Exchange Rates and Asset
Returns – numerical example
Viktória Boršodiová
Viera - Anna Vahula
 Exchange
rates play a central role in international
trade because they allow us to compare the prices of
goods and services produced in different countries.
 An exchange rate can be quoted in two ways:
a) as the price of the foreign currency in terms of
dollars (for example, $0.01194 per yen)
b) or as the price of dollars in terms of the
foreign currency (for example, ¥83.77 per dollar)
In USA a handbag costs $54 and in Britain a pair of shoes
costs £70.
a) At an exchange rate of $1.50 per pound, what is the
price of a pair of shoes in terms of a handbag?
b) At an exchange rate $1.50 per pound, what is the price
of a handbag in terms of a pair of shoes?
c) All else equal, how does this relative price change if the
dollar depreciates to $1.25 per pound?
d) Compared with the initial situation, has a pair of shoes
become more or less expensive relative to a handbag?
Suppose the interest rate on a dollar deposit is 2%, the
interest rate on an euro deposit is 5%. The exchange rate
today is $1,32/€1. What should the expected rate look
like in a year if the exchange market is in equilibrium?