CHAPTER 12EXCHANGE-RATE DETERMINATION

MULTIPLE CHOICE
1. The relationship between the exchange rate and the prices of tradable goods is known as the:
a
.
Purchasing-power-parity theory
b
.
Asset-markets theory
c
.
Monetary theory
d
.
alance-of-payments theory
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#. $f the exchange rate between "wiss francs and ritish pounds is % francs per pound& then the number of
pounds that can be obtained for #'' francs e(uals:
a
.
#' pounds
b
.
)' pounds
c
.
*' pounds
d
.
+' pounds
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,. -ow real interest rates in the .nited "tates tend to:
a
.
/ecrease the demand for dollars& causing the dollar to depreciate
b
.
/ecrease the demand for dollars& causing the dollar to appreciate
c
.
$ncrease the demand for dollars& causing the dollar to depreciate
d
.
$ncrease the demand for dollars& causing the dollar to appreciate
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). 0igh real interest rates in the .nited "tates tend to:
a
.
/ecrease the demand for dollars& causing the dollar to depreciate
b
.
/ecrease the demand for dollars& causing the dollar to appreciate
c
.
$ncrease the demand for dollars& causing the dollar to depreciate
d $ncrease the demand for dollars& causing the dollar to appreciate
.
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%. Assume that the .nited "tates faces an + percent inflation rate while no 12ero3 inflation exists in 4apan.
According to the purchasing-power parity theory& the dollar would be expected to:
a
.
Appreciate by + percent against the yen
b
.
/epreciate by + percent against the yen
c
.
5emain at its existing exchange rate
d
.
!one of the abo6e
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*. $n the presence of purchasing-power parity& if one dollar exchanges for # ritish pounds and if a 785
costs 9)'' in the .nited "tates& then in :reat ritain the 785 should cost:
a
.
#'' pounds
b
.
)'' pounds
c
.
*'' pounds
d
.
+'' pounds
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;. $f wheat costs 9) per bushel in the .nited "tates and # pounds per bushel in :reat ritain& then in the
presence of purchasing-power parity the exchange rate should be:
a
.
9.%' per pound
b
.
91.'' per pound
c
.
9#.'' per pound
d
.
9+.'' per pound
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+. A primary reason that explains the appreciation in the 6alue of the ..". dollar in the 1<+'s is:
a
.
-arge trade surpluses for the .nited "tates
b
.
5elati6ely high inflation rates in the .nited "tates
c
.
-ack of in6estor confidence in the ..". monetary policy
d
.
5elati6ely high interest rates in the .nited "tates
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<. The high foreign exchange 6alue of the ..". dollar in the early 1<+'s can best be explained by:
a
.
Additional in6estment funds made a6ailable from o6erseas
b
.
-ack of in6estor confidence in ..". fiscal policy
c
.
Market expectations of rising inflation in the .nited "tates
d
.
American tourists o6erseas finding costs increasing
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1'. =hen the price of foreign currency 1i.e.& the exchange rate3 is below the e(uilibrium le6el:
a
.
An excess demand for that currency exists in the foreign exchange market
b
.
An excess supply of that currency exists in the foreign exchange market
c
.
The demand for foreign exchange shifts outward to the right
d
.
The demand for foreign exchange shifts backward to the left
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11. =hen the price of foreign currency 1i.e.& the exchange rate3 is abo6e the e(uilibrium le6el:
a
.
An excess supply of that currency exists in the foreign exchange market
b
.
An excess demand for that currency exists in the foreign exchange market
c
.
The supply of foreign exchange shifts outward to the right
d
.
The supply of foreign exchange shifts backward to the left
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1#. The appreciation in the 6alue of the dollar in the early 1<+'s is explained by all of the following
except:
a
.
The .nited "tates being considered a safe ha6en by foreign in6estors
b 5elati6ely high real interest rates in the .nited "tates
.
c
.
8onfidence of foreign in6estors in the ..". economy
d
.
5elati6ely high inflation rates in the .nited "tates
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1,. "uppose Mexico and the .nited "tates were the only two countries in the world. There exists an excess
supply of pesos on the foreign exchange market. This suggests that:
a
.
Mexico>s current account is in surplus
b
.
Mexico>s current account is in deficit
c
.
The ..". current account is in deficit
d
.
The ..". current account is in e(uilibrium
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1). $f 8anada runs a trade surplus with Mexico and exchange rates are floating:
a
.
The peso will depreciate relati6e to the dollar
b
.
The dollar will depreciate relati6e to the peso
c
.
The prices of all foreign goods will fall for 8anadians
d
.
The prices of all foreign goods will rise for 8anadians
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1%. $f Mexico>s labor producti6ity rises relati6e to ?urope>s labor producti6ity:
a
.
The peso tends to depreciate against the euro in the short run
b
.
The peso tends to appreciate against the euro in the short run
c
.
The peso tends to depreciate against the euro in the long run
d
.
The peso tends to appreciate against the euro in the long run
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1*. The international exchange 6alue of the ..". dollar is determined by:
a
.
The rate of inflation in the .nited "tates
b
.
The number of dollars printed by the ..". go6ernment
c
.
The international demand and supply for dollars
d
.
The monetary 6alue of gold held at @ort Anox& Aentucky
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1;. @or the .nited "tates& suppose the annual interest rate on go6ernment securities e(uals + percent while
the annual inflation rate e(uals ) percent. @or 4apan& suppose the annual interest rate on go6ernment
securities e(uals 1' percent while the annual inflation rate e(uals ; percent. These 6ariables would
cause in6estment funds to flow from:
a
.
The .nited "tates to 4apan& causing the dollar to depreciate
b
.
The .nited "tates to 4apan& causing the dollar to appreciate
c
.
4apan to the .nited "tates& causing the yen to depreciate
d
.
4apan to the .nited "tates& causing the yen to appreciate
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1+. @or the .nited "tates& suppose the annual interest rate on go6ernment securities e(uals 1# percent
while the annual inflation rate e(uals + percent. @or 4apan& suppose the annual interest rate e(uals %
percent. These 6ariables would cause in6estment funds to flow from:
a
.
The .nited "tates to 4apan& causing the dollar to depreciate
b
.
The .nited "tates to 4apan& causing the dollar to appreciate
c
.
4apan to the .nited "tates& causing the yen to depreciate
d
.
4apan to the .nited "tates& causing the yen to appreciate
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1<. :i6en a system of floating exchange rates& stronger ..". preferences for imports would trigger:
a
.
An increase in the demand for imports and an increase in the demand for foreign
currency
b
.
An increase in the demand for imports and a decrease in the demand for foreign currency
c
.
A decrease in the demand for imports and an increase in the demand for foreign currency
d
.
A decrease in the demand for imports and a decrease in the demand for foreign currency
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#'. :i6en a system of floating exchange rates& weaker ..". preferences for imports would trigger:
a
.
An increase in the demand for imports and an increase in the demand for foreign
currency
b
.
An increase in the demand for imports and a decrease in the demand for foreign currency
c
.
A decrease in the demand for imports and an increase in the demand for foreign currency
d
.
A decrease in the demand for imports and a decrease in the demand for foreign currency
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#1. .nder a system of floating exchange rates& relati6ely low producti6ity and high inflation rates in the
.nited "tates result in:
a
.
An increase in the demand for foreign currency& a decrease in the supply of foreign
currency& and a depreciation in the dollar
b
.
An increase in the demand for foreign currency& an increase in the supply of foreign
currency& and an appreciation in the dollar
c
.
A decrease in the demand for foreign currency& a decrease in the supply of foreign
currency& and a depreciation in the dollar
d
.
A decrease in the demand for foreign currency& an increase in the supply of foreign
currency& and an appreciation in the dollar
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##. .nder a system of floating exchange rates& relati6ely high producti6ity and low inflation rates in the
.nited "tates result in:
a
.
An increase in the demand for foreign currency& a decrease in the supply of foreign
currency& and a depreciation in the dollar
b
.
An increase in the demand for foreign currency& an increase in the supply of foreign
currency& and an appreciation in the dollar
c
.
A decrease in the demand for foreign currency& a decrease in the supply of foreign
currency& and a depreciation in the dollar
d
.
A decrease in the demand for foreign currency& an increase in the supply of foreign
currency& and an appreciation in the dollar
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#,. =hich example of market expectations causes the dollar to appreciate against the yen--expectations
that the ..". economy will ha6e:
a
.
@aster economic growth than 4apan
b
.
0igher future interest rates than 4apan
c
.
More rapid money supply growth than 4apan
d
.
0igher inflation rates than 4apan
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#). =hich example of market expectations causes the dollar to depreciate against the yen--expectations
that the ..". economy will ha6e:
a
.
@aster economic growth than 4apan
b
.
0igher future interest rates than 4apan
c
.
-ess rapid money supply growth than 4apan
d
.
-ower inflation rates than 4apan
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#%. @or an American in6estor& the expected rate of return on ?uropean securities depends on all of the
following factors except the:
a
.
5ate of return on e(ui6alent American securities
b
.
The current exchange rate between the dollar and the pound
c
.
?xchange rate anticipated to pre6ail when the securities mature
d
.
$nterest rate paid on ?uropean securities
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#*. =hich of the following is likely to result in long-run depreciation of the ..". dollar relati6e to the
euroB
a
.
5elati6ely low interest rates in the .nited "tates
b
.
5elati6ely high labor producti6ity in the .nited "tates
c
.
Tariffs le6ied by the .nited "tates on steel imports from ?urope
d
.
"tronger American preferences for goods produced in ?urope
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#;. =hich of the following is likely to result in long-run appreciation of the ..". dollar relati6e to the
pesoB
a
.
5elati6ely high interest rates in Mexico
b
.
5elati6ely high labor producti6ity in Mexico
c
.
Tariffs applied by Mexico on computer imports from the .nited "tates
d
.
"tronger Mexican preferences for goods produced in the .nited "tates
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#+. -ong-run determinants of the dollar>s exchange 6alue include all of the following except:
a
.
Preferences of Americans for foreign produced goods
b
.
..". tariffs placed on imports of foreign produced goods
c
.
Producti6ity of the American worker
d
.
$nterest rates in ..". financial markets
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#<. =hich theory of exchange-rate determination best 6iews the foreign exchange market as being similar
to a stock exchange where future expectations are important and prices are 6olatileB
a
.
alance-of-payments approach
b
.
Purchasing-power-parity approach
c
.
Asset-markets approach
d
.
Monetary approach
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,'. According to the purchasing-power-parity theory& the ..". dollar maintains its purchasing-power parity
if it depreciates by an amount e(ual to the excess of:
a
.
..". interest rates o6er foreign interest rates
b
.
@oreign interest rates o6er ..". interest rates
c
.
..". inflation o6er foreign inflation
d
.
@oreign inflation o6er ..". inflation
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,1. An exchange rate is said to CCCC when its short-run response to a change in market fundamentals is
greater than its long-run response.
a
.
D6ershoot
b .ndershoot
.
c
.
/epreciate
d
.
Appreciate
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,#. 8oncerning exchange rate forecasting& CCCC is a common sense approach based on a wide array of
political and economic data.
a
.
?conometric analysis
b
.
Technical analysis
c
.
4udgmental analysis
d
.
"unspot analysis
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,,. 8oncerning exchange rate forecasting& CCCC in6ol6es the use of historical exchange rate data to
estimate future 6alues& while ignoring the economic determinants of exchange rate mo6ements.
a
.
?conometric analysis
b
.
4udgmental analysis
c
.
Technical analysis
d
.
"unspot analysis
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,). 8oncerning exchange rate forecasting& CCCC relies on econometric models which are based on
macroeconomic 6ariables likely to affect currency 6alues.
a
.
@undamental analysis
b
.
Technical analysis
c
.
4udgmental analysis
d
.
"unspot analysis
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,%. 8oncerning exchange-rate determination& Emarket fundamentalsE include all of the following except:
a
.
Monetary policy and fiscal policy
b
.
Profitability and riskiness of in6estments
c
.
"peculati6e opinion about future exchange rates
d
.
Producti6ity changes affecting production costs
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,*. $n the short run& exchange rates respond to market forces such as:
a
.
$nflation rates
b
.
?xpectations of future exchange rates
c
.
$n6estment profitability
d
.
:o6ernment trade policy
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,;. -ong-run exchange rate mo6ements are go6erned by all of the following except:
a
.
!ational producti6ity le6els
b
.
8onsumer tastes and preferences
c
.
5ates of inflation
d
.
$nterest rate le6els
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,+. ?xchange rate determination in the short run is underlied by which of the following assumptions:
a
.
Tariffs and (uotas affect trade patterns only in the short run
b
.
Prices of goods and ser6ices affect trade patterns only in the short run
c
.
?xpected returns on financial assets affect in6estment flows in the short run
d
.
Preferences for goods and ser6ices affect trade flows only in the short run
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,<. That identical goods should cost the same in all nations& assuming it is costless to ship goods between
nations and there are no barriers to trade& is a reflection of the:
a
.
Monetary approach to exchange-rate determination
b
.
-aw of one price
c
.
@undamentalist approach to exchange-rate determination
d
.
?xchange-rate-o6ershooting principle
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)'. The 8anadian dollar would depreciate on the foreign exchange market if:
a
.
8anadian consumer tastes change in fa6or of goods produced domestically
b
.
The profitability of assets in 8anada rises relati6e to the profitability of assets abroad
c
.
8anada experiences a disastrous wheat-crop failure& leading to imports of more wheat
d
.
8anada reali2es technological impro6ements in the production of manufactured goods&
leading to relati6ely low costs for 8anada
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)1. The demand in the .nited "tates for yen will increase if& other things remaining e(ual:
a
.
-abor costs rise in 4apan
b
.
$ncome rises in 4apan
c
.
Prices rise in 4apan
d
.
$nterest rates rise in 4apan
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)#. The (uantity of 8anadian dollars supplied to the foreign exchange market would increase if& other
things remaining e(ual:
a
.
Preferences for imports rise in 8anada
b
.
-abor producti6ity increases in 8anada
c
.
Prices of goods and ser6ices decrease in 8anada
d
.
$mport tariffs rise in 8anada
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),. The ..". demand for pesos would shift to the right if there occurred a 1an3:
a
.
8hange in preferences toward ..". manufactured goods
b
.
$ncrease in the dollarFpeso exchange rate
c
.
/ecrease in the ..". population
d
.
$ncrease in the ..". price le6el
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)). The supply of francs& would shift to the right for all of the following reasons except:
a
.
An increase in "wiss real income
b
.
An increase in "wiss prices
c
.
An increase in the "wiss population
d
.
An increase in "wiss interest rates
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The figure below illustrates the supply and demand schedules of Swiss francs in a market of freely-
floating exchange rates.
Figure 12.1 The Marke !"r Fra#$%
)%. 5efer to @igure 1#.1. "hould preferences for imports rise in the .nited "tates and fall in "wit2erland&
there would occur a 1an3:
a
.
$ncrease in the demand for francs--decrease in the supply of francs-depreciation of the
dollar
b
.
$ncrease in the demand for francs--decrease in the supply of francs-appreciation of the
dollar
c
.
/ecrease in the demand for francs--decrease in the supply of francs-appreciation of the
dollar
d
.
/ecrease in the demand for francs--increase in the supply of francs-depreciation of the
dollar
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)*. 5efer to @igure 1#.1. "hould real interest rates in the .nited "tates rise relati6e to real interest rates in
"wit2erland& there would occur a 1an3:
a
.
$ncrease in the demand for francs--decrease in the supply of francs-depreciation of the
dollar
b
.
$ncrease in the demand for francs--decrease in the supply of francs-appreciation of the
dollar
c
.
/ecrease in the demand for francs--increase in the supply of francs-appreciation of the
dollar
d
.
/ecrease in the demand for francs--decrease in the supply of francs-depreciation of the
dollar
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);. 5efer to @igure 1#.1. "hould the ..". price le6el rise relati6e to the "wiss price le6el& there would
occur a 1an3:
a
.
$ncrease in the demand for francs--increase in the supply of francs-appreciation of the
dollar
b
.
/ecrease in the demand for francs--decrease in the supply of francs-depreciation of the
dollar
c
.
$ncrease in the supply of francs--decrease in the demand for francs-appreciation of the
dollar
d
.
/ecrease in the supply of francs--increase in the demand for francs-depreciation of the
dollar
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)+. 5efer to @igure 1#.1. "hould the .nited "tates impose tariffs on imports from "wit2erland& there would
occur a 1an3:
a
.
$ncrease in the demand for francs and a depreciation of the dollar
b
.
/ecrease in the demand for francs and an appreciation of the dollar
c
.
/ecrease in the supply of francs and an appreciation of the dollar
d
.
$ncrease in the supply of francs and a depreciation of the dollar
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)<. 5efer to @igure 1#.1. "hould "wiss labor producti6ity rise& leading to a decrease in "wiss
manufacturing costs& there would occur a 1an3:
a
.
$ncrease in the supply of francs and a depreciation of the dollar
b
.
$ncrease in the supply of francs and an appreciation of the dollar
c
.
/ecrease in the demand for francs and an appreciation of the dollar
d
.
$ncrease in the demand for francs and a depreciation of the dollar
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%'. 5efer to @igure 1#.1. $f "wit2erland experienced a disastrous wheat-crop failure& leading to additional
wheat imports from the .nited "tates& there would occur an:
a
.
$ncrease in the supply of francs and an appreciation of the dollar
b
.
$ncrease in the supply of francs and a depreciation of the dollar
c
.
$ncrease in the demand for francs and a depreciation of the dollar
d
.
$ncrease in the demand for francs and an appreciation of the dollar
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%1. :i6en floating exchange rates& if 4apan increases its demand for 8anadian goods at the same time that
8anada increases its demand for 4apanese goods& then we would expect the yen>s exchange 6alue to:
a
.
Appreciate against the dollar
b
.
/epreciate against the dollar
c
.
5emain constant against the dollar
d
.
Appreciate& depreciate& or remain constant against the dollar
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%#. :i6en floating exchange rates& assume that the "wiss decrease their import purchases from $taly while
at the same time the $talians increase their purchases of "wiss go6ernment securities. The first action
by itself would lead to a 1an3 CCCC of the franc against the lira while the second action by itself would
lead to a 1an3 CCCC of the franc against the lira.
a
.
Appreciation& appreciation
b
.
/epreciation& depreciation
c
.
Appreciation& depreciation
d
.
/epreciation& appreciation
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%,. :i6en floating exchange rates& a simultaneous decrease in the 8anadian demand for ritish products
and increase in the ritish desire to in6est in 8anadian go6ernment securities would cause a 1an3:
a
.
Appreciation of the pound against the dollar
b
.
/epreciation of the pound against the dollar
c
.
.nchanged poundFdollar exchange rate
d
.
!one of the abo6e
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%). Assume a system of floating exchange rates. /ue to a high sa6ings rate& suppose the le6el of sa6ings in
4apan is in excess of domestic in6estment needs. $f 4apanese residents in6est abroad& the yen>s
exchange 6alue will CCCC and the 4apanese trade balance will mo6e toward CCCC.
a
.
Appreciate& deficit
b
.
Appreciate& surplus
c
.
/epreciate& deficit
d
.
/epreciate& surplus
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%%. :i6en a system of floating exchange rates& assume that oeing $nc. of the .nited "tates places a large
order& payable in yen& with a 4apanese contractor for Get engine parts. The immediate effect of this
transaction will be a shift in the:
a
.
"upply cur6e of yen to the left which causes the dollar to appreciate against the yen
b
.
"upply cur6e of yen to the right which causes the dollar to depreciate against the yen
c
.
/emand cur6e for yen to the left which causes the dollar to appreciate against the yen
d
.
/emand cur6e for yen to the right which causes the dollar to depreciate against the yen
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%*. @or purchasing-power parity to exist:
a
.
@lows of currency in the trade account must be offset by flows of currency in the capital
account
b
.
The nominal interest rate must be e(ual to the real interest rate in all countries
c
.
8on6erting a sum of funds from one currency to another does not alter its purchasing
power
d
.
A country>s trade account must always be in balance
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%;. Assume that interest rates in the .nited "tates and ritain are the same. $f a ..". resident anticipates
that the exchange 6alue of the dollar is going to appreciate against the pound& she should:
a
.
orrow needed funds from ritish banks rather than ..". banks
b
.
orrow needed funds from ..". banks rather than ritish banks
c
.
8on6ert ..". dollars into ritish pounds
d
.
Any of the abo6e
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%+. :i6en a system of floating exchange rates& if 8anada>s labor producti6ity rises relati6e to the labor
producti6ity of its trading partners:
a
.
8anadian imports will fall and the dollar will appreciate
b
.
8anadian imports will fall and the dollar will depreciate
c
.
8anadian imports will rise and the dollar will appreciate
d
.
8anadian imports will rise and the dollar will depreciate
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%<. Assume that labor producti6ity growth is slower in the .nited "tates than in its trading partners. :i6en
a system of floating exchange rates& the impact of this growth differential for the .nited "tates will be:
a
.
$ncreased exports and an appreciation of the dollar
b
.
$ncreased exports and a depreciation of the dollar
c
.
$ncreased imports and an appreciation of the dollar
d
.
$ncreased imports and a depreciation of the dollar
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*'. "uppose the exchange rate between the ..". dollar and the 4apanese yen is initially <' yen per dollar.
According to purchasing-power parity& if the price of traded goods rises by 1' percent in the .nited
"tates and remains constant in 4apan& the exchange rate will become
a
.
;# yen per dollar
b
.
+1 yen per dollar
c
.
<< yen per dollar
d
.
1'+ yen per dollar
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*1. "uppose the exchange rate between the ..". dollar and the 4apanese yen is initially <' yen per dollar.
According to purchasing-power parity& if the price of traded goods rises by % percent in the .nited
"tates and 1% percent in 4apan& the exchange rate will become:
a
.
;# yen per dollar
b
.
+1 yen per dollar
c
.
<< yen per dollar
d
.
1'+ yen per dollar
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*#. "uppose the exchange rate between the ..". dollar and the 4apanese yen is initially <' yen per dollar.
According to purchasing power parity& if the price of traded goods falls by % percent in the .nited
"tates and rises by % percent in 4apan& the exchange rate will become:
a
.
;# yen per dollar
b
.
+1 yen per dollar
c
.
<< yen per dollar
d
.
1'+ yen per dollar
A!": PT": 1
*,. "uppose that the yen-dollar exchange rate changes from +% yen per dollar to +' yen per dollar. Dne can
say that the:
a
.
Hen has appreciated against the dollar and the dollar has depreciated against the yen
b
.
Hen has depreciated against the dollar and the dollar has appreciated against the yen
c
.
Hen has appreciated against the dollar and the dollar has appreciated against the yen
d
.
Hen has depreciated against the dollar and the dollar has depreciated against the yen
A!": A PT": 1
*). :i6en a floating exchange rate system an increase in CCCC would cause the dollar to appreciate against
the euro.
a
.
..". labor costs
b
.
The ..". money supply
c
.
..". prices of goods
d
.
..". real interest rates
A!": / PT": 1
*%. .nder a system of floating exchange rates& a 4apanese trade surplus against 8anada would result in a
1an3:
a
.
5ise in the dollar price of the yen
b
.
@all in the dollar price of the yen
c
.
5ise in the yen price of the dollar
d
.
.nchanged dollarFyen exchange rate
A!": A PT": 1
**. =hen deciding between ..". and ritish go6ernment securities& an American in6estor typically
considers:
a
.
..". and ritish interest rates and anticipated changes in the exchange rate
b
.
udget deficits of the ..". go6ernment and ritish go6ernment
c
.
"hifts in the demand for ..". goods and ritish goods
d
.
..". and ritish inflation rates and anticipated changes in the exchange rate
A!": A PT": 1
*;. $n the long run& exchange rates are primarily determined by:
a Agreements among go6ernments of the world>s industrial countries
.
b
.
5elati6e interest rates in de6eloping countries and industrial countries
c
.
?conomic fundamentals such as relati6e producti6ity le6els
d
.
The rate at which country>s currencies exchange for gold
A!": 8 PT": 1
*+. $ncreased tariffs on ..". steel imports cause the dollar to CCCC in the CCCC.
a
.
Appreciate& long run
b
.
/epreciate& long run
c
.
Appreciate& short run
d
.
/epreciate& short run
A!": A PT": 1
*<. -ower tariffs on ..". agricultural imports cause the dollar to CCCC in the CCCC.
a
.
Appreciate& long run
b
.
/epreciate& long run
c
.
Appreciate& short run
d
.
/epreciate& short run
A!": PT": 1
;'. 5elati6ely high interest rates in the .nited "tates causes the dollar to CCCC in the CCCC.
a
.
Appreciate& long run
b
.
/epreciate& long run
c
.
Appreciate& short run
d
.
/epreciate& short run
A!": 8 PT": 1
;1. The asset market theory of exchange rate determination suggests that the most important factor
influencing the demand for domestic and foreign securities is:
a
.
?xpected return on these assets relati6e to one another
b
.
Ability of these assets to easily be con6erted into cash
c
.
5iskiness of these assets relati6e to one another
d
.
-e6el of go6ernment restrictions on trade and in6estment flows
A!": A PT": 1
;#. =ith floating exchange rates& easy credit and low short term interest rates lead to
a
.
?xchange rate depreciation in the short run
b
.
?xchange rate appreciation in the short run
c
.
?xchange rate depreciation in the long run
d
.
?xchange rate appreciation in the long run
A!": A PT": 1
;,. =ith floating exchange rates& relati6ely high producti6ity growth for a nation leads to
a
.
?xchange rate depreciation in the short run
b
.
?xchange rate appreciation in the short run
c
.
?xchange rate depreciation in the long run
d
.
?xchange rate appreciation in the long run
A!": / PT": 1
;). All of the following are important long-run determinants of exchange rates except
a
.
8onsumer tastes
b
.
Trade policy
c
.
-abor producti6ity
d
.
$nterest rates
A!": / PT": 1
;%. The purchasing-power parity theory suffers from the problem
a
.
Df choosing the appropriate price index
b
.
That it o6erlooks the influence of capital flows
c
.
That go6ernment policy may modify exchange rates
d
.
All of the abo6e
A!": / PT": 1
TRUE&FAL'E
1. $n a free market& exchange rates are determined by market fundamentals and market expectations.
A!": T PT": 1
#. 8oncerning exchange-rate determination& market fundamentals include inflation rates& producti6ity
le6els& and speculati6e opinion about future exchange rates.
A!": @ PT": 1
,. Market expectations include news about market fundamentals& speculati6e opinion about future
exchange rates& and profitability and riskiness of in6estments.
A!": T PT": 1
). $n a free market& the e(uilibrium exchange rate occurs at the point where the (uantity demanded of a
foreign currency e(uals the (uantity of that currency supplied.
A!": T PT": 1
%. ?xchange rates are determined by the unregulated forces of supply and demand for foreign currencies
as long as central banks do not inter6ene in the foreign exchange markets.
A!": T PT": 1
*. D6er the long run& foreign exchange rates are determined by transfers of bank deposits that respond to
differences in real interest rates and to shifting expectations of future exchange rates.
A!": @ PT": 1
The figure below illustrates the supply and demand schedules of Swiss francs under a system of
floating exchange rates.
Figure 12.2. The Marke !"r '(i%% Fra#$%
;. 5efer to @igure 1#.#. $f the .nited "tates decreases tariffs on imports from "wit2erland& there would
occur a decrease in the demand for francs and a decrease in the dollar price of the franc.
A!": @ PT": 1
+. 5efer to @igure 1#.#. $f "wiss manufacturing costs increase relati6e to those of the .nited "tates& there
would occur an increase in the supply of francs and an appreciation in the dollar>s exchange 6alue.
A!": T PT": 1
<. 5efer to @igure 1#.#. $f the @ederal 5eser6e adopts a restricti6e monetary policy that leads to relati6ely
high interest rates in the .nited "tates& the demand for francs would decrease& the supply of francs
would increase& and the dollar>s exchange 6alue would appreciate.
A!": T PT": 1
1'. 5efer to @igure 1#.#. As the profitability of assets in "wit2erland rises relati6e to the profitability of
assets in the .nited "tates& ..". residents make additional in6estments in "wit2erlandI this leads to an
increased demand for francs and a depreciation of the dollar>s exchange 6alue.
A!": T PT": 1
11. 5efer to @igure 1#.#. $f the rate of inflation in the .nited "tates is higher than the rate of inflation in
"wit2erland& the demand for francs decreases& the supply of francs increases& and the dollar>s exchange
6alue appreciates.
A!": @ PT": 1
1#. .nder floating exchange rates& short-run exchange rates are primarily determined by national
differences in real interest rates and shifting expectations of future exchange rates.
A!": T PT": 1
1,. /ay-to-day influences on foreign exchange rates always cause rates to mo6e in the same direction as
changes in long-term market fundamentals.
A!": @ PT": 1
1). =ith floating exchange rates& a country experiencing faster economic growth than its trading partners
find its currency>s exchange 6alue appreciating.
A!": @ PT": 1
1%. $f ..". labor producti6ity growth is # percent per annum and "wiss labor producti6ity growth is *
percent per annum& the dollar will depreciate against the franc under a system of floating exchange
rates.
A!": T PT": 1
1*. $n 1<+% and 1<+* ..". interest rates fell relati6e to interest rates in 4apan. .nder floating exchange
rates& this would lead to the dollar>s exchange 6alue depreciating against the yen.
A!": T PT": 1
1;. A country ha6ing stronger preferences for imports than its trading partners ha6e for its exports finds its
demand for foreign exchange rising more rapidly than its supply of foreign exchange.
A!": T PT": 1
1+. ?conomies with relati6ely high growth rates in labor producti6ity tend to find their currencies>
exchange 6alues appreciating under a floating exchange-rate system.
A!": T PT": 1
1<. .nder floating exchange rates& relati6ely low domestic interest rates tend to promote depreciation of a
currency>s exchange 6alue while relati6ely high domestic interest rates lead to currency appreciation.
A!": T PT": 1
#'. "uppose expansionary monetary policy in the .nited "tates leads to interest rates falling to # percent
while tight monetary policy in "wit2erland leads to interest rates rising to + percent. =ith floating
exchange rates& the dollar would appreciate against the franc.
A!": @ PT": 1
#1. The purchasing-power-parity theory is used to predict exchange-rate mo6ements in the short run.
A!": @ PT": 1
##. According to the law of one price& identical goods should cost the same in all nations& assuming there
are no shipping costs nor trade barriers.
A!": T PT": 1
#,. The purchasing- power-parity theory predicts that if the ..". inflation rate exceeds the 4apanese
inflation rate by ) percent& the dollar>s exchange 6alue will appreciate by ) percent against the yen.
A!": @ PT": 1
#). Assume the initial yenFdollar exchange rate to be 1'' yen per dollar. $f the ..". inflation rate is #
percent and the 4apanese inflation rate is ; percent& the exchange rate should mo6e to 1'% yen per
dollar according to the purchasing-power-parity theory.
A!": @ PT": 1
#%. Assume the initial dollarFpound exchange rate to be 9# per pound. $f the ..". inflation rate is + percent
and the ..A. inflation rate is , percent& the exchange rate should mo6e to 9#.1' per pound according to
the purchasing-power-parity theory.
A!": T PT": 1
#*. $f consumer tastes in the .nited "tates change in fa6or of goods produced in @rance& the demand for
francs will increase which causes an appreciation of the dollar against the franc under a floating
exchange rate system.
A!": @ PT": 1
#;. As the profitability of 4apanese assets rises relati6e to the profitability of Australian assets& Australian
residents will make additional in6estments in 4apanI this results in an increased demand for yen and a
depreciation of the dollar under a system of floating exchange rates.
A!": T PT": 1
#+. $f the .nited "tates experiences an enormous wheat crop failure& it will ha6e to import more wheat and
the dollar>s exchange 6alue will depreciate under a system of floating exchange rates.
A!": T PT": 1
#<. $f 4apan reali2es technological impro6ements in the production of automobiles& which lowers its
production costs relati6e to foreign producers& 4apanese exports will rise and the yen>s exchange 6alue
will appreciate under a system of floating exchange rates.
A!": T PT": 1
,'. $f Mexico applies tariffs to imports of manufactured goods& Mexico>s demand for foreign exchange
will rise and the peso will depreciate under a system of floating exchange rates.
A!": @ PT": 1
,1. According to the Eig MacE index& if a ig Mac costs 9#.#+ in the .nited "tates and #%.;% krone in
/enmark 1e(ui6alent to 9).#%3& the /anish krone is an under6alued currency.
A!": @ PT": 1
,#. According to the Eig MacE index& if a ig Mac costs 9#.#+ in the .nited "tates and )+ baht in
Thailand 1e(ui6alent to 91.<13& the baht is an under6alued currency.
A!": T PT": 1
,,. -ong-run determinants of exchange rate include labor producti6ity le6els& inflation rates& consumer
preferences for goods and ser6ices& and trade barriers.
A!": T PT": 1
,). $n the short run& exchange rates are primarily determined by in6estor expectations of returns on assets
such as go6ernment securities and bank accounts.
A!": T PT": 1
,%. 8hanges in market expectations ha6e their greatest impact on exchange-rate changes o6er the long run
as opposed to the short run.
A!": @ PT": 1
,*. $f it is widely expected that the ritish economy will experience more rapid inflation than the
Australian economy& the pound will depreciate against the dollar under a system of floating exchange
rates.
A!": T PT": 1
,;. According to the asset-markets approach& adGustments among financial assets are a key determinant of
long-run mo6ements in exchange rates.
A!": @ PT": 1
,+. The asset-markets approach 6iews exchange-rate determination as similar to the stock market in which
prices are 6olatile and expectations are important.
A!": T PT": 1
,<. According to the principle of exchange-rate o6ershooting& a short-run depreciation of a currency is
likely to be greater than a long-run depreciation of that currency.
A!": T PT": 1
)'. ?xchange-rate o6ershooting is based on the notion that the supply schedule of a currency is more
elastic in the short run than in the long run.
A!": @ PT": 1
)1. According to exchange-rate o6ershooting& an appreciation of the Australian dollar is likely to be
greater o6er a long time period than o6er a short time period.
A!": @ PT": 1
)#. 8oncerning exchange rate forecasting& fundamental analysis in6ol6es consideration of a 6ariety of
macroeconomic 6ariables and policies that tend to affect currency 6alues.
A!": T PT": 1
),. ?conometric models are best suited for forecasting long-run exchange rates rather than short-run
exchange rates.
A!": @ PT": 1
)). 8oncerning exchange rate forecasting& technical analysis extrapolates from past exchange-rate trends
while ignoring economic and political determinants of exchange rates.
A!": T PT": 1
)%. :i6en an efficient foreign exchange market& the spot rate is the rational approximation of the markets
expectation of the forward rate that will exist at the end of the forward period.
A!": @ PT": 1
)*. A forward premium on the ritish pound ser6es as a rough benchmark of the expected rate of
appreciation in the pound>s spot rate.
A!": T PT": 1
);. A forward discount on Mexico>s peso ser6es as a rough benchmark of the expected appreciation in the
peso>s spot rate.
A!": @ PT": 1
)+. $f you were considering hiring a forecasting firm to predict future spot rates of the yen& you would
hope that the firm could predict better what would be implied by the yen>s forward rate.
A!": T PT": 1
)<. Although the law of one price predicts that identical goods should cost the same in all nations&
transportation costs and tariffs tend to pre6ent this prediction from actually occurring.
A!": T PT": 1
%'. $f real interest rates decline in the .nited "tates relati6e to real interest rates abroad& the dollar>s
exchange 6alue will appreciate under a floating exchange-rate system.
A!": @ PT": 1
'HORT AN')ER
1. =hat is the purchasing power parity approach to exchange rate determinationB
A!":
The purchasing power parity approach asserts that changes in relati6e national price le6els determine
changes in exchange rates o6er the long run. A currency maintains its purchasing power parity if it
depreciates 1appreciates3 by an amount e(ual to the excess of domestic 1foreign3 inflation o6er foreign
1domestic3 inflation.
PT": 1
#. =hat is exchange rate o6ershootingB
A!":
An exchange rate is said to o6ershoot when its short-run response to a change in market fundamentals
is greater than its long-run response.
PT": 1
E''A*
1. $n a free market& what determines exchange rates in the long run and the short runB
A!":
The long-run determinants of exchange rates include market fundamentals such as consumer
preferences for domestic and foreign goods& go6ernment trade policies& producti6ity le6els& and
relati6e price le6els. $n the short run& exchange rates are determined by interest rate differentials and
market expectations concerning economic growth& inflation rates& and interest rates.
PT": 1
#. =hat is the asset market approach to exchange rate determinationB
A!":
D6er short periods of time& decisions to hold domestic or foreign financial assets play a much greater
role in exchange rate determination than the demand for imports and exports does. According to the
asset market approach& in6estors consider two key factors when deciding between domestic and
foreign in6estments: relati6e interest rates and expected changes in exchange rates. 8hanges in these
factors& in turn& account for fluctuations in exchange rates that we obser6e in the short run.
PT": 1