If we know the exchange rate between Country A’s currency and Country B’s curren

Question

If we know the exchange rate between Country A’s currency and Country B’s currency, and we know the exchange rate between Country B’s currency and Country C’s currency, then we can compute the exchange rate between Country A’s currency and Country C’s currency. (Assume PPP holds.) (4 pts.)

a ) Suppose the exchange rate between the Korean Won and the US dollar is currently “1,100 Won = $1” and the exchange rate between the British pound and the US dollar is “0.70 Pound = $1”. What is the exchange rate between the Won and the Pound? (1 pt.)

b) Suppose that exchange rate between the Won and dollar changes to “1,000 Won = $1” and the exchange rate between the pound and dollar changes to “0.80 Pound = $1”. Has the dollar appreciated or depreciated against the won? Has the dollar appreciated or depreciated against the pound? Has the Won appreciated or depreciated against the pound

Explanation / Answer

(a)

Exchange rate between Won/US Dollar = 1,100 Won/ $1

Exchange rate between British Pound and US Dollar = 0.7 Pound / $1

Exchange rate between Won and Pound = (Won/Dollar) Exchange rate / (Pound/Dollar) exchange rate

= 1,100 / 0.7

= 1,571.43 Won per Pound

(b)

Earlier, 1 dollar could buy 1,100 Wons, but now 1 Dollar can buy 1,000 Wons. So, Won has gained in value (i.e. appreciated) and Dollar has lost in value (i.e. depreciated).

Earlier, 1 dollar could buy 0.7 Pounds. Now, 1 dollar can buy 0.8 Pounds. So, Pound has lost value (i.e. depreciated) and dollar has gained in value (i.e. appreciated).

New Won/Pound exchange rate = 1,000 / 0.8 = 1,250 Won per pound

Earlier, 1 pound could buy 1,571.43 Wons. Now, 1 Pound can buy 1,250 Wons. So, Won has gained in value (i.e. appreciated) and Pound has lost in value (i.e. depreciated).

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