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Jamaican Dollar Exchange Rate Analysis

This document contains the answers to Problem Set 4 in an economics course. It first provides scenarios where the exchange rate between the Jamaican dollar and Guyanese dollar changes by 1-4% and asks to calculate the new exchange rates. It also asks to explain the reasons for the changes in a market diagram. It then asks whether a Guyanese businessman would invest in a 6% returning Jamaican asset or 4% returning Guyanese asset based on expected future exchange rates. It works through examples where the Jamaican dollar is expected to appreciate or depreciate against the Guyanese dollar.

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39 views1 page

Jamaican Dollar Exchange Rate Analysis

This document contains the answers to Problem Set 4 in an economics course. It first provides scenarios where the exchange rate between the Jamaican dollar and Guyanese dollar changes by 1-4% and asks to calculate the new exchange rates. It also asks to explain the reasons for the changes in a market diagram. It then asks whether a Guyanese businessman would invest in a 6% returning Jamaican asset or 4% returning Guyanese asset based on expected future exchange rates. It works through examples where the Jamaican dollar is expected to appreciate or depreciate against the Guyanese dollar.

Uploaded by

sandrae brown
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

ECON 20031

Problem Set 4 - Answers

1. Assume that JMD$ 1.00 = GYD $ 2.00. In each scenario below you are asked
to find the new value of the Jamaican Dollar (JMD). You will always start a new
calculation using the original exchange rate given above. Further, you are required
to arrive at a possible explanation for each change and illustrate same on a diagram
of the market for Jamaican Dollars. Note that GYD stands for Guyana Dollars.

(a) The JMD depreciates by 1%.


JMD$ 1.00 = GYD $ 1.98
(b) The JMD depreciates by 3%.
JMD$ 1.00 = GYD $ 1.94
(c) The JMD appreciates by 2%.
JMD$ 1.00 = GYD $ 2.04
(d) The JMD appreciates by 4%.
JMD$ 1.00 = GYD $ 2.08

NB: For a depreciation the demand for JMD could fall, or the supply of
JMD will rise. For an appreciation the demand for JMD will increase,
or the supply of JMD will fall. In each case the story will focus on one
of these.
2. A Guyanese businessman is contemplating investing his money in a Jamaican fi-
nancial asset which gives a return of 6%. A similar asset in Guyana gives a return
of 4%. Note that to invest in Jamaica the Guyanese businessman will have to buy
JMDs. He will then resell the JMDs for GYDs at the time the asset matures. Based
on the expectations of the value of the exchange rate at the maturity of said asset
you are required to say whether or not the businessman will invest in the asset. In
each case your calculations will be based on the initial exchange rate of JMD $1.00
= GYD $2.00. For simplicity, it has been assumed that the businessman is unable
to purchase foreign exchange on the forward market. You may, if needed, use a
simple interest approach and assume that the period of investment is one.
(a) The value of the JMD is expected to be GYD $2.06.
Since the JMD appreciates and the interest rate is greater in Jamaica
then clearly the businessman will invest in Jamaica. Note that 6%
return and a 3% appreciation yields an approximate return of 9% in
terms of GYD. To see how this is so JMD $100 (GYD $200) yields
JMD $106. And JMD $106 gives GYD $218.36 at the new exchange
rate, so in GYDs the businessman, having started our with GYD
$200 has earned approximately 9%.
(b) The value of the JMD is expected to be GYD $1.98.
The JMD depreciates by 1% so the businessman gets approximately
5% return on his GYD. He will still invest in Jamaica.
(c) The value of the JMD is expected to be GYD $1.90. The JMD depreciates
by 5% so the businessman gets approximately 1% return on his GYD.
He is better off investing his money in Guyana where he will get a
4% return.
1
Department
c of Economics, The University of the West Indies (Mona).

Common questions

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When the Jamaican Dollar appreciates by 3%, the businessman will invest in Jamaican financial assets. This is because the appreciation, combined with a higher interest rate of 6% in Jamaica compared to 4% in Guyana, offers a combined approximate return of 9% in terms of GYD, making it more profitable .

The inability to purchase foreign exchange on the forward market exposes the businessman to exchange rate risk, meaning he cannot lock in a future rate. This adds a level of uncertainty regarding the actual returns when converting JMD back to GYD after the investment matures .

To illustrate the 4% appreciation on a foreign exchange market diagram, one would show the demand curve for JMD shifting to the right or the supply curve shifting to the left, resulting in a new equilibrium point where the exchange rate increases from JMD $1.00 = GYD $2.00 to JMD $1.00 = GYD $2.08 .

The appreciation of the Jamaican Dollar by 4% to an exchange rate of JMD $1.00 = GYD $2.08 can result from an increase in demand for JMD or a decrease in its supply. An increase in JMD demand relative to its supply could lead to this appreciation .

A 2% appreciation of the Jamaican Dollar results in a new exchange rate of JMD $1.00 = GYD $2.04. This appreciation might be explained by an increased demand for the JMD or a decreased supply in the foreign exchange market .

The businessman expects a combined return of 9% if the JMD appreciates because the 6% interest rate on the Jamaican asset, combined with a 3% currency appreciation, effectively enhances his returns when converted back into GYD .

The businessman would decide not to invest in a Jamaican financial asset if the JMD is anticipated to depreciate by 5%, resulting in only a 1% return in terms of GYD. This return is less favorable than the 4% he could obtain from a similar investment in Guyana .

The depreciation of the Jamaican Dollar by 1% results in a new exchange rate of JMD $1.00 = GYD $1.98. A possible explanation for this depreciation is a decrease in demand for the JMD or an increase in its supply .

Despite a 1% depreciation of the JMD, it remains advantageous for the businessman to invest in Jamaican assets because he still receives an approximate 5% return in terms of GYD. This is better than the 4% return he would earn by investing in Guyana .

A decrease in the supply of JMD, which could lead to its appreciation, might be caused by factors such as a reduction in the money available for trade, increased use of Jamaican currency domestically, or governmental policies limiting currency availability for foreign exchange .

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