International Economics and Exchange Rate Calculations

Posted on Jun 19, 2026 in Business Administration and Management (BAM)

International Trade and Exchange Rates

Section A: Comparative Advantage

A1: Portugal and Italy

  • a) Relative prices:
    • Portugal wine: 4/2 = 2 pasta
    • Portugal pasta: 2/4 = 0.5 wine
    • Italy wine: 8/5 = 1.6 pasta
    • Italy pasta: 5/8 = 0.625 wine
  • b) Specialization:
    • Italy → wine (1.6 < 2, cheaper opportunity cost)
    • Portugal → pasta (0.5 < 0.625, cheaper opportunity cost)

A2: Belgium and Canada (Beer and Beef)

  • a) Absolute advantage: Belgium in BOTH (6 > 3 beer, 4 > 1 beef)
  • b) Relative prices:
    • Belgium beer: 4/6 = 0.67 beef
    • Belgium beef: 6/4 = 1.5 beer
    • Canada beer: 1/3 = 0.33 beef
    • Canada beef: 3/1 = 3 beer
  • c) Specialization:
    • Canada → beer (0.33 < 0.67)
    • Belgium → beef (1.5 < 3)

Section B: Exchange Rates and Trade Prices

B1: Sweater and Jeans Price Conversions

Initial conditions: Sweater = £60, Jeans = $40, Exchange Rate (E) = 1.50 $/£

  • a) Conversions:
    • Sweater in USD: 60 × 1.50 = $90
    • Jeans in GBP: 40 / 1.50 = £26.67
  • b) Relative price: 90 / 40 = 2.25 jeans per sweater
  • c) After depreciation (E = 1.80):
    • New sweater price: 60 × 1.80 = $108
    • New relative price: 108 / 40 = 2.7 jeans per sweater
    • The sweater became more expensive for Americans.

B2: Spanish Imports and Euro Depreciation

  • a) Prices in euros:
    • Computer: 1200 / 1.08 = €1,111.11
    • Backpack: 85 / 1.46 = €58.22
    • Watch: 150 / 0.95 = €157.89
  • b) Euro depreciates 10%:
    • New exchange rate: 1.08 × 0.90 = $0.972/€
    • New computer price: 1200 / 0.972 = €1,234.57
    • Difference: +€123.46 (more expensive)

B3: Italian Firm Export and Import Analysis

Initial conditions: Exports €500, Imports $300, Exchange Rate (E) shifts from 1.10 to 0.95

  • a) Dollar price of exports:
    • Before: 500 × 1.10 = $550
    • After: 500 × 0.95 = $475 (cheaper, more competitive)
  • b) Euro cost of imports:
    • Before: 300 / 1.10 = €272.73
    • After: 300 / 0.95 = €315.79 (€43 more expensive per unit)
  • c) Monthly profit:
    • Before (1,000 units): 500,000 − 272,730 = €227,270
    • After (1,150 units): 575,000 − 363,159 = €211,841
    • Difference: −€15,429 (profit dropped)
  • d) Conclusion: The depreciation hurts the firm because higher input costs are larger than the extra revenue earned from increased sales.

Section C: International Investment and Options

C1: Japanese Bonds in Australia

Initial conditions: ¥50M investment, 8% return, Exchange Rate shifts from 90 to 78 ¥/AUD

  • a) 50,000,000 / 90 = 555,555.56 AUD
  • b) 555,555.56 × 1.08 = 600,000 AUD
  • c) 600,000 × 78 = ¥46,800,000
  • d) ROI: (46.8M − 50M) / 50M × 100 = −6.4%. The AUD depreciated (90 → 78), so despite the 8% return, the company lost money due to exchange rate risk.

C2: Euro Fund Performance and Depreciation

Initial conditions: €20,000 fund, 15% return, Exchange Rate (E) shifts from 1.10 to 1.02 $/€

  • a) Values after 1 year:
    • In euros: 20,000 × 1.15 = €23,000
    • In dollars: 23,000 × 1.02 = $23,460
  • b) Effect of depreciation:
    • If exchange rate stayed at 1.10: 23,000 × 1.10 = $25,300
    • Loss due to depreciation: 25,300 − 23,460 = −$1,840
    • Depreciation decreased the dollar return.

C3: Iberdrola Put Option Analysis

Initial conditions: Put Option, 25M MXN, Strike 22, Spot 19

  • Decision: Spot 19 < Strike 22 → peso appreciated → let option expire, use spot market.
  • Calculation:
    • At spot (19): 25,000,000 / 19 = €1,315,789.47
    • At strike (22): 25,000,000 / 22 = €1,136,363.64
    • Net benefit: 1,315,789.47 − 1,136,363.64 − 10,000 = €169,425.83

Section D: Interest Rate Parity and Deposits

D1: Dollar vs. Euro Deposits

Initial conditions: Exchange Rate (E) shifts from 1.10 to 1.18, Interest rates: USD = 6%, EUR = 4%

  • a) Dollar is depreciating: (1.18 − 1.10) / 1.10 × 100 = 7.27% euro appreciation
  • b) Expected return on euro deposit (in USD): 4% + 7.27% = 11.27%
  • c) Preference: Euro deposit (11.27%) > Dollar deposit (6%) → prefer euros.
  • d) If E rises to 1.15 (expected stays 1.18):
    • (1.18 − 1.15) / 1.15 × 100 = 2.61%
    • New euro return: 4% + 2.61% = 6.61% → still above 6%, euros still preferred but only slightly.

D2: Dollar vs. Yen Depreciation Scenarios

Formula: Yen return = Interest rate of Yen (i¥) + expected dollar depreciation. (USD interest rate = 5%, Yen interest rate = 2%)

  • Case A (0%): 2% + 0% = 2% vs. Dollar 5% → Winner: Dollar.
  • Case B (3%): 2% + 3% = 5% vs. Dollar 5% → Equal (Interest Rate Parity holds).
  • Case C (6%): 2% + 6% = 8% vs. Dollar 5% → Winner: Yen.
  • Adjustment:
    • Case A → investors buy dollars, dollar appreciates, depreciation expectations rise until parity returns.
    • Case C → investors buy yen, dollar depreciates, depreciation expectations fall until parity returns.

Section E: Supply, Demand, and Trade Equilibrium

E1: Market Equilibrium and Imports

Equations: D = 300 − 20P, S = 60 + 40P, World Price (Pw) = 3

  • a) Equilibrium without trade (D=S):
    300 − 20P = 60 + 40P → 240 = 60P → Equilibrium Price (P*) = 4
  • b) With world price Pw = 3:
    • D(3): 300 − 20(3) = 240 units
    • S(3): 60 + 40(3) = 180 units
    • Imports: 240 − 180 = 60 units
  • c) Reason for imports: Home imports because Pw (3) < P* (4). At the lower world price, consumers demand more while producers supply less, so the difference is covered by imports.

Section F: Macroeconomic Questions and Answers

  • Why did interest rates go down? Because the European Central Bank (ECB) injected a lot of money into the economy. It is simple supply and demand: when there is suddenly a lot of money available, its “price” (which is the interest rate) drops.
  • Why did investors go to the US? Because they want to make more money. Since interest rates went down in Europe, investing here became less profitable. Investors moved their money to the US because American assets were offering higher interest rates and better returns.
  • Why did the euro lose value (depreciate) against the dollar? It is because of the investors moving their money. To invest in the US, European investors had to sell their euros and buy dollars. Because everyone was selling euros and wanting dollars, the value of the euro went down.
  • Is a weaker currency better for exports? Yes, it is! When the euro depreciates, European products become cheaper for people outside Europe (like Americans). Since our products are cheaper, we sell more abroad, which is great for exports. The only bad thing is that buying things from outside (imports, like oil) becomes more expensive.