Suppose $1 = 10.5 pesos in New York and $1 = 9.6 pesos in Mexico City. Because of arbitrageurs, the exchange rate of E(peso/$) in New York will go ____ and, the rate in Mexico City will go _____. Question 5 Answer a. down; up. b. up; down. c. down; up. d. up; up.
Question
Suppose 1 = 9.6 pesos in Mexico City. Because of arbitrageurs, the exchange rate of E(peso/$) in New York will go ____ and, the rate in Mexico City will go _____. Question 5 Answer
a. down; up.
b. up; down.
c. down; up.
d. up; up.
Solution
The answer is a. down; up.
Here's why:
Arbitrageurs take advantage of price differences in different markets. In this case, they can buy pesos at a cheaper rate in Mexico City (where 1 = 10.5 pesos).
This will increase the demand for pesos in Mexico City (pushing the price up) and increase the supply of pesos in New York (pushing the price down). So, the exchange rate E(peso/$) in New York will go down and the rate in Mexico City will go up.
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