Working group 2 12-09-2019
Question 1 (chapter 14, problem 2)
a US dollar costs 7.5 Norwegian Kroner, but the same dollar can be purchased for 1.25
Swiss francs. What is the Norwegian Kroner/Swiss franc exchange rate?
Answer:
N OK CHF N OK
7.5 ∧1.25 →
$ $ CHF
N OK
7.5
$ 7.5 N OK $ 7.5 N OK N OK
= x x = =6
CHF 1.25 $ CHF 1.25 CHF CHF
1.25
$
Triangular arbitrage: exchange rates doesn’t match.
Make sure that there is no triangular arbitrage in this case there is no triangular
arbitrage, therefore you can make this calculation.
Question 2 (chapter 14, problem 7)
In 2014, Germany’s Volkswagen (VW) makes a contract with Malaysia to supply 100 cars
in 2015. €700,000 is to be paid on the date of supply. Suppose today’s rate is Malaysian
ringgit (MYR) 3/€ and the expected exchange rate for the next year is MYR 3.15/€.
Suppose after the deal, the rate changed to MYR 3.10/€. In this case, what will happen to
VW’s expected gain and loss in bonus in 2015?
Answer:
3.10 is lower than 3.15 so the euro has depreciated against MYR. To still get your
€700.000 you have to make your contract in euros. Malaysia still have to pay €700.000 in
MYR whatever the exchange rate is.
Likely: the deal is made on the basis of €.
No effect
If Western countries make deals with developing countries, it is better to make these
deals on the basis of € nothing can happen if the exchange rate will differ in the
following years.
Unlikely: the deal is made on the basis of MYR.
VW probably expected the following payment
o €700.000 * (MYR 3.15/€) = MYR 2.205.000
But they will only receive:
o €700.000 * (MYR 3.10/€) = MYR 2.170.000
That is: €700.000 * (MYR 0.05/€) = MYR 35.000 less
In terms of VW’s currency, the loss is
o MYR 35.000 * 1/(MYR 3.15/€) = €11.111 (based on e they expected)
o MYR 35.000 * 1/(MYR 3.10/€) = €11.290 (based on current e)
More realistic: VW will hedge the expected future exchange rate by a forward contract.
, Question 3 (chapter 14, problem 17)
Multinationals generally have production plants in a number of countries. Consequently,
they can move production from expensive locations to cheaper ones in response to
various economic developments – a phenomenon called outsourcing when a domestically
based firm moves part of its production abroad. If the dollar depreciates, what would you
expect to happen to outsourcing by American companies? Explain and provide an
example.
Answer:
The foreign currency in which your production took place is more expensive now
compared to production in the US.
Outsourcing: move a part of the company to another country, to reduce production costs.
Outsourcing is done to reduce production costs, so that a firm becomes more competitive
by producing abroad.
However, if the home currency depreciates (loss value), local production becomes more
competitive, in particular:
Foreign production facilities become more expensive in own currency.
Imports back into home country become more expensive;
Producing at home benefits from lower export prices
Outsourcing will be reduced, and production will remain to be domestically
situated.
Question 4 (chapter 16, problem 1)
Suppose in the year 2010 (where the price level is 100) the Japanese yen and the Indian
rupee exchange rate (¥/rupee) is 0.54. If the price level in 2013 stands at ¥105 and 110
rupees in Japan and India respectively, what will be the exchange rate in 2013, based on
PPP?
Answer:
Wrong:
Absolute PPP: P = eP* e = P/P*
e = ¥105/110 rupees = ¥ 0.95454/rupee
2010: e= ¥0.54/rupee
2010: P=P* = 100 – an index
2013: P = ¥105 but P = 105 – an index
2013: P* = 110 rupees but P* = 110 – an index
What is asked?
What is inflation and how should e change according to relative PPP?
What do we know?
Relative PPP: the inflation rate difference is offset by the change rate in e (more
precisely, the expected rate of depreciation):
π = ∆e e + π*
Calculate π and π*:
π = (105-100)/199 = 5% π* = 10*
π - π* = (e e -e)/e
π - π* = 5%-10% = -5%
-5% = (e e -e)/e exchange rate will be 5% lower
expected rate of appreciation of 5% of the yen
Question 1 (chapter 14, problem 2)
a US dollar costs 7.5 Norwegian Kroner, but the same dollar can be purchased for 1.25
Swiss francs. What is the Norwegian Kroner/Swiss franc exchange rate?
Answer:
N OK CHF N OK
7.5 ∧1.25 →
$ $ CHF
N OK
7.5
$ 7.5 N OK $ 7.5 N OK N OK
= x x = =6
CHF 1.25 $ CHF 1.25 CHF CHF
1.25
$
Triangular arbitrage: exchange rates doesn’t match.
Make sure that there is no triangular arbitrage in this case there is no triangular
arbitrage, therefore you can make this calculation.
Question 2 (chapter 14, problem 7)
In 2014, Germany’s Volkswagen (VW) makes a contract with Malaysia to supply 100 cars
in 2015. €700,000 is to be paid on the date of supply. Suppose today’s rate is Malaysian
ringgit (MYR) 3/€ and the expected exchange rate for the next year is MYR 3.15/€.
Suppose after the deal, the rate changed to MYR 3.10/€. In this case, what will happen to
VW’s expected gain and loss in bonus in 2015?
Answer:
3.10 is lower than 3.15 so the euro has depreciated against MYR. To still get your
€700.000 you have to make your contract in euros. Malaysia still have to pay €700.000 in
MYR whatever the exchange rate is.
Likely: the deal is made on the basis of €.
No effect
If Western countries make deals with developing countries, it is better to make these
deals on the basis of € nothing can happen if the exchange rate will differ in the
following years.
Unlikely: the deal is made on the basis of MYR.
VW probably expected the following payment
o €700.000 * (MYR 3.15/€) = MYR 2.205.000
But they will only receive:
o €700.000 * (MYR 3.10/€) = MYR 2.170.000
That is: €700.000 * (MYR 0.05/€) = MYR 35.000 less
In terms of VW’s currency, the loss is
o MYR 35.000 * 1/(MYR 3.15/€) = €11.111 (based on e they expected)
o MYR 35.000 * 1/(MYR 3.10/€) = €11.290 (based on current e)
More realistic: VW will hedge the expected future exchange rate by a forward contract.
, Question 3 (chapter 14, problem 17)
Multinationals generally have production plants in a number of countries. Consequently,
they can move production from expensive locations to cheaper ones in response to
various economic developments – a phenomenon called outsourcing when a domestically
based firm moves part of its production abroad. If the dollar depreciates, what would you
expect to happen to outsourcing by American companies? Explain and provide an
example.
Answer:
The foreign currency in which your production took place is more expensive now
compared to production in the US.
Outsourcing: move a part of the company to another country, to reduce production costs.
Outsourcing is done to reduce production costs, so that a firm becomes more competitive
by producing abroad.
However, if the home currency depreciates (loss value), local production becomes more
competitive, in particular:
Foreign production facilities become more expensive in own currency.
Imports back into home country become more expensive;
Producing at home benefits from lower export prices
Outsourcing will be reduced, and production will remain to be domestically
situated.
Question 4 (chapter 16, problem 1)
Suppose in the year 2010 (where the price level is 100) the Japanese yen and the Indian
rupee exchange rate (¥/rupee) is 0.54. If the price level in 2013 stands at ¥105 and 110
rupees in Japan and India respectively, what will be the exchange rate in 2013, based on
PPP?
Answer:
Wrong:
Absolute PPP: P = eP* e = P/P*
e = ¥105/110 rupees = ¥ 0.95454/rupee
2010: e= ¥0.54/rupee
2010: P=P* = 100 – an index
2013: P = ¥105 but P = 105 – an index
2013: P* = 110 rupees but P* = 110 – an index
What is asked?
What is inflation and how should e change according to relative PPP?
What do we know?
Relative PPP: the inflation rate difference is offset by the change rate in e (more
precisely, the expected rate of depreciation):
π = ∆e e + π*
Calculate π and π*:
π = (105-100)/199 = 5% π* = 10*
π - π* = (e e -e)/e
π - π* = 5%-10% = -5%
-5% = (e e -e)/e exchange rate will be 5% lower
expected rate of appreciation of 5% of the yen
