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Econ 635

Name: ___________________________

Problem Set 6

Fall 2019

To obtain full credit, you need to show ALL your work

. Feel free to work in groups, but the

answers must be written up individually!

Round your answers to two decimal places.

1.

(5 points) Name 2 factors that affect the behavior of the (nominal) exchange rate (defined as

euros per dollar) in the LONG run. Explain how a change in each of the factors will affect the

exchange rate (whether it increases or decreases) and what happens to the value of the dollar

relative to euro (i.e. does the dollar appreciate or depreciate?).

2. (10 points) Name 2 factors that affect the behavior of the (nominal) exchange rate (defined as

euros per dollar) in the SHORT run. Explain how a change in ea

ch of the factors will affect the

exchange rate (whether it increases or decreases) and what happens to the value of the dollar

relative to euro (i.e. does the dollar appreciate or depreciate?).

Use the

Foreign Exchange market

to

GRAPHICALLY ILLUSTRATE

your reasoning

(don’t forget to label all axes, curves etc

.)

3.

(5 points)

The president of the United States announces that he will increase inflation with his

new pro-

inflation program. If the public believes him, predict what will happen, holding

everything else constant,

to the exchange rate for the U.S. dollar (relative to other currencies) in

the short run. Use the

Foreign Exchange market

to

GRAPHICALLY ILLUSTRATE

your

reasoning

(don’t forget to label all axes, curves etc.)

4.

(5 points)

The current exchange rate is 0.93 euros per dollar, but experts

believe the exchange

rate

will

drop

to

0.85 euros per dollar. What will be

the percentage change in

the

exchange rate if

experts are right

? Will the euro (relative to $)

appreciate or d

epreciate?

5. (5 points) An investor in England purchased a 91-

day

US

T-bill for $987.65

with a face value

of $1,000. At that time, the exchange rate was $1.75 per pound. At maturity, the exchange rate was

$1.83 per pound. What was the investor’s percentage

holding period return (given that investor’s

domestic currency is pounds

)?

In general, if

investors

expect the dollar to appreciate in the future

, how will these

expectations affect the demand for US assets and the

current value of the US dollar? Is

this

in line with the Efficient Market Hypothesis? Explain briefly.