Question 1

Suppose the exchange rate is such that 1 U.S.dollar equals 1 euro in New York and 0.9 euros in Paris.An arbitrageur would sell euros

Accepted Answer

The answer of Suppose the exchange rate is such that...

Question 2

Those who simultaneously buy and sell currency to take advantage of exchange rate differences are called

Accepted Answer

Those who simultaneously buy and sell currency to take advantage of exchange rate differences are called arbitrageurs.

Question 3

The purchasing power parity (PPP)theory suggests the prices of identical items will equalize internationally.An illustration that supports this theory is the fact that the price of a McDonald's "Big Mac" is the same around the world.

Accepted Answer

The price of a McDonald's "Big Mac" varies around the world due to differences in local costs, taxes, and economic conditions, which contradicts the PPP theory.

Question 4

The theory that changes in the exchange rate reflect only changes in the price levels of two countries is called

Accepted Answer

The theory that changes in the exchange rate reflect only changes in the price levels of two countries is called purchasing power parity. The floating exchange rate theory, fixed exchange rate theory, flexible exchange rate theory, and managed exchange rate theory are all different theories that explain how exchange rates are determined, but they do not specifically focus on the relationship between exchange rates and price levels.

Question 5

A speculator in foreign exchange is a person who

Accepted Answer

A speculator in foreign exchange buys foreign currency with the hope of selling it at a higher rate in the future, taking risks to make a profit. The other options either involve illegal or unethical behavior or are not representative of the role of a foreign exchange speculator.

Question 6

An arbitrageur in foreign exchange is a person who

Accepted Answer

An arbitrageur in foreign exchange is someone who simultaneously buys large amounts of a currency in one market and sells it in another market to take advantage of differences in exchange rates. This allows them to make a profit without taking on any significant risk.

Question 7

Which of the following statements concerning speculators is true?

Accepted Answer

Speculators enter the foreign exchange market in the hope of making a profit by buying a currency at a lower price and selling it at a higher price in the future. This involves taking on risk, as exchange rates can fluctuate unpredictably. Therefore, statement A is false. Speculators do not simultaneously buy and sell a currency in different markets, as this describes the activity of arbitrageurs (B is incorrect). Speculators do impact exchange rates, as their buying and selling activity can influence supply and demand for a currency in the market (D is false). Finally, while there may be some overlap in the activities of speculators and arbitrageurs, they are not exactly the same (E is incorrect).

Question 8

The actions taken by arbitrageurs in the foreign exchange markets

Accepted Answer

Arbitrageurs help assure that exchange rates are equalized across all markets by taking advantage of price discrepancies between different markets. They buy low in one market and sell high in another, which helps to bring exchange rates in line with their true values. This process actually helps to stabilize foreign exchange markets by reducing price discrepancies and increasing market efficiency. While there may be risk involved in trading, the actions of arbitrageurs are not inherently risky or destabilizing. Additionally, while there may be some overlap between the activities of arbitrageurs and speculators, the two groups are not identical.

Question 9

Suppose a basket of goods costs $400 in the United States and £200 in Britain.If the exchange rate is $1/pound, what will happen in the foreign exchange market, according to the purchasing power parity theory?

Accepted Answer

According to the purchasing power parity theory, the exchange rate between two currencies should be equal to the ratio of the prices of a basket of goods in the two countries. In this case, the basket of goods costs $400 in the United States and £200 in Britain, so the exchange rate should be $1/pound. However, the current exchange rate is $1/pound, which means that the pound is undervalued relative to the dollar. This will lead to an increase in demand for pounds, which will drive up the price of pounds.

Question 10

The fact that exchange rates are nearly identical in different markets around the world is due to

Accepted Answer

The nearly identical exchange rates in different markets around the world are due to the actions of arbitrageurs. Arbitrageurs take advantage of small differences in exchange rates to buy and sell currencies across different markets, which ultimately leads to the equalization of exchange rates. Central banks and policy makers may play a role in shaping exchange rates, but they do not directly ensure that rates are nearly identical across markets. Speculators and currency converters may also impact exchange rates, but they do not explain why rates are nearly identical across markets.

Question 11

The purchasing power parity theory helps explain long-run trends in exchange rates, but not short-run fluctuations.

Accepted Answer

The purchasing power parity theory suggests that exchange rates should adjust in the long-run to equalize the purchasing power of different currencies, but it does not necessarily account for short-term fluctuations in exchange rates caused by various factors such as speculative trading, government policies, or sudden shocks to the economy.

Question 12

Exchange rates

Accepted Answer

Exchange rates fluctuate to equate the quantity of foreign exchange demanded with the quantity supplied. This is because exchange rates are determined by the market forces of supply and demand for currencies. If the demand for a currency exceeds its supply in the foreign exchange market, its exchange rate appreciates. Conversely, if the supply of a currency exceeds its demand, its exchange rate depreciates. This fluctuation in exchange rates helps to balance the supply and demand of currencies and thereby equate the quantity of foreign exchange demanded with the quantity supplied.

Question 13

If the same basket of goods costs $400 in the United States and 200 pounds in Britain, then according to the purchasing power parity theory,

Accepted Answer

According to the purchasing power parity theory, the exchange rate between two currencies should adjust to equalize the price of a basket of goods in both countries. In this case, if the same basket of goods costs $400 in the U.S. and 200 pounds in Britain, then the exchange rate should approach $2/pound, as this would make the price of the basket of goods equivalent in both countries (400/2=200). Choice A is incorrect because goods and services in Britain do not have to cost exactly half as much as in the U.S., but rather the exchange rate should adjust so that they can be purchased at equivalent prices. Choice C is incorrect because a rate of $0.50/pound would make goods in Britain cheaper for U.S. consumers than in the U.S., which would not be consistent with the principle of purchasing power parity. Choice D is incorrect because goods and services do not have to cost twice as much in Britain as in the U.S., but rather the exchange rate should adjust so that they can be purchased at equivalent prices. Choice E is incorrect because knowing the exchange rate is actually integral to applying the purchasing power parity theory.

Question 14

One difference between arbitrageurs and speculators is that

Accepted Answer

Arbitrageurs seek to profit from the price differences between markets, while speculators take positions in the hopes of making a profit based on expected future currency movements. Arbitrage is generally considered a low-risk strategy, as the profits are usually very small and the trades are conducted quickly, while speculation is considered a high-risk strategy as it involves predicting future market movements. Therefore, speculators take more risks than arbitrageurs.

Question 15

Speculators profit by taking risks, while the actions of arbitrageurs involve no risk.

Accepted Answer

Speculators take risks by buying and selling assets in the hope of making a profit, while arbitrageurs take advantage of price differences between different markets without taking any risk.

Question 16

Under a flexible exchange rate system, which one of the following would not directly affect the exchange rate?

Accepted Answer

The salary of the president of the United States would not directly affect the exchange rate because it is not related to any economic factors that influence the demand and supply of currencies. The other options listed (A, B, D, and E) can directly affect the exchange rate. For example, changes in income or capital flows can affect the demand and supply of currencies, and changes in relative inflation rates or the level of exports or imports can affect the purchasing power of a currency.

Question 17

According to the purchasing power parity theory, in the long run

Accepted Answer

The purchasing power parity theory states that in the long run, the exchange rate between two currencies should reflect the differences in price levels between the two countries. Therefore, the exchange rate between the Canadian dollar and the British pound should reflect differences in price levels between Canada and Britain. Choices A through D are incorrect because they overgeneralize and do not fully capture the essence of the purchasing power parity theory.

Question 18

Foreign exchange rates tend toward equality around the world because of the actions of

Accepted Answer

Arbitrageurs are traders who seek to profit from differences in exchange rates between two or more markets. Their actions serve to narrow the gaps in exchange rates between markets, eventually leading to greater equality in exchange rates globally. Central banks, stock markets, commodity markets, and the World Bank may also have an impact on exchange rates, but their influence is more indirect and less immediate than that of arbitrageurs.

Question 19

The purchasing power parity theory

Accepted Answer

The answer of The purchasing power parity theory
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Question 20

Suppose a basket of goods that costs $400 in the United States costs only £200 in Britain and the current exchange rate is $1/pound.According to the purchasing power parity theory, the equilibrium exchange rate should be higher than $1/pound.Why?

Accepted Answer

According to the purchasing power parity theory, the exchange rate should adjust such that the basket of goods costs the same amount in both countries when converted to a common currency. Since the basket costs $400 in the United States and £200 in Britain, the exchange rate should be $2/pound ($400 divided by £200). However, the current exchange rate is only $1/pound, which means that the pound is undervalued relative to the dollar. This presents an opportunity for arbitrage, where an individual could purchase the basket in Britain for £200, convert the pounds to dollars at the current exchange rate ($1/pound), and then sell the basket in the United States for $400. The individual could then take the $400 and exchange it back into pounds at the current exchange rate, receiving £400. Since the initial cost of the basket was only £200, the individual would make a profit of £200 ($400 - £200 = £200), demonstrating that the exchange rate should be higher than $1/pound. Choice A is the only option that correctly explains this concept.

Quiz 20: International Finance