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UNIT THREE
International Finance: Enduring Issues
CHAPTER SIX
Balance of Payments and Foreign Exchange Markets
I. Fundamental Issues
1.
2.
3.
4.
5.
6.
7.
What is a country’s balance of payments, and what does this measure?
What is the role of foreign exchange markets in the global marketplace?
What is the spot foreign exchange market?
What is foreign exchange risk, and what is the role of forward foreign exchange markets?
What determines the value of a currency?
How are the spot and forward exchange markets related?
What other foreign exchange instruments are commonly traded?
II. Chapter Outline
1. Balance of Payments
a. Balance of Payments as a Double-Entry Bookkeeping System
b. Balance of Payments Accounts
c. Deficits and Surpluses in the Balance of Payments
d. Other Deficit and Surplus Measures
2. The Role of Foreign Exchange Markets in the Global Marketplace
a. How Foreign Exchange Rates and Foreign Exchange Markets Facilitate Global Transactions
b. How a Foreign Exchange Transaction is Conducted
c. What is the Foreign Exchange Market?
d. Online Globalization: Online Foreign Exchange Services
3. The Spot Market for Foreign Exchange
a. Exchange Rates as Relative Prices
b. Real Exchange Rates
c. Measuring the Overall Strength or Weakness of a Currency: Effective Exchange Rates
4. Foreign Exchange Risk and the Forward Market for Foreign Exchange
a. Foreign Exchange Risk
b. The Forward Market for Foreign Exchange
c. Covering a Transaction With a Forward Contract
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Chapter 6
5. Demand for and Supply of Currencies
a. Demand for a Currency
b. Visualizing Global Economic Issues: The Demand for the Euro
c. Supply of a Currency
d. Visualizing Global Economic Issues: The Dollar Demand-Euro Supply Relationship
e. The Equilibrium Exchange Rate
f. Visualizing Global Economic Issues:: The Equilibrium Exchange Rate
6. Relationship between the Spot Market and the Forward Market
a. The Forward Premium and Discount
b. The Standard Forward Premium
c. The Forward Rate and the Expected Future Spot Rate
7. Other Foreign Exchange Instruments
a. Foreign Exchange Derivatives
b. Common Foreign Exchange Derivatives
c. Management Notebook: Just How Widespread is the Use of Derivatives by U.S. Businesses?
8. Questions and Problems
III. Chapter in Perspective
The chapter introduces balance of payments accounts, and then covers the purpose of the foreign
exchange markets. The calculation of real and effective exchange rates is presented, and the
determination of the equilibrium exchange rate is introduced. The terms forward discount and premium
are introduced, and the uses of currency derivatives such as currency forward and futures contracts are
discussed.
IV. Teaching Notes
1. Balance of Payments
a. Balance of Payments as a Double-Entry Bookkeeping System
The balance of payments (BOP) accounts attempt to measure the value of flows in and out of a
country during a given time period. Every international transaction results in two entries (i.e.,
standard double-entry bookkeeping is employed). For example if a private resident of the U.S.
imports a computer assembled in Taiwan the value of the computer coming into the U.S. results
in one entry and the value of the payment for the computer going to Taiwan generates an
offsetting entry. Text Table 6-1 presents summary BOP data for the U.S. for 2001.
Teaching Tip:
Any transaction that results in money leaving the country (such as an import) will be entered as a
negative, or debt, in the appropriate balance of payments account. Similarly, any transaction that
results in money entering the country (such as an export) will be entered as a positive, or credit,
in the appropriate account.
Balance of Payments and Foreign Exchange Markets
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b. Balance of Payments Accounts
•
•
•
•
•
Current Account: The current account measures the flow of goods, services, income and
transfers between domestic residents, businesses, and governments and the rest of the world.
This is the “headline” account that is often mentioned in the media. It has the following
subcomponents:
– Merchandise balance (imports and exports of goods): –$426,615 million
The minus sign indicates the U.S. imported $426,615 more than it exported.
– Services balance (imports and exports of services): +$78,805 million
Notice that this component of the Current Account is in surplus, implying that the U.S.
exported more services than it imported.
– Balance on income (income received and income paid including dividends and interest
payments on assets): –$19,118 million
· Balance on goods, services and income = –$366,928 million
– Unilateral transfers: –$50,501 million
· Current account balance = Balance on goods, services and income + unilateral
transfers = –$417,429
Capital Account: The capital account measures the flows of financial assets between
domestic private residents and businesses and foreign private residents and businesses.
– U.S. private investments overseas: –$434,079 million
– Foreign private investment in the U.S. +$889,367 million
– Other: +$726 millions
· Capital account balance = +$456,014 million
Official Settlement Balance: measures transactions of official holdings of gold, foreign
currencies and other reserve assets by official government agencies.
– U.S. official reserves assets and other U.S. govt. assets held abroad: –$5484 million
– Foreign official assets in the U.S.: +$6,092 million
· Official Settlement Balance = +$608 million
Statistical Discrepancy: an account reflecting measurement error in all other accounts. The
statistical discrepancy is set to equal the negative of the sum of the current, capital and
official settlement balance and is assumed to be measurement error:
– Statistical discrepancy = –(–$417,429 + $456,014 + $608) = –$39,193
The Overall Balance of Payments: The overall balance is always zero and is equal to the sum
of the debt and credits in the current, capital, official settlement and statistical discrepancy
accounts.
c. Deficits and Surpluses in the Balance of Payments
If an individual account is in surplus, then the sum of the credit entries exceeds the sum of debit
entries in that account. If an account is in the deficit then this implies that transactions in that
category net the sum of the debit entries exceeds the sum of the credit entries. When the media
refers to a balance of payments deficit (surplus) they are probably indicating that the sum of the
current and capital accounts is in deficit (surplus).
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Chapter 6
d. Other Deficit and Surplus Measures
Individual BOP accounts may be in surplus (net money moving into the country), or in deficit
(net money leaving the country) due to transactions in that account. A current account deficit
implies that a country is importing more than it is exporting, or similarly its demand for funds for
consumption and investment is greater than its supply of funds. The excess funds demanded are
provided through the large capital account surplus. Because of the high current account deficit,
and the resulting capital account surplus, the U.S. has become a net debtor nation, one that owes
far more to foreigners on net than foreigners owe to the U.S.
Teaching Tip:
In recent years in the U.S., the current account has experienced very high deficits. Part of this is
due to the size of the U.S. economy. The account balances are normally standardized by dividing
the deficit or surplus by GDP. Recently the current account deficit has been over 4 percent of
GDP Nonetheless, analysis concludes that a deficit of this size is sustainable in the near term.
[See for instance, “Is the Large U.S. Current Account Deficit Sustainable?” J. Holman, Federal
Reserve Bank of Kansas City Economic Review, First Quarter 2001, pp. 5-23.] High current
account deficit levels imply a high level of borrowing from foreigners (or high asset sales to
foreigners). Eventually the terms of trade will likely deteriorate if the high deficit levels continue
resulting in either higher U.S. inflation, a lower value of the dollar and/or higher U.S. interest
rates. Better growth prospects in the U.S. than elsewhere, uncertainty over the Euro and
weaknesses in Japan and Asia have probably helped the U.S. maintain its large deficits with
favorable terms of trade so far. The logical conclusion is that the U.S. will not be able to continue
to consume more than it produces unless it can continue to generate more favorable growth
opportunities than other countries. Hence our standard of living has become very dependent on
relative growth of the U.S. and the rest of the world.
2. The Role of Foreign Exchange Markets in the Global Marketplace
a. How Foreign Exchange Rates and Foreign Exchange Markets Facilitate Global
Transactions
The major participants in the foreign exchange market are commercial banks, central banks,
foreign exchange brokers and multinational corporations. Foreign exchange trading supports
global trade in goods and services and financial assets, but the growth in foreign exchange
(hereafter FX) has been much more rapid than the growth in trade, primarily because FX markets
are also used extensively for speculation, capital raising and for hedging various international
risks. Most wholesale trades involve banks and financial earning assets denominated in a foreign
currency.
Balance of Payments and Foreign Exchange Markets
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b. How a Foreign Exchange Transaction is Conducted
A U.S. importer may contract to pay for an import in say Canadian dollars (C$) after delivery of
the goods is made. The U.S. firm may inform its bank of its desire to purchase Canadian dollars
or the firm may call a foreign exchange broker and have the broker search for the best rate at
various banks. Different banks may offer better rates because trading costs vary inversely with
dealer volume. For example, a buyer may find a better rate for the Swiss franc from UBS than
from Citicorp. Most international banks make a market in the major currencies. Dealers
maintain a bid and ask quote with a typical spread of 0.1 percent on active currencies. Brokers
charge a small commission as well. Note that using a broker will normally impose an additional
cost on the currency buyer or seller above the bid-ask spread. The typical currency transaction is
now in the range of $3,000,000 (or equivalent) per trade.
c. What is the Foreign Exchange Market?
Traditionally, trades have been conducted by telephone and telex, with banks comprising about
66 percent of trading and brokers accounting for about 20 percent. Foreign exchange trading is
increasingly being conducted online, and a few websites now offer trades to the public. The
company Opulent FX at http://www.forexmarketonline.com/site.htm offers accounts to the public
with minimums as low as $300. However, banks and brokers still dominate trading, only the
mechanism of trade execution has changed. The largest centers for FX trading are London,
followed by New York and Tokyo respectively. The FX market is basically a global, 24-hour
market.
d. Online Globalization: Online Foreign Exchange Services
For Critical Analysis: Do you think that online foreign exchange services like those
described above will have any impact on exchange rate prices and their volatility? Why or
why not?
The growth of online services may increase competition among dealers and result in lower
trading costs for customers. Generally, these services allow customers to more easily compare
rates, leading to a convergence of prices among dealers. As trading costs fall, trading tends to
increase and some economists believe that trading generates increased volatility. In deep markets
this is not necessarily true. Trading can also improve efficiency, because it is the actions of
traders that results in new information being incorporated into current prices.
3. The Spot Market for Foreign Exchange
The spot market is normally for delivery of a currency within two business days. Trades between the
Canadian dollar and the U.S. dollar may settle within one day. The bulk of foreign exchange trading
involves the dollar, followed by the euro and the yen. The volume of spot market trading is much
larger than forward trading.
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Chapter 6
a. Exchange Rates as Relative Prices
There are two prices involved in purchasing a foreign good or service: the price of the good and
the price of the currency. The nominal (quoted) exchange rate considers only one of those two
prices. An exchange rate may be thought of as an entry price to acquire a country’s goods,
services and financial assets. Foreign exchange rates may be quoted in two methods, the foreign
currency per domestic currency, say the U.S. dollar (e.g. ¥124 / $), or the domestic currency per
unit of foreign currency ($0.008065 / ¥). The two quotes are inverses of one another.
Teaching Tip:
It is very important to keep track of the quote method and keep the quote method correct when
dealing with parity equations, real exchange rates and supply/demand curves. It is also important
to put the currency quote in the correct form when dealing with currency appreciations and
depreciations.
Because most transactions involve the dollar, one may have to calculate cross rates if a firm is
interested in converting two currencies, neither of which is the dollar. For instance, if the Danish
Krone is trading at 7.5 Krone to the dollar and the British pound is trading at $1.58 to the pound,
what is the exchange rate between the Krone and the pound?
Set up the problem to cancel out the dollar:
Kr 7.5 / $1 * $1.58 / £ = Kr 11.85 / £ or inverting, £0.084 / Kr.
b. Real Exchange Rates
The quoted exchange rate is the nominal exchange rate and it accounts for only one of the two
prices involved in purchasing foreign goods, services or financial assets. The real exchange rate
is a bilateral exchange rate that has been adjusted for price changes that occurred in the two
nations. Hence, real exchange rates are relative price measures that measure relative purchasing
power in two different countries.
Teaching Tip:
Suppose that the exchange rate between the yen and the dollar is ¥125 / $. Also, the
price of a market basket of goods and services purchased in one year in the U.S. is $30,000 and
the price of the same market basket purchased in Japan is ¥4 million. Though the exchange rate
between dollars and yen is ¥125, the relative value of the market baskets purchased in the two
countries is not ¥125 per dollar. At the nominal exchange rate the Japanese market basket has an
equivalent dollar cost of ¥4 million / ¥125 / $ = $32,000, or $2,000 more than the similar market
basket in the U.S.
Balance of Payments and Foreign Exchange Markets
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c. Measuring the Overall Strength or Weakness of a Currency: Effective Exchange Rates
It is sometimes useful to calculate an “overall” value of a currency. Firms often calculate
effective exchange rates for their home currency against the value of the currencies of their major
trading partners. Effective exchange rates (EERs) are a weighted average measure of the value of
a currency relative to two or more other currencies. The currencies selected are called the
currency basket, and the weights are selected to reflect the relative importance of the currency in
the basket. EERs are index numbers that are calculated relative to a base year.
Teaching Tip:
Probably the most widely used EER in the U.S. is the trade-weighted value of the dollar.
Monthly values for this index are available from
http://woodrow.mpls.frb.fed.us/Research/data/us/charts/exc1.cfm.
4. Foreign Exchange Risk and the Forward Market for Foreign Exchange
a. Foreign Exchange Risk
Foreign exchange risk is the risk that arises when a firm’s economic value is affected by an
exchange rate change. There are three main types of FX exposure.
• Transaction Exposure: Transaction exposure is the risk that arises from a specific
transaction involving a foreign currency payment or receipt. Suppose an importer agrees to
purchase manufactured goods made in Singapore priced in the Singapore dollar (S$). The
importer does not wish to pay until the goods are received in the U.S. in about 90 days. The
importer may agree to obtain a letter of credit signifying that they have the funds available to
purchase the goods. Based upon the letter of credit, the Singaporean exporter agrees to ship
the goods. Once the contract is signed, the importer has a transaction exposure in the S$.
The importer is at risk from the U.S. dollar depreciating against the S$. Transaction
exposures are generally the easiest to hedge.
• Translation exposure: Translation is an accounting term that refers to the need to translate
foreign currency denominated assets and liabilities into the domestic currency. Translation
exposure refers to the risk that foreign currency denominated assets and liabilities (and
revenues and expenses) may have to be reported at different values on the balance sheet (or
income statement) if currency values change. If a firm has a net asset exposure (i.e., more
foreign currency denominated assets than liabilities), the translated value can be hurt by
falling foreign currency values. If the firm has a net liability exposure instead, rising foreign
currency exchange rates would hurt the value of the firm’s foreign position.
• Operating Exposure: Operating exposure refers to the changes in competitive conditions
that can occur when exchange rates change. Firms’ comparative advantages can be altered by
changing exchange rates. A foreign firm that incurs revenues in dollars and has its costs in
euros may enjoy a rising profit margin on U.S. sales if the dollar strengthens against the euro.
Competing U.S. based firms (who may have no foreign currency transaction exposure (and
thus think themselves insulated from currency changes) may then find themselves losing
market share to foreign firms.
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Chapter 6
•
Economic Exposure: Economic exposure is the broadest measure of exposure and this term
refers to changes in the present value of a firm’s future income stream as currency values
change. Note that the income stream itself may change as currency values fluctuate.
b. The Forward Market for Foreign Exchange
The forward market is the wholesale market for delivery of a currency beyond two working days,
although the price of the currency is set at the time the contract is enacted. Forward contracts are
negotiated with FX market participants, usually banks. Currencies are typically bought or sold
for delivery in one month, three months, six months and one year. Deals for delivery of a
currency beyond one year are unusual and will normally be more expensive. No cash changes
hands initially in a forward contract, although the bank may require collateral.
c. Covering a Transaction With a Forward Contract
Forward contracts are often used to hedge transaction exposures, such as the one discussed above
for the U.S. firm that had contracted to pay Singapore dollars in 90 days. The U.S. importer
could easily hedge this risk by buying the Singapore dollar forward. Whether the U.S. dollar
depreciates will then not matter to the importer since their firm has already locked in the U.S.$
value of the Singapore dollar.
5. Demand for and Supply of Currencies
a. Demand for a Currency
The demand for a currency is derived from the international demand for that country’s goods,
services and financial assets. The exchange rate follows the basic law of demand.
Teaching Tip:
Be careful how you quote the exchange rate when depicting supply and demand curves. The
quote should be per unit of currency depicted on the horizontal (quantity) axis of the supply and
demand curves.
Balance of Payments and Foreign Exchange Markets
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b. Visualizing Global Economics Issues: The Demand for the Euro
For Critical Analysis: Would an appreciation of the dollar relative to the euro always result
in a greater quantity demanded of euros? What role does the slope of the demand curve
play in determining the answer to this question?
An appreciation of the dollar relative to the euro would not result in a greater quantity demanded
of euros if the demand curve for the euro was perfectly inelastic or vertical. The more inelastic
(elastic) demand is, the smaller (greater) the change in quantity of euros demanded as the price of
the euro changes. Recall that the demand for the currency is a derived demand so the shape of the
curve is dependent upon the extent to which U.S. consumers’ desire for European goods and
services is sensitive to price.
c. Supply of a Currency
The supply of a currency is derived from domestic residents’ demand for the foreign country’s
goods, services and financial assets. Notice that the supply of one currency is the demand for the
other currency. To continue with the above example, in the critical analysis of the demand for the
euro, the U.S. demand for the Euro is the supply of the dollar offered for exchange with the euro.
d. Visualizing Global Economics Issues: The Dollar Demand-Euro Supply Relationship
For Critical analysis: How would you derive the supply curve for the U.S. dollar? What
factors would influence the demand for the U.S. dollar?
The supply curve for the U.S. dollar is the demand curve for the Euro (with the exchange rate
quote switched from €/$ to $/€. The European demand for the dollar will be influenced by the
relative attractiveness of U.S. goods and services relative to European goods and services.
Relative price, quality, tastes and income levels are all factors that will affect the demand. )See
also the discussion in e. below.)
e. The Equilibrium Exchange Rate
As always in a market situation, the interaction of supply and demand sets the price absent
government interference. The exchange rate is set where the quantity of currency demanded
equals the quantity supplied.
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Teaching Tip:
A brief discussion may be in order of some of the major determinants of exchange rates:
 Relative real interest rates: Higher real interest rates attract more capital and tend to raise FX
rates.
 Relative inflation rates: Lower relative inflation rates promote higher FX rates. In line with
this, strong, credible central banks that have a record of maintaining low inflation tend to be
associated with stronger currency values.
 Countries with sound fiscal policies and low levels of foreign currency denominated debt
tend to have stronger currencies.
 Relative economic strength: Countries with strong growth prospects tend to offer assets with
relatively higher rates of return that attract capital and result in strong currency values.
 Relatively low political and economic risk implies that a country’s investments will be valued
more highly in the global market and imply a higher currency value.
f.
Visualizing Global Economic Issues: The Equilibrium Exchange Rate
For Critical Analysis: What would happen to the equilibrium exchange rate of the yen if
the demand for the yen and the supply of the yen were to increase simultaneously?
The answer is indeterminate, as it depends on the relative increases in supply and demand. If
demand increased more (less) than supply, then the value of the yen would appreciate
(depreciate).
6. Relationship between the Spot Market and the Forward Market
a. The Forward Premium and Discount
The forward premium or discount is the difference between the forward exchange rate and the
spot exchange rate expressed as a percentage of the spot exchange rate.
b. The Standard Forward Premium
The standard forward premium is the forward premium or discount expressed on an annual basis.
Balance of Payments and Foreign Exchange Markets
61
c. The Forward Rate and the Expected Future Spot Rate
The forward exchange rate may contain information about the future spot rate. In other words,
the forward rate for time T (call it FN) is related to the expected future spot rate at time T (call it
S eN ).
A currency is trading at a forward premium if the forward rate implies a higher value for the
currency than the spot rate. Likewise, a currency is trading at a forward discount if the forward
rate implies a lower value for the currency than the spot rate.
Forward premiums and discounts may be standardized by annualizing without compounding the
percentage change implied by the difference in the forward and spot rates:
 100 where N is the number f the
Standard forward premium or discount = (FN – S)/ S  12
N
months forward.
7. Other Foreign Exchange Instruments
a. Foreign Exchange Derivatives
FX derivatives are contracts whose value is linked to or derived from other financial instruments.
Forward contracts are a form of derivative that is particularly useful in hedging, because the terms
are negotiated and can be tailored to offset the risk of specific spot positions that arise in the
course of business. Forwards however are not liquid and have significant counterparty risk.
Consequently, other instruments are often more useful for speculating in the major currencies.
b. Common Foreign Exchange Derivatives

Currency futures: Futures are a highly standardized, very liquid form of a forward contract.
The world’s largest current futures market is the Chicago Mercantile Exchange
(www.cme.com). If a party goes long (short) in a futures contract, he or she is committing to
buy (deliver) the foreign currency at a preset price at contract maturity. Other differences
between futures and forwards include:
– Forwards are usually for much larger currency amounts than futures contracts.
– Futures contracts recognize gains and losses daily as currency values change whereas
gains or losses on forward contracts are recognized only at maturity.
– Futures are highly liquid, and most futures participants never make or take delivery of a
foreign currency, whereas most forwards do result in making or taking delivery.
– Futures contracts are highly levered and there is no counterparty default risk so
participants can remain anonymous. This makes futures very suitable contracts for
speculation.
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

Currency options: Currency call (put) options provide the holder the right, but not the
obligation, to purchase (sell) the foreign currency at a preset price for a preset time period.
American style options can be exercised at anytime until the contract expires, and European
style options can only be exercised on the date of expiration. Some buyers prefer European
style options because they are cheaper.
Currency swaps: Swaps are sometimes likened to a series of forward contracts, for which
the forward rates are set according to some predetermined formula. Swaps are an exchange
of cash flow streams denominated in different currencies. These are complex, negotiated
contracts that can be tailored to meet a variety of purposes. They evolved from parallel loans
and often serve a similar purpose. A U.S. firm may earn euro revenues, which it has to
convert to dollars. Likewise, a French concern may be earning dollars from its American
subsidiary that it needs to convert to euros on an ongoing basis. The two could negotiate a
swap that avoids the exchange rate risk by swapping the U.S. firm’s euros for the French
firm’s American subsidiary’s dollars.
c. Management Notebook: Just How Widespread is the Use of Derivatives by U.S. Businesses?
For Critical Analysis: Why would larger firms be more likely to use foreign exchange
derivative instruments than smaller firms? Why would firms that use foreign exchange
derivatives hedge less than 100 percent of their perceived foreign exchange exposure?
Larger firms are more likely to have greater FX exposures. The bigger firms are also more likely
to have the expertise needed to handle these complex instruments and can call on the large banks
that deal in these instruments to assist them at fairly low cost because they are important
customers of the bank. It is rare to find firms that hedge 100 percent of their FX exposure.
Hedging involves the familiar risk-return tradeoff. The more a firm hedges the more likely it is to
reduce its overall rate of return. If a firm’s managers hedged all of its risks, the shareholders
could expect to earn the Treasury rate (and would assuredly fire the managers). Hedging is akin
to buying insurance, and all insurance has a cost. There are both out of pocket and opportunity
costs involved in hedging. Moreover, almost all managers are willing to take on some risks.
More simply, hedging strategies allow firms to tailor their desired risk-return tradeoff patterns
and there is no implication that 100 percent hedging strategy is optimal.
Balance of Payments and Foreign Exchange Markets
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8. Answers to End of Chapter Questions
1. The merchandise trade balance is $106 – $119 = –$13 (deficit). The balance on goods services and
income is $106 – $119 + $34 – $28 = –$7 (deficit). The current account is –$7 + $8 = 1 (surplus).
2. The euro depreciated by 1.07 percent {[(0.9805 – 0.9701) / 0.9701] * 100}.
3.
$
₤
Can$
€
—
0.7001
1.5433
1.0255
US$
1.4284
—
2.2044
1.4648
UK₤
0.6480
0.4536
—
0.6645
Can$
0.9751
0.6827
1.5049
—
euro
4. a. The euro depreciated 20 percent.
b. U.S. inflation was 4.91 percent [113.3 – 108.0) / 108.0] and euro-area inflation was 3.32 percent
[(108.8 – 105.3) / 105.3].
5. The real rate for 2003 was (0.90)(108.0 / 105.3) = 0.9231. The real rate for 2004 is
(1.08)(113.3 / 108.8) = 1.1247. This represents a real depreciation of 21.84 percent
[(1.1247 – 0.9231) / 0.9231].
6. The euro depreciated and the yen depreciated.
7. There is no way of knowing, based on this information alone, whether the euro appreciated or
depreciated against the yen. One would assume that the yen is a currency represented in the effective
exchange for the euro, and that the euro is represented in effective exchange rate for the yen. Without
knowing the weight of each, it is impossible to deduce to tell how the value of the euro changed
relative to the yen alone.
8. The baht is trading at a discount of 6.11 percent [(46.50 – 45.80) / 45.80 * (12/3) * 100].
9. a. As European savers purchase more Canadian assets, the demand for the Canadian dollar
increases, resulting in an appreciation of the Canadian dollar relative to the euro.
b. As European firms shift their business from Canadian firms to Russian firms, the demand for the
Canadian dollar decreases, resulting in a depreciation of the Canadian dollar relative to the euro.
10. Because one event results in an increase in demand while the other results in a decrease in demand,
there is no way of knowing what happened to the exchange rate and quantity transacted.
11. Because the peso is trading at a discount, one would expect the peso to depreciate. The forward
discount is equal to 7.69 percent [(57.29 – 53.20) / (53.20) * 100].