# Exchange rates

1. Exchange rates are exceedingly difficult to predict. Explain the factors that determine the exchange rate over the long run, medium run, and short run.
2. According to the following equation (1/R)(1+i*)F = F/R (1+i*). Explain what is the interest parity condition, and how can we derive the interest parity condition from the previous equation.
3. If the dollar/pound exchange rate is \$2/£, a Big Mac costs \$5 in New York City and costs £4 in London. From the point of view of an American consumer estimate and explain whether the pound is undervalued or overvalued and indicate in what city U.S. consumers are better off.
4. Consider the case of a sudden increase in demand for foreign exchange in a country with a fixed exchange rate system. Indicate what are the conditions for the monetary authority to sustain the fixed exchange rate and explain the mechanism to maintain the exchange rate fixed using a graph.
5. Use a J-curve to illustrate the effect on the current account of an exchange rate depreciation. Explain why the curve has the shape that it does. What condition must be fulfilled to have a positive effect of the depreciation of the currency on the current account?

Last Updated on May 4, 2020

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