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Students Zone - Revision Questions
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Chapter 1
Question 1
Explain using numerical examples the difference between a nominal exchange rate index and a real exchange rate index.
Question 2
Explain using numerical examples how we construct a nominal trade weighted exchange rate index for the pound against based on hypothetical dollar per pound and euro per pound parities.
Question 3
The $/£ spot rate is $1.85/£1. The UK interest rate is 4% and the US interest rate is 1%. Calculate the six month forward rate using the covered interest parity formula and state whether the pound is at a forward premium of discount.
Question 4
Fill in the missing values for nominal and real $/£ indexes in the table below.
| Actual | Nominal | UK Price | US Price | Real | |
| Period | $/£ rate | $/£ Index | Index | Index | $/£ Index |
| 1 | $2.00/£1 | ? | 100 | 100 | ? |
| 2 | $2.20/£1 | ? | 120 | 110 | ? |
| 3 | $2.30/£1 | ? | 140 | 120 | ? |
| 4 | $2.00/£1 | ? | 120 | 140 | ? |
| 5 | $1.70/£ | ? | 150 | 150 | ? |
Question 5
Fill in the missing values for effective pound index in the table below. Assuming that the UK does 40% of its trade with the US and 60% of its trade with Europe.
| Nominal | Nominal | Nominal (Effective) | |
| Period | $/£ index | Euro/£ Index | £ Trade Weighted Index |
| 1 | 100 | 100 | ? |
| 2 | 110 | 120 | ? |
| 3 | 120 | 100 | ? |
| 4 | 80 | 120 | ? |
| 5 | 100 | 80 | ? |
Question 6
The spot dollar-pound rate is $1.85/£1 and the one year forward rate is $1.80/£1. You expect the spot dollar-pound rate will be $1.60/£1 in one year's time. You have £1 million to speculate with.
(i) Do you buy or sell £1 million in the forward market?
(ii) What is your profit in pounds if you are correct and the spot dollar-pound rate is $1.60/£1 in one year's time?
(iii) What is you loss in pounds if you are wrong and the spot sterling rate is $2.00/£1 in one years' time?
