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International Finance

10. Over the past year, China has experienced an inflation rate of about 17 percent, in contrast to U.S. inflation of about 2.5 percent. At the same time, the exchange rate has gone from Y8.7/U.S.$1 to Y8.2/U.S.$1.

a. What has happened to the real value of the yuan over the past year? Has it gone up or down? A little or a lot?

b. What are the likely effects of the change in the yuan's real value on the dollar profits of a company like Procter & Gamble that sells almost exclusively in the local market?

c. What are the likely effects of the change in the yuan's real value on the dollar profits of a textile manufacturer that exports most of its output to the United States? What can it do to cope with these effects?

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a. What has happened to the real value of the yuan over the past year? Has it gone up or down? A little or a lot?

ANSWER. The real value of the yuan, relative to its value one year ago, has risen significantly. Specifically, in dollar terms, the nominal exchange rate has appreciated from $0.1149 (1/8.7) to $0.1220 (1/8.2), a 6.1% increase ([0.1220 - 0.1149]/0.1149). In real terms, the yuan has appreciated to $0.1220 x 1.17/1.025 = $0.1392. Thus, the real value of the yuan has risen by 21.1%:

(0.1392 - 0.1149)/0.1149 = 21.1%

If purchasing power parity held, the yuan should have devalued to a new exchange rate of

e = 8.7 x 1.17/1.025 = Y9.93/$

You can tell this is the PPP rate ...

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$2.19