Question 1

According to purchasing power parity (PPP), if a foreign country's inflation rate is below the inflation rate at home, home country consumers will increase their imports from the foreign country, and foreign consumers will lower their demand for home country products. These market forces cause the foreign currency to appreciate.

Accepted Answer

This statement is true according to the theory of purchasing power parity. When a foreign country's inflation rate is lower than the home country's, goods and services from the foreign country become relatively cheaper, causing an increase in imports from the foreign country and a decrease in demand for home country products. As a result, the foreign currency is likely to appreciate.

Question 2

If interest rate parity holds, and the international Fisher effect (IFE) holds, foreign currencies with relatively high interest rates should have forward discounts, and those currencies would be expected to depreciate.

Accepted Answer

According to interest rate parity, the forward exchange rate should reflect the difference in interest rates between two currencies. According to the international Fisher effect, currencies with higher interest rates should have higher inflation rates, which would lower their real value over time. Therefore, the combination of interest rate parity and IFE suggests that foreign currencies with higher interest rates should have forward discounts, which would indicate an expectation of depreciation in the future.

Question 3

According to the IFE, when the nominal interest rate at home exceeds the nominal interest rate in the foreign country, the home currency should depreciate.

Accepted Answer

According to the International Fisher Effect (IFE), if the nominal interest rate in the home country is higher than in the foreign country, it suggests that inflation is expected to be higher in the home country, leading to the depreciation of the home currency in the future.

Question 4

If interest rate parity holds, then the international Fisher effect must hold.

Accepted Answer

Interest rate parity and the international Fisher effect are related but distinct concepts. Interest rate parity focuses on the relationship between spot and forward exchange rates to prevent arbitrage, while the international Fisher effect deals with the relationship between interest rates and exchange rate movements, predicting that currencies with higher interest rates will depreciate. One can exist without the strict application of the other.

Question 5

Brazil has a very high interest rate. According to _____, the Brazilian real should depreciate substantially.

Accepted Answer

The international Fisher effect (IFE) suggests that a country with a high interest rate will experience a depreciation in its currency. Therefore, according to the given information, the Brazilian real should depreciate substantially due to its high interest rate. Purchasing power parity (PPP) and interest rate parity (IRP) are also important concepts in the foreign exchange market, but they are not directly relevant to the given information about Brazil's interest rate.

Question 6

According to the international Fisher effect (IFE), the exchange rate percentage change should be approximately equal to the differential in income levels between two countries.

Accepted Answer

According to the International Fisher Effect, the exchange rate percentage change should be approximately equal to the differential in nominal interest rates between two countries rather than income levels.

Question 7

​The inflation rate in the United States is 3 percent while the inflation rate in Japan is 10 percent. The current exchange rate for the Japanese yen (¥) is $0.0075. After supply and demand for the Japanese yen have adjusted in the manner suggested by purchasing power parity, the new exchange rate for the yen will be:

Accepted Answer

The answer of ​The inflation rate in the United States...

Question 8

There is much evidence to suggest that Japanese investors invest in U.S. Treasury securities when U.S. interest rates are higher than Japanese interest rates. These investors most likely believe in the international Fisher effect.

Accepted Answer

The answer of There is much evidence to suggest that...

Question 9

If purchasing power parity holds, then the Fisher effect must also hold.

Accepted Answer

Purchasing Power Parity (PPP) and the Fisher Effect are two separate economic theories. PPP relates to the exchange rates between currencies adjusting to equalize the purchasing power of different currencies. The Fisher Effect describes the relationship between nominal interest rates, real interest rates, and inflation. One can exist without the other necessarily holding true.

Question 10

Purchasing power parity (PPP) focuses on the relationship between nominal interest rates and exchange rates between two countries.

Accepted Answer

Purchasing power parity (PPP) focuses on the relationship between prices of goods and services in two countries and how that affects exchange rates, not on nominal interest rates.

Question 11

The IFE theory suggests that foreign currencies with relatively high interest rates will appreciate because the high nominal interest rates reflect expected inflation.

Accepted Answer

The International Fisher Effect (IFE) theory suggests that currencies in countries with higher interest rates will depreciate, not appreciate, because the high interest rates reflect expected inflation.

Question 12

The nominal interest rate can be measured as the real interest rate minus the expected inflation rate.

Accepted Answer

The nominal interest rate is the sum of the real interest rate and the expected inflation rate, not the difference between them.

Question 13

Interest rate parity can only hold if purchasing power parity holds.

Accepted Answer

Interest rate parity and purchasing power parity are two separate concepts. While interest rate parity relates to the balance between expected returns on two different currencies, purchasing power parity relates to the exchange rate between two currencies and the relative costs of goods in each country. While the two can be related, they are not reliant on each other, and interest rate parity can hold even if purchasing power parity does not.

Question 14

Research indicates that deviations from purchasing power parity (PPP) are less pronounced over the long run.

Accepted Answer

Long-term deviations from PPP tend to be smaller compared to short-term deviations. This is known as the PPP convergence hypothesis. Over the long run, differences in inflation rates, productivity, and other factors tend to balance out and bring exchange rates closer to the PPP value. However, in the short term, the exchange rates can deviate significantly from PPP due to various factors such as speculation, market sentiment, and unexpected shocks to the economy.

Question 15

The international Fisher effect (IFE) suggests that the currencies with relatively high interest rates will appreciate because those high rates will attract investment and increase the demand for that currency.

Accepted Answer

The International Fisher Effect suggests that currencies with relatively high interest rates will actually depreciate, not appreciate, because the higher interest rates are expected to be offset by a future decrease in the value of the currency.

Question 16

If the IFE theory holds, that means that covered interest arbitrage is not feasible.

Accepted Answer

The International Fisher Effect (IFE) theory relates to the expected change in exchange rates based on interest rate differentials, while covered interest arbitrage involves exploiting differences in interest rates between countries using forward contracts. They address different aspects of international finance.

Question 17

The relative form of purchasing power parity (PPP) accounts for the possibility of market imperfections such as transportation costs, tariffs, and quotas in establishing a relationship between inflation rates and exchange rate changes.

Accepted Answer

This statement is true. The relative form of PPP takes into account market imperfections such as transportation costs, tariffs, and quotas that can affect the prices of goods and services in different countries, and adjusts exchange rates accordingly to reflect the relative purchasing power of currencies.

Question 18

Assume that inflation in the United States is expected to be 9 percent, while inflation in Australia is expected to be 5 percent over the next year. Today you receive an offer to purchase a one-year put option for $.03 per unit on Australian dollars at a strike price of $0.72. Today the Australian dollar is quoted at $0.70. You believe that purchasing power parity holds. You should accept the offer.

Accepted Answer

According to the purchasing power parity (PPP) theory, the exchange rate should adjust to offset the inflation differential between two countries. With the U.S. expecting higher inflation (9%) than Australia (5%), the Australian dollar should appreciate relative to the U.S. dollar. Therefore, a put option (the right to sell Australian dollars at a fixed rate) would likely not be profitable if the Australian dollar is expected to strengthen, making the offer less attractive.

Question 19

If the international Fisher effect (IFE) holds, the local investors are expected to earn the same return from investing internationally as they would from investing in their local markets.

Accepted Answer

According to the IFE, there is a long-run equilibrium relationship between nominal interest rates and expected inflation rates across different countries. Therefore, if the IFE holds, local investors would be expected to earn the same return from investing internationally as they would from investing in their local markets.

Question 20

​Assume that the international Fisher effect (IFE) holds between the United States and the United Kingdom. The U.S. inflation is expected to be 5 percent, while British inflation is expected to be 3 percent. The interest rate offered on pounds is 7 percent, and the U.S. interest rate is 7 percent. What does this say about real interest rates expected by British investors?

Accepted Answer

The answer of ​Assume that the international Fisher effect (IFE)...

Quiz 8: Relationships Among Inflation, Interest Rates, and Exchange Rates