation or depreciation of currency C? (b) What are the expected price levels in the two countries (i.e., P C 1 and P D 1 ) and the expected no-arbitrage exchange rate in one period (i.e., S C D 1 )? (Use the exact form). (c) Use answer b) to check that your answer a) is correct. (d) What is the expected no-arbitrage exchange rate two-years into the future? 5. Assume that the United States and the United Kingdom produce only one good, wheat. Suppose the price of wheat is $3.25 in the United States and 1.35 in the United Kingdom. (a) According to the Law of One Price, what should the spot exchange rate ( $ ) be? (b) Assume the U.S. government imposes a tariff of $0.50 per bushel on wheat imported from the United Kingdom. What is the spot exchange rate ( $ ) that ensures no arbitrage? (c) Based on your answer b), does the British pound appreciate or depreciate to keep any investor indifferent after the introduction of the tariff? 6. One year ago, the spot exchange rate between country F and country J was S0 = F J 155. Today, the spot rate is S1 = F J 160. Inflation over the year was 2% in country J and 3% in country F. (a) Did currency J appreciate or depreciate over the year? By how much? (b) One year ago, what F J exchange rate would PPP have predicted for today? (c) Was currency J overvalued or undervalued against currency F over the period? By how much? (d) Given your answers, could investors profit from arbitrage in the goods market over the year? Why? 7. A Big Mac costs $5.67 in the United States and 3.39 in the United Kingdom. One U.S. dollar buys 0.77. (a) Compute the Big Mac PPP-predicted exchange rate. (b) Based on your answer above, is the British pound undervalued or overvalued relative to the U.S. dollar? By how much? 8. Look back at your answers to Question 2. (a) Did the U.S. dollar appreciate or depreciate in nominal terms against the euro over the period? Why? (b) Compute the real exchange rate at the beginning of the period. (c) Compute the real exchange rate at the end of the period. (d) Did the U.S. dollar appreciate or depreciate in real terms against the euro over the period? 9. Look back at your answers to Question 6. Assume the prices indexes in both countries were at 100 at the beginning of the period. (a) Did currency F appreciate or depreciate in nominal terms against currency J? (b) Compute the percentage change in the real exchange rate ( J F ). Did currency F appreciate or depreciate in real terms against currency J? (c) Are your answers good or bad news for country F exporters? And importers? (d) Are your answers consistent with those from Question 6? Briefly justify your answer. 10. Assume the price indexes in Spain and the U.S are at 100 in January 1981 and at 117 and 105, respectively, in May 1981. Assume the peseta is worth $0.1320 in January 1981 and $0.1185 in May 1981. (a) Compute the PPP rate of the peseta over the period (S $ P S ,P P P 1 ). (b) Did the peseta appreciate or depreciate against the U.S. dollar in nominal terms over the period? By how much? (c) What is the real exchange rate for the peseta in May 1981? (d) Did the peseta appreciate or depreciate against the U.S. dollar in real terms over the period? By how much? (e) Does your answer in d) make sense? Why? You discover that your Professor was distracted and reported an incorrect nominal exchange rate. In May 1981, the correct exchange was PS 1 = $ 0.1125. (f) Was the nominal depreciation of the peseta against the U.S. dollar larger, smaller or equal to the PPP prediction between January and May 1981? Was the peseta undervalued or overvalued relative to the U.S. dollar in May 1981? (g) What was the real exchange rate for the peseta in May 1981? (h) Did the peseta appreciate or depreciate against the U.S. dollar in real terms over the period? By how much? (i) What are the implications of your findings for Spanish exporters? (j) Takeaway message from this long problem: Compare answ