Deck 18: Exchange Rate Theories

Question 1

The usefulness of asset market models for predicting future exchange rates

A) is limited by the propensity for the unexpected to occur.
B) has been verified by how well they predict unexpected events.
C) was established in the 1950s.
D) Both B and C.

Answer 1

A

Question 2

The independence of domestic monetary policy under flexible exchange rates may be reduced if there is

A) sterilization.
B) currency substitution.
C) overshooting of exchange rates.
D) All of the above.

Answer 2

B

Question 3

Modern exchange rate models

A) emphasize financial asset markets.
B) emphasize goods markets.
C) assume that covered IRP holds.
D) Both A and B.

Answer 3

D

Question 4

assume perfect substitutability of assets internationally.

A) All asset approach models
B) Portfolio-balance approach models
C) Monetary approach models
D) No models

Question 5

The assumes that assets are imperfect substitutes internationally because investors perceive foreign exchange risk to be attached to foreign currency denominated bonds.

A) portfolio-balance approach
B) monetary approach
C) traditional exchange rate model
D) All of the above

Question 6

The issue of currency substitution deals with substitutability among currencies on the of the market.

A) left side
B) supply side
C) demand side
D) All of the above

Question 7

A foreign exchange market intervention that leaves the domestic money supply unchanged is called

A) non-sterilized intervention.
B) sterilized intervention.
C) open market operation.
D) coordinated intervention.

Question 8

Perfect capital mobility

A) implies currency substitution.
B) is a common assumption used by all asset approach models.
C) means uncovered IRP holds.
D) All of the above.

Question 9

If sterilization exists, then this implies that

A) there is no causality between domestic credit and reserve changes.
B) domestic credit changes cause reserve flows.
C) reserve changes cause domestic credit changes.
D) the monetary approach cannot be useful as a theory of exchange rate determination.

Question 10

Sterilized intervention under flexible exchange rates is "ultimately" an exchange of

A) domestic bonds for foreign money.
B) domestic money for foreign bonds.
C) domestic bonds for foreign bonds.
D) All of the above.

Question 11

The assumption of perfect substitutability among assets in the monetary approach models implies

A) uncovered IRP.
B) a foreign exchange risk premium.
C) that the forward rate will be a biased predictor of the future spot rate.
D) perfect capital mobility.

Question 12

The assumption of imperfect substitution between assets in the asset market models implies that

A) domestic and foreign money are perfect substitutes.
B) uncovered IRP holds.
C) there is no foreign exchange risk premium.
D) None of the above.

Question 13

With exchange rates, central banks make currencies perfect substitutes on the supply side of the market.

A) flexible
B) managed float
C) fixed
D) Both A and B

Question 14

When countries follow different policies, currency substitution leads to

A) high -risk currencies.
B) low-inflation currencies.
C) more volatile exchange rates.
D) less volatile exchange rates.

Question 15

A high degree of currency substitution

A) breeds currency union.
B) adds an additional source of exchange rate variability.
C) limits the ability of central banks to follow an independent domestic monetary policy.
D) All of the above.

Question 16

refers to central banks offsetting international reserve flows in order to follow an independent monetary policy.

A) Monetary Approach
B) Portfolio-Balance Approach
C) Sterilization
D) Currency Substitution

Question 17

The main reason why "overshooting" occurs is

A) not known.
B) trade flows.
C) a slow adjustment of goods markets relative to financial markets.
D) currency substitution.

Question 18

Countries cannot become independent in terms of their ability to formulate domestic monetary policy when

A) exchange rates are fixed.
B) exchange rates are flexible.
C) there is a high degree of currency substitution.
D) Both A and C.

Question 19

Which of the following may not be consistent with the asset approach to exchange rate?

A) the existence of trade flows
B) the existence of financial asset flows
C) the existence of news
D) None of the above

Question 20

We should expect currency substitution to be most important

A) in less developed countries with immobile resources.
B) in highly developed countries.
C) in a regional setting with a high degree of mobility of resources
D) All of the above.

Question 21

What is the role of "trade flows" in the modern asset market approach to exchange rate determination? Suppose you are expecting a future U.S. trade deficit, how does this affect the dollar today?

Question 22

With perfect capital mobility, uncovered interest parity holds.

Question 23

Asset approach models to exchange rate determination put more emphasis on financial assets rather than relying on international trade in goods to explain exchange rate changes. Therefore, there is no useful role for trade flows in these models.

Question 24

Suppose that the U.S. dollar depreciates in value against the South African rand and the Fed intervenes in the foreign exchange market by selling its rand holdings in exchange for dollars. To sterilize the effect of the intervention on the domestic money supply the Fed has to

A) sell U.S. government bonds in the domestic open market.
B) buy U.S. government bonds in the domestic open market.
C) buy U.S. dollars in the foreign exchange market.
D) sell South African government bonds in the international market.

Question 25

The financial crisis that started in 2008 increased foreign exchange volatility around the world. The only currency that did not see its volatility increase was the Swiss franc.

Question 26

Understanding the foreign exchange market microstructure allows us to predict where exchange rates tend to go in the long-run.

Question 27

The portion of base money used to settle international debts is known as

A) international reserves.
B) foreign credit.
C) letter of credit.
D) international commodities.

Question 28

What are the similarities and differences between the "monetary approach" and the "portfolio- balance approach." Briefly explain.

Question 29

Explain how exchange rates can overshoot their long-run equilibrium level.

Question 30

If sterilization is a real world phenomenon, the implications of the MAER regarding the causality between domestic credit and reserve changes must be reconsidered.

Question 31

The domestic component of base money is known as

A) international reserves.
B) domestic credit.
C) domestic multiplier.
D) home financing currency.

Question 32

We should expect currency substitution to be most important in a setting where there is a relatively high degree of mobility of resources between countries.

Question 33

Currency substitution between monies makes it easier for central banks to follow an independent monetary policy under flexible exchange rates since the currency substitution leads to less volatile exchange rates.

Question 34

In the monetary approach to exchange rate determination, relative supplies of domestic and foreign bonds have a crucial role in determining exchange rates.

Question 35

We should expect currency substitution to be most important in highly developed industrial countries rather than in a regional setting where there is a relatively high degree of mobility of resources between countries.

Question 36

Imperfect substitution between bonds implies that there is no foreign exchange risk premium, and thus, covered interest parity holds.

Question 37

Base money is defined as currency plus commercial bank reserves, which is also equal to international reserves plus domestic credit.

Question 38

We find great difficulty in predicting future spot rates, because the exchange rate will be in part, determined by events that cannot be expected or foreseen.

Question 39

One of the most important implications of the asset approach exchange rate models is that exchange rates should be much more variable than goods prices.

Question 40

Suppose, under fixed exchange rates, you find evidence of sterilization. What does it mean regarding the ability of central banks to follow independent monetary policies? What does sterilization imply regarding the causality between domestic credit and reserve flows under fixed exchange rates?

Question 41

The inventory control effect of the foreign-exchange market microstructure may explain why traders may alter their quotes in absence of any news. Explain how this can happen.