Question

Chance Co., the parent of a US-based MNC, uses fundamental forecasting to estimate future values of exchange rates. Suppose that Chance Co. believes that movements in the value of the British (as measured by percentage change from the previous quarter), ebpebp , pound are dictated entirely by the inflation rate differential between the pound and the U.S. dollar in the previous quarter Infi . That is, the firm uses the following regression equation:
ebp = bo + b1 + Inf1 + μt

Where μt is the error term and bo is a constant.

Suppose that Chance Co. estimates bo to be 0.0 and b1 to be 0.6.

According to these estimates, which of the following is associated with a one unit increase in Inft?

a. A decrease in the value Of the pound by 0.6 percent
b. A decrease in the value Of the pound by 0.4 percent
c. An increase in the value Of the pound by 0.4 percent
d. An increase in the value of the pound by 0.6 percent

Answer 1

Answer:

d. An increase in the value of the pound by 0.6 percent

Explanation:

Given :

Regression equation :  $e_{bp}=b_0+b_1Inf_t+\mu_t$

Change company estimates that $b_0$ to be 0.0 and the value of $b_1$ to be 0.6.

Now, ebp = 0.6 x inf + μt     ----------------- $b_1=0.6$

When Inf = 1 (assume that the error term is 0)

ebp = 0.6 x 1 = 0.6

That is it is an increase in the value of pound by 0.6% with the one unit increase in the $Inf_t$.

Therefore, option (d) is correct.