Question: Explain how a real effective exchange rate is calculated, in your answer explain how this differs from a nominal effective exchange rate. Under what circumstances

  1. Explain how a real effective exchange rate is calculated, in your answer explain how this differs from a nominal effective exchange rate. Under what circumstances might the REER be considered superior to the NEER, and under what circumstances may the NEER be considered more useful than the REER?
  2. The following rates of interest and exchange rates are prevailing within Australia and Canada:

Country

Interest Rates

Australia

5%

Canada

11%

Exchange Rate - (AUD/CAD) 0.7375-0.7425

  1. What are the key macro-economic factors that influence exchange rates?
  2. If uncovered interest rate parity theory holds, what will happen to the AUD/CAD exchange rate?
  3. Estimate the forward rate based on the current exchange rates and rates of interest.

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