( Answers to Textbook Problems

1. At an exchange rate of 1.05 $ per euro, a 5 euro bratwurst costs 1.05$/euro ( 5 euros ’ $5.25. Thus, the bratwurst in Munich is $1.25 more expensive than the hot dog in Boston. The relative price is $5.25/$4 ’ 1.31. A bratwurst costs 1.31 hot dogs. If the dollar depreciates to 1.25$/euro, the bratwurst now costs 1.25$/euro ( 5 euros ’ $6.25, for a relative price of $6.25/$4 ’ 1.56. You have to give up 1.56 hot dogs to buy a bratwurst. Hot dogs have become relatively cheaper than bratwurst after the depreciation of the dollar.

2. E(NOK/CHF) ’ E(NOK/USD)/E(CHF/USD) ’ 7.5/1.25 ’ 6 NOK/CHF

3. When the yen depreciates vs. the dollar, its costs go up. This depresses its profits. On the other hand, if it exports products to the United States, it can increase the yen price (without changing the dollar price) so there may be some offsetting effects. But, by and large, a firm that has substantial imported input costs does not relish a depreciating home currency.

4. The dollar rates of return are as follows: a. ($250,000 − $200,000)/$200,000 ’ 0.25. b. ($275 − $255)/$255 ’ 0.08. c. There are two parts to this return. One is the loss involved due to the appreciation of the dollar; the dollar appreciation is ($1.38 − $1.50)/$1.50 ’ −0.08. The other part of the return is the interest paid by the London bank on the deposit, 10 percent. (The size of the deposit is immaterial to the calculation of the rate of return.) In terms of dollars, the realized return on the London deposit is thus 2 percent per year.

5. Note here that the ordering of the returns of the three assets is the same whether we calculate real or nominal returns. a. The real return on the house would be 25% − 10% ’ 15%. This return could also be calculated by first finding the portion of the $50,000