# Foreign exchange parity... I KNOW YOU LOVE IT

Seth Antonio, CFA, is an international currency trader for the Mega Currency Fund. Recently, Japan unexpectedly reduced its money supply by 5 percent increasing interest rates from 1 percent to 1.5 percent. Japan’s current spot rate is 108.74 Japanese yen per United States dollar (JPY/USD). Seth believes that it will take two years for the effects of the decrease in the money supply to reduce the inflation rate in Japan. The current interest rate in the U.S. is 2 percent. A firm believer in the asset markets approach, he computed a value of 102.29 for the current spot rate. What was the immediate percentage change in the value of the yen as a result of the unexpected change in the money supply? A) 5.93% depreciation in the Japanese yen against the U.S. dollar. B) 6.31% appreciation in the Japanese yen against the U.S. dollar. C) 5.93% appreciation in the Japanese yen against the U.S. dollar. D) 6.31% depreciation in the Japanese yen against the U.S. dollar. What are the most likely effects on real GDP and the country’s current account balance? Real GDP - Current account A) Decrease - Deficit B) Increase - Surplus C) Increase - Deficit D) Decrease - Surplus

Less yen per dollar means Yen appreciated. C

and part 2?

Inflation decreases so real GDP should increase. Exports will be more expensive so the current account acct. should have a deficit. A

The price effect takes longer to occur. Since interest rates are up the financial account will go up because foreign investors will immediately find Japan more attractive to invest in. This will lead to an offsetting decrease in the current account. Hopefully I am not way off here. I say C for part 2

C for 1st A for 2nd

I have to admit the long term vs short term effects confuse the hel1 out of me

What’s the calculation for #1?

someone want to show me how to get part 1. The assets market approach isn’t ringing a bell here.

C A - I’m never sure on this one…

Real GDP should decrease (reduction of money supply), currency appreciation (because of increased rate), current account deficit (import more than export). So A for that question. I can’t get the asset market approach to work. 108.74/1.05 = 104.58 104.58/(1.015/1.02)^2 = 105.61 105.61/102.29 - 1 =3.25% What gives?

You’re right on this one, though, Mumu. C&A are the ones.

I didn’t even bother using the whole process… they say the dude calculated the current spot as 102.29. Given the spot before that was 108.74…just calculate the difference 102.29 - 108.74 / 108.74 = 5.93%

You gotta be kidding me . . . we didn’t have to go through that process?

can u give me the explanation for the C answer for this question

Ok that makes sense. The incorrect answer 6.31% is if you’ve calculated (108.74 - 102.29) / 102.29.

I guess so… and Nibs 108.74/1.05 = 103.56 nevertheless…i can’t seem to get the 102.29 based on the asset market approach…don’t know how the fella in the question got it

Yea, I guess I wrote down some random number for that one . . . But, the way of getting the number (if we had to) is correct right? Assuming I wrote 103.56 instead of 104.58.

yes I believe so… someone please correct if we’re wrong…!

so actual numbers 103.56/((1.015/1.02)^2) = 104.58 thats where that number came from haha.