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18 a) The reason for economic depreciation of the peso is the high inflation and interest rates as compared to that of the United States.

b) Why do you think U.S. investors do not try to capitalize on the high interest rates in Mexico?

This is because high interest rates raises inflation rate and commodity price in Mexico becomes higher than that in U.S. The real interest rate in U.S is lower than the real interest rate in Mexico. Therefore Mexico will be encouraged to import more and export less and given the high inflation expectations, the U.S investors are discouraged to invest in Mexican securities (Banco de México, 1994).

c) Why do you think the bid/ask spread is higher for pesos than for currencies of industrialized countries? How does this affect a U.S. firm that does substantial business in Mexico?

This is because the foreign exchange market providers are subject to risk for maintaining a volatile peso that could devalue at any time. This affects a U.S firm doing a business in Mexico because it raises the transaction costs involved in exchanging both currencies since the peso is weak.

23) Based on the information provided, will the euro appreciate, depreciate or stay at about same level against the dollar over the next year? Explain

The Euro will appreciate over the next year since it is compared with the U.S dollar which will devalue with 2% while the Euro will devalue with 1 %.

28) Explain why and how (which direction) the euro’s value would change today based on the information provided.

The Euro will weaken because of negative balance of trade since the U.S market demand for Europe goods will be more compared to Europe demand for U.S goods.  Capital flows between these two countries will weaken in that it will reduce U.S demand and supply of the Euro.

Chapter 5 Explain why the central bank’s intervention caused such panic among currency futures traders with buy positions.

It increased the supply of foreign currency in the economy and reduced dollar supply raising its value thus the future traders will incur losses while exchanging their foreign currency to the dollar. The dollar will be more expensive than at the time they had sold it.

b) Explain why the floor broker’s willingness to sell 300 pound futures contracts at the going market rate aroused such concern. What might this action signal to other brokers?

Through the sale of future contracts for British pound, it again increased the supply of dollar therefore pause an effect of reducing the dollar value. The other brokers might not hold their future contracts since it is unpredictable.

c) Explain why speculators with short (sell) positions could benefit as a result of the central bank’s intervention.

The changes in supply of the dollar may create significant increase in demand in the short term for both the dollar and foreign currencies which will increase speculators revenue in transacting in exchange markets and therefore don’t know the rice of their contracts.

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