TOWSON UNIVERSITYCOLLEGE OF BUSINESS AND ECONOMICSFIN435.001Dr. M. RheeFall 20101. Describe how the changes in the following macroeconomic variables effect the exchange rates? (provide logical rationale and use diagrams)a) higher interest rate in Germany Higher interest rate in Germany → Increased investments in Germany to get a higher return on investment → Demand for € increases → Demand curve for € shifts out→ ($) price of € (called an exchange rate) increases → Stronger € and weaker $b) Comment on the statement, “a stronger economy has a stronger currency” Is that true? Why and why not?Stronger German economy can have an impact on the exchange rate in two different ways; one is through aconsumption channel and the other is an investment channel. It may depend on which side has stronger impact on the exchange rate. However, “a stronger economy has a stronger currency” is empirically true because the investment side has been dominating the consumption side empirically. (i) Consumption Side→ German income increases→ Demand for U.S. products (as well as German products) increases→ Demand for US$ increases = Supply of € increases→ € supply curve shifts out→ ($) price of € (called an exchange rate) decreases→ Stronger $ and weaker €(ii) Investment Side→ Investment in Germany increases to get a higher return from the stronger German Economy→ Demand for € increases → Demand curve for € shifts outQ (€)$/€S (€)D (€)D’ (€)S0S1Q (€)$/€S (€)D (€)D’ (€)S0S1Q (€)$/€S (€)D’ (€)D (€)S0S1→ ($) price of € (called an exchange rate) increases → Stronger € and weaker $ Empirically, investment side dominates. Strong economy results in the stronger currencyc) Comment on the following statement. "An increase in the US interest rate would result in an influx of foreign capital as everyone wants to invest in the US for a higher return. The demand for US $ will increase as a result. The demand for $ is the same as the supply of a foreign currency. An increase in the supply of a foreign currency would decrease the $ price of a foreign currency, i.e., the exchange rate. A decrease in the exchange rate would, however, causes an increase in the demand for the foreign currency, causing the foreign currency stronger and the US$ gets weaker. The conclusion is that an increase in the US interest rate would result in weaker US$."Everything is fine until the phrase “A decrease in the exchange rate would, however, causes an increase in the demand for the foreign currency, causing the foreign currency stronger and the US$ gets weaker.” This sentence describes the move along the curve, not the shift of the curve from the macroeconomic factors. Thus, the sentence alone may be ok without having it in the context of a shift of the supply of a foreign currency as we are now on a new supply curve and we cannot continue talking about “moving along the same old supply or demand curve.” We should have stopped right after the sentence “An increase in the supply of a foreign currency would decrease the $ price of a foreign currency, i.e., the exchange rate.”2. a) How many dollars does it take to get 10 SFs if SF/$=1.4?SF/$ = 1.4 ⇨ 10SFs, SF10 * (1/1.4)$/SF = $7.1429 (When SF/$ = 1.4, $7.1429 are needed to get 10SFs).b) If the price of a twinkie drops 25%, how much the dollar has gained its value?If S0 = $1/TW, S1 = $0.75/TW ⇨ (1/S1 – 1/S0)/(1/S0) = (S0 – S1)/S1 = ($1/TW – $0.75/TW)/ $0.75/TW = 0.25/0.75 = 33.33%⇨$ has gained its value against twinkie by33.33%c) yen/$ was 201.6 in 1948 and it is now 108.2. How much yen has appreciated from 1948? S0 = $(1/201.6)/¥, S1 = $(1/108.2)/¥ ⇨ (S1 – S0)/S0 = {(1/108.2) – (1/201.6)}/(1/201.6) = 86.32% ⇨ ¥ has appreciated against $ by 86.32% from 1948 to 2010.d) If yen/$ = 108.2, yen/BP = 197.45, what is the BP/$ rate? £/$ = (¥/$) * (£/¥) = 108.2 * (1/197.45) = £0.54799/$3. A MNC has the following cash flows from their operations around the world. What is the $ amount of total cash flows from all the operations?US operation: $100m, Canadian operation: C$150m, Japanese operation: 12billion yen, UK operation: 70mpoundsCAD/USD=1.2783, GBP/USD=0.8702, JPY/USD=112.3968$100m + {C$150m * $(1/1.2783)/C$} + {¥12,000m * $(1/112.3968)/¥} + {£70m * $(1/0.8702)/£} = $404.5492mIf C$ and Japanese yen have depreciated 10% against the US$, what would be the new $ amount?$100m + {C$150m * $(1/1.2783)/C$ * 0.9} + {¥12,000m * $(1/112.3968)/¥ * 0.9} + {£70m * $(1/0.8702)/£} = 382.1384m 4. Using the information given in the table below, provide your answers.1) What is the yen/US$ exchange rate? ¥/$ = ¥116.3750/$2) What would be the AU$/Can exchange rate?AU$/C$ = (AU$/$) * ($/C$) = 1.3303 * (1/1.1170) = AU$1.190958/C$CurrencyLast TradeU.S. $N/A¥en11:29am ETEuro11:29am ETCan $11:29am ETU.K. £11:29am ETAU $11:29am ETSwiss Franc11:29am ET 1 U.S. $ = 1 116.3750 0.7844 1.1170 0.5262 1.33031.2382 1 ¥en = 0.008593 1 0.006740 0.009598 0.004521 0.0114310.010640 1 Euro = 1.2749 148.3607 1 1.4239 0.6708 1.6960 1.57855. a) Differentiate between gold standard and gold exchange system. (i) The Classical Gold Standard: The Classical Gold standard was between 1875 and 1914. All currencies were fully convertible into gold. Under this system the supply of money is solely dependent on the amount of gold the economy/ country has. Advantage: $ supply is under tighter control & keeps the value of money. Disadvantage: could create a shortage of $ as the economy grows (ii) The Gold-Exchange System: The Gold-Exchange (the Bretton Woods, IMF) took place between 1945 and 1972, (system $35/ounce). Only US$ was fully convertible into gold. Other currencies were fixed to US $. The system is based on the $ maintaining its value, however, as more $ is provided to the world, $ value drops.b) Identify the problem associated with bimetallism and explain how you might be able to save the system. The major problem with Bimetallism is that “Bad money drive good money out of circulation”, Gresham’s law. The government fixed the exchange rate at 1ounce Gold for 16ounce Silver. Such a monetary system can be saved by letting the market freely determine the exchange rate between gold and silver based on the relative demand and supply of each metal. c) J curve? J-Curve: It takes time to see an improvement in trade balance as the domestic currency value gets lowered. Initially, the