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If Tut 4

The document discusses exchange rates between currencies and factors that affect them. It analyzes how economic indicators like growth rates, inflation, interest rates, productivity, and restrictions on foreign investment would impact the value of the US dollar relative to the Japanese yen. It also explains how monetary authorities can cause a currency's value to drop by increasing its supply, and how an easier monetary policy in Malaysia would weaken the ringgit and lower interest rates.

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Ong CH
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126 views7 pages

If Tut 4

The document discusses exchange rates between currencies and factors that affect them. It analyzes how economic indicators like growth rates, inflation, interest rates, productivity, and restrictions on foreign investment would impact the value of the US dollar relative to the Japanese yen. It also explains how monetary authorities can cause a currency's value to drop by increasing its supply, and how an easier monetary policy in Malaysia would weaken the ringgit and lower interest rates.

Uploaded by

Ong CH
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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1.

For each of the following six scenarios, say whether the value of the dollar will
appreciate, depreciate, or remain the same relative to the Japanese yen. Explain
each answer. Assume that exchange rates are free to vary and that other factors are
held constant.

a) The economic growth rate of the United States is higher than in Japan.
When the economic growth rate of the United States is higher than in Japan, the domestic
investment in the U.S. is higher, demand for currency increases. Then, the value of the
U.S. dollar appreciates.

b) Inflation is higher in the U.S. than in Japan.


While the inflation is higher in the U.S. than in Japan, (in short term) the domestic
investment in the U.S. is lower, demand for currency decreases. Then, the value of the
U.S. dollar depreciates.

c) Prices in Japan and the United States are rising at the same rate.
When prices in Japan and the U.S. are rising at the same rate, the exchange rate remains
the same. Then, the value of the U.S. dollar will remain the same relative to the Japanese.

d) Real interest rates are higher in the United States than in Japan.
When the interest rate in the United States is higher than in Japan, capital will flow from
Japan to the United States. This causes an increase in domestic investment. Therefore, the
demand for the U.S dollar rises and the value of currency increases which means the U.S dollar
appreciates.

e) The United States imposes new restrictions on the ability of foreigners to buy
American companies and real estate.
When the United States imposes new restrictions on the ability of foreigners to buy
American companies and real estate, this causes a decrease of foreigners to purchase.
Then, this will lead to the decrease in domestic investment, demand for the U.S dollar
also decreases. Therefore, the value of currency will depreciate.

f) U.S. wages rise relative to Japanese wages, and ​American productivity falls
behind Japanese productivity.
When the American productivity falls behind Japanese productivity, the economy of the
U.S is decreasing which means the growth rate of national income is lower in the U.S then in
Japan. The decrease in the U.S economy will cause domestic investment to decrease also. Hence,
the demand for U.S currency will decrease and the value of U.S dollar depreciates.
2. The maintenance of money's value is said to depend on the monetary authorities.
What might the monetary authorities do to a currency that would cause its value to
drop?

Monetary authorities ​is an entity that manages a country’s currency, and money supply.
For example, in Malaysia we have the Central Bank of Malaysia (Bank Negara), its main
purpose is to issue currency.

● The value of any good or asset is driven by its ​scarcity​.


Higher scarcity, lesser goods/assets, thus value will be higher.

● What the monetary authorities could do is to make money less scarce by issuing more of
it​. This would lower its scarcity value. Hence, the value of currency will drop.
More goods/assets, Lower scarcity, thus value will be lower.

Example RM 1:

When monetary authorities issue more currency. Value of RM 1 will drop.

Nominal value = RM 1
Value drop? Still RM 1

So what value actually is dropping? Answer is purchasing power per unit of money.
Purchasing power per unit of money = Amount of goods/services that can be purchased with a
unit of currency.

For example, Before issuing more currency, 1 dollar can purchase 5 units of ringgits.
After issuing, 1 dollar only can purchase 3 units of ringgits.

● Even though its nominal value will always be the same, the added supply will reduce the
purchasing power per unit of money.
3. If Malaysia adopts an ​easier monetary policy​. How is the likely to affect the value of
the ringgit and Malaysia interest rates?
easier monetary policy = expansionary monetary policy

If Malaysia adopts an easier monetary policy ​central bank will supply more money to the market​,
which causes the value of ringgit will drop as well as Malaysia interest rates. ​An easy money
policy is a monetary policy that ​increases the money supply usually by lowering interest rates. It
occurs when a country’s central bank decides to allow new cash flows into the banking system.
The most immediate effect of easy money, if implemented when the economy is below capacity,
may be increased economic growth. Therefore. ​interest rate decrease, money supply increase,
value of Ringgit Malaysia decrease. Short term interest rates will decline, long term interest will

4. On May 2018, one Mexico peso bought US$ 0.07358 and changed to
US$0.05866/peso in May 2019.
a) What was the value of U.S. dollar in Mexico peso on May 2018 and
2019?
1
$0.07358 = 13.59 Peso in 2018
1
$0.05866 = 17.047 Peso in 2019

b) By what percent has the Mexico peso appreciated (depreciated)


relative to the U.S. dollar?
0.05866−0.07358
0.07358 = -20.28%
= Peso ​depreciated​ 20.28% against USD.

c) By what percent has the U.S. dollar appreciated (depreciated) relative


to the Mexico peso?
17.047−13.59
13.59 = 25.44%
= USD ​appreciated​ 25.44% against Peso.

(USD appreciated, Ringgit depreciated)


5. Polaxus Bhd. (Polaxus) is a Malaysian garments manufacturer with a Chinese subsidiary that
produces in China and sells them in the US. ​This subsidiary pays its wages and its rent in
Chinese yuan, which is stable relative to ringgit （+ve relationship）. The garments sold to US
are denominated in US dollar. ​Assume that Polaxus expects that the Chinese yuan will continue
to stay stable against the ringgit. The subsidiary’s main goal is to generate profits for itself and
reinvest the profits and it does not plan to remit any funds to the Malaysia holding company.

a) Assuming the US dollar strengthens against ringgit over time, how would this affect the
profits earned by the Chinese subsidiary?

(USD appreciated, ​Ringgit depreciated = yuan depreciated​) USD goes up, u get more
Yuan,because of the conversion rate. When USD currency is higher, as the profit is in USD
therefore , the profit convert in Chinese Yuan would be higher.

b) If Polaxus had established its subsidiary in US, instead of China, would its subsidiary’s profits
be more exposed or less exposed to exchange rate risk. Explain. ​(**when don't have to convert,
there is less exposed exchange rate risk)
Less exposed ​to exchange rate risk . As the business take place in US , the profit
is in USD therefore they don’t need to convert USD to Chinese Yuan or Malaysia
Ringgit.

c) If the Chinese subsidiary needs to apply for a long term loan to finance its expansion
and wants to reduce its exchange rate risk, should it borrow ringgit, Chinese yuan, or US
dollar? Explain.

US dollar, The company generates revenue in US dollar. Hence, the company


should loan in USD to reduce the exchange risk and minimize the conversion risk

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