Answer to the Question of part- 1

1. Increase the value of dollar.

2. Depreciate
3. Fall
4. Rise.
5. Rise.
6. Fall
7. Rise
8. Fall.
9. Fall.
10. Downward.
11. Depreciation.
12. Importing more than export.
13. Conversion of one currency to another.
14. Because of double entry account system.

Answer to the Question of part- 2(A)

We know, the purchasing power-parity theory helps explain the behavior of a currency’s exchange
value. According to this theory, changes in relative national price levels determine changes in exchange
rates over the long term. A currency is expected to depreciate by an amount equal to the excess of
domestic inflation over foreign inflation; it appreciates by an amount equal to the excess of foreign
inflation over domestic inflation.

Figure shows the relation between inflation and the exchange rate for selected countries. The horizontal
axis shows the country’s average inflation minus the U.S average inflation. The vertical axis shows the
average percentage change in a country’s exchange rate (foreign currency per dollar) over that period.
Consistent with the predictions of the purchasing power parity theory, the figure shows that countries
with relatively low inflation rates tend to have appreciating currencies and countries with relatively high
inflation tend to have depreciating currencies.
 Answer to the Question of part- 2(B)

Starting at equilibrium income, an autonomous in domestic exports leads to a rise in domestic income
which promotes an increase in imports and savings. Because of the multiplier effect, the induced
increase in income tends to be larger than the initial increase in exports. The trade account moves into
surplus because the induced increased in imports tends to be less than the initial increase in exports.
Again, starting at equilibrium income, an autonomous increase in domestic investment generates an
increase in income, which promotes additional savings and imports. Because of the multiplier effect, the
increase in investment generates a magnified increase in income. As the increase in income induces a
rise in imports, a trade deficit appears.

Answer to the Question of part- 2(C)

Figure shows, the hypothetical capital and financial account schedules for the United States. Capital and
financial account surpluses and deficits are measured on the vertical axis. In particular, financial flows
between the United States and the rest of the world are assumed to respond to interest-rate
differentials between the two areas (U.S interest rate minus foreign interest rate) for a particular set of
economic conditions in the United States & abroad.

Referring to schedule CFAo, the U.S capital and financial capital is in balance at point A, where the U.S
interest rate is equal to that abroad. Should the united states reduce its monetary growth, the scarcity
of money would tend to rise interest rates in the United States compared with the rest of the world.
Suppose U.S interest rates rise one percent above those overseas. Investors, seeing higher U.S interest
rates, will tend to sell foreign securities to purchase U.S securities that offer a higher yield. The one
percent interest rate differential leads to net financial inflows of $5 billion for the United States, which
thus moves to point B on schedule CFAo. Conversely, should foreign interest rates rise above those in
the United States, the United States will face net financial outflows as investors sell U.S securities to
purchase foreign securities offering a higher yield.

Answer to the Question of part- 3

1. 1 yen = $ 0.01, so 55000 yen = 55000* 0.01; so, in dollar cost is $550.
2. 170 yen = $1; 1 yen =1/170 = $0.0059; 55000 yen = 0.0059* 55000 = $324.5.
3. $ 1.3 = 1 euro; $1= 1/1.3 = 0.77 euro.
4. Buy 3 francs with 1 dollar; then with 3 francs 6 schilling since 1 frances= 2 schilling. 4 schilling =
1 dollars; then 6 schilling are 6/4 = 1.5 dollar. $ ( 1.5-1) = 0.5 dollar. A person can make 0.5-
dollar profit by $ 1.
5.
(A) with $1 million dollar the speculator buys 0.5 euro in forward market and can sell it in future
spot market when speculation gets right. When the price of pound gets higher.

(B) when pound price is $1.9 then he will have 1.9*0.5= 0.95, so, ($1-$0.95) million = 0.05
million will be lost when price is $2= 1 euro , then no profit no lose; when the price is $2.1 then
(2.1*0.5) =$1.05. so, (1.05-1)= $0.05 million profit.