118 CHAPTER 3. SPOT MARKETS FOR FOREIGN CURRENCY
- A bank is currently quoting the spot rates ofeur/usd 1.3043-1.3053 and
nok/usd6.15-6.30. What is the lower bound on the bank’s bid rate for the
nokin terms ofeur? - Suppose that an umbrella costsusd20 in Atlanta, and theusd/cadexchange
is 0.84. How manycaddo you need to buy the umbrella in Atlanta? - Given the bid-ask quotes forjpy/gbp220-240, at what rate will:
(a) Mr. Smith purchasegbp?
(b) Mr. Brown sellgbp?
(c) Mrs. Green purchasejpy?
(d) Mrs. Jones selljpy?True or false?Indicate the correct statement(s).
- CPPsays that you can make a risk-free profit by buying and selling goods
across countries. - CPPimplies causality. It states that foreign prices are determined by domes-
tic prices and other factors such as production costs, competitive conditions,
money supplies, and inflation rates. - In order for a firm not to be affected by real exchange risk,CPPmust hold not
only for the goods a firm produces but also for all production inputs, and for
the prices of complementary and substitute goods. - The equilibrium exchange rate suggested by the Absolute Purchasing Power
Parity hypothesis depends on the relative relationship between the prices of a
representative consumption bundle in the currencies of two countries. - Your purchasing power is the number of representative consumption bundles
that you can buy. - The real effective exchange rate is the price of an average foreign consumption
bundle in units of domestic currency. - RelativePPPshows how a consumer’s purchasing power changes over time.
- AbsolutePPPmay hold even when RelativePPPdoes not because absolutePPP
looks at levels at a specific point in time, and levels are always comparable
regardless of the composition of the consumption bundle. - Given the empirical evidence on the correlation between the nominal and real
exchange rate, it is possible to use the nominal financial instruments to hedge
real exchange risk.