3 multiple choice questions. Please state your confidence level for each (not su

Question

3 multiple choice questions. Please state your confidence level for each (not sure, pretty sure, or postitve).

1. When a country's real exchange rate appreciates..

a. Its nominal exchange must have also appreciated.

b. Foreign goods become more expensive in terms of domestic purchasing power.

c. It could result if the domestic exchange rate is pegged in terms of the foreign exchange rate and foreign inflation rates are relatively high compared to domestic inflation rates.

d. It could result if the domestic exchange rate is pegged in terms of the foreign exchange rate and domestic inflation rates are relatively high compared to foreign inflation rates.

2. Under what condition would you maximize your return from investing in Japanese assets vs U.S. assets..

a. Annual rate of return on U.S. assets = 6%, annual rate of return on Japanese assets = 8%, dollar is expected to depreciate by 10% against the Japanese yen during the next year.

b. Annual rate of return on U.S. assets = 6%, annual rate of return on Japanese assets = 8%, dollar is expected to appreciate by 10% against the Japanese yen during the next year.

c. Annual rate of return on U.S. assets = 12%, annual rate of return on Japanese assets = 6%, dollar is expected to depreciate by 10% against the Japanese yen during the next year.

d . Annual rate of return on U.S. assets = 12%, annual rate of return on Japanese assets = 6%, dollar is expected to appreciate by 10% against the Japanese yen during the next year.

3. If the forward exchange rate of the yen in terms of dollars is greater than the spot exchange rate..

a. Japanese interest rates must be higher than U.S. interest rates.

b. U.S. interest rates must be higher than Japanese interest rates.

c. Market participants must be expecting the dollar to appreciate against the yen.

d. Market participants must be expecting the dollar to depreciate against the yen.

Explanation / Answer

1. d. It could result if the domestic exchange rate is pegged in terms of the foreign exchange rate and domestic inflation rates are relatively high compared to foreign inflation rates. (Confident)

This is because real exchange rate is ratio of price of a good in domestic market to the price of the same good in the foreign market.

2. a. Annual rate of return on U.S. assets = 6%, annual rate of return on Japanese assets = 8%, dollar is expected to depreciate by 10% against the Japanese yen during the next year. (Confident)

Assume initially 1 dollar = K yen

Now 1.1 dollar = K yen

Real return on US assets = (1.08/1.1) -1= -1.81 %

While that on Japanese is positive.

3. d. Market participants must be expecting the dollar to depreciate against the yen.  (Confident)

Because yield on yen is expected to increase against the dollar

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