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Answers to End of Chapter 6s Questions

1. Under a fixed exchange rate system, the governments attempted to maintain exchange rates within 1% of the initially set value (slightly widening the bands in 1971) Under a freely floating system, government intervention would be non!existent Under a managed float system, governments will allow exchange rates move according to mar"et forces# however, they will intervene when they believe it is necessary $ freely floating system may help correct balance!of!trade deficits since the currency will ad%ust according to mar"et forces $lso, countries are more insulated from problems of foreign countries under a freely floating exchange rate system &owever, a disadvantage of freely floating exchange rates is that firms have to manage their exposure to exchange rate ris" $lso, floating rates still can often have a significant adverse impact on a country's unemployment or inflation 7. $ wea" home currency can cause inflation since it tends to reduce foreign competition within any given industry &igher inflation can wea"en the currency further since it encourages consumers to purchase goods abroad (where prices are not inflated) $ strong home currency can reduce inflation since it reduces the prices of foreign goods and forces home producers to offer competitive prices (ow inflation, in turn, places upward pressure on the home currency 8. )ntervention may have a more pronounced impact when the mar"et for a given currency is less active, such that the intervention can %olt the supply and demand conditions more $ central ban"'s indirect intervention can affect the factors that influence exchange rates and therefore affect the natural e*uilibrium exchange rate +onversely, direct intervention is a superficial method of affecting the demand and supply conditions for a currency, and could be overwhelmed by mar"et forces 12. ,terili-ed intervention is conducted to ensure no change in the money supply while nonsterili-ed intervention is conducted without concern about maintaining the same money supply 13. a .xchange rates are partially driven by relative interest rates of the countries of concern /hen +hile0s interest rates decline, there is a smaller flow of funds to be exchanged into +hilean pesos because the +hile interest rate is not as attractive to investors 1here may be a shift of investment into the other (atin $merican countries where interest rates have not declined &owever, if these (atin $merican countries are expected to reduce their rates as well, they will not attract more capital and may even attract less capital flows in the future, which could reduce their values 1he central ban"s would li"ely attempt to lower interest rates, which causes the currency to wea"en $ wea"er currency and lower interest rates can stimulate the economy 1he exporter is adversely affected if the +hilean peso and other currencies depreciate )t is favorably affected by the appreciation of any (atin $merican currencies

b
c

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15. 1he higher interest rates did not attract sufficient funds to offset the outflow of funds, as investors had no confidence that the currencies would stabili-e and were unwilling to invest in $sia 18. a 1he volume of the sales should decline as the cost to consumers who finance their purchases would rise due to the higher interest rates

b 1he cost of purchasing materials should decline because the $< appreciates against the &=< as it appreciates against the U , dollar c 1he interest expenses should decline because it will ta"e fewer $< to ma"e the monthly payment of <166,666 23. a b 3ecrease 1he & = dollar appreciated against the ,ingapore dollar while fixed against U, dollar, so it should shift purchases to ,ingapore and away from the U, )ncrease 1he U , dollar appreciated against the ,ingapore dollar, so it is cheaper to buy goods in ,ingapore 1he -ap's value is higher 3emand for >apa"ar's exports will be reduced 1he -ap's value is higher against all currencies 1he demand for >apa"ar's exports by non! U , countries will be reduced $ rise in the U , interest rate will be followed by a rise in >apa"ar's interest rate

24. a b c

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