FIN 335
Quiz 1: Fall 2015
100 Points Possible

Names:______Todd_________________________________________________

This quiz is due at the beginning of class on October 27th, 2015 (Tuesday). You may work in groups of two students. Please write each group member’s name at the top of the quiz. Working with students outside of your own group is prohibited. Please SHOW ALL WORK (including formulas where necessary) to receive full credit. Do not round in any intermediate steps (i.e. only round your final solution – round to six decimal points please).

1.) Assume that a fixed exchange rate system exists between the United States and the fictional country of Neverland. Note that the currency of the United States is the U.S. Dollar, while the currency of Neverland is the Gold Doubloon. Assume that the inflation rate becomes much higher in Neverland, relative to the inflation rate in the United States. Clearly explain how a fixed exchange rate system between Neverland and the United States could make the United States more vulnerable to economic problems (high inflation in this case) of Neverland while a floating exchange rate system between Neverland and the United States could lead to compounded economic problems in Neverland. Please use the countries given in the problem (the United States and Neverland) in your explanation. Clearly explain your logic and use graphs, as necessary. (45 Points)

With a fixed exchange rate system existing between the United States and Neverland, the United States could definitely be vulnerable to high inflation. Since Neverland’s inflation rate is much higher than the United States’, Neverland’s goods and services are more expensive. The United States will demand fewer Neverland’s expensive goods and services (so demand fewer Gold Doubloon as well). So instead the US start to purchase more goods and services from their own