Question 1

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

The statement is true. The relative form of PPP adjusts for market imperfections that could affect the relationship between inflation and exchange rate changes. This includes factors such as transportation costs, tariffs, and quotas.

Question 2

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, leading investors to anticipate a decrease in the currency's value over time.

Question 3

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 4

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

According to the purchasing power parity (PPP) theory, the exchange rate adjusts so that the same goods cost the same in both currencies when measured in a common currency. Given that the inflation rate in the United States is 3% and in Japan is 10%, the Japanese yen should depreciate relative to the US dollar. The expected depreciation can be calculated as: (1 + inflation rate of foreign country) / (1 + inflation rate of home country) = (1 + 0.10) / (1 + 0.03) = 1.10 / 1.03 ≈ 1.06796. The initial exchange rate is $0.0075, so the new exchange rate should be $0.0075 / 1.06796 ≈ $0.0070, which matches option C.

Question 5

The following regression analysis was conducted for the inflation rate information and exchange rate of the British pound:
Regression results indicate that a₀ = 0 and a₁ = 2. Therefore:

Accepted Answer

The coefficient of 2 on inflation rate indicates that for every 1% increase in inflation, the exchange rate of the British pound increased by 2%. Since the coefficient is positive and greater than 1, it suggests that purchasing power parity underestimated the exchange rate change during the period under examination. Therefore, the best choice is C.

Question 6

Assume that the U.S. inflation rate is higher than the New Zealand inflation rate. This will cause U.S. consumers to ____ their imports from New Zealand and New Zealand consumers to ____ their imports from the United States. According to purchasing power parity (PPP), this will result in a(n) ____ of the New Zealand dollar (NZ$).

Accepted Answer

The answer of Assume that the U.S. inflation rate is...

Question 7

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

Accepted Answer

Research has shown that over the long run, deviations from PPP tend to be less pronounced, meaning that exchange rates tend to converge towards their PPP values. However, in the short run, there can be significant deviations from PPP due to a variety of factors such as changes in interest rates, inflation, and macroeconomic conditions.

Question 8

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 the interest rate parity and the international Fisher effect, foreign currencies with higher interest rates should have forward discounts, which means that their forward exchange rate would be lower than their spot exchange rate. This implies an expected depreciation of those currencies in the future.

Question 9

If nominal British interest rates are 3 percent and nominal U.S. interest rates are 6 percent, then the British pound (£) is expected to ____ by about ____percent, according to the international Fisher effect (IFE).

Accepted Answer

The International Fisher Effect (IFE) suggests that the currency of the country with the lower interest rate (in this case, Britain) is expected to appreciate against the currency of the country with the higher interest rate (in this case, the U.S.). The expected percentage change in the exchange rate can be approximated by the difference in nominal interest rates, which is 6% - 3% = 3%. However, the exact calculation involves using the formula for the IFE, which results in an appreciation of approximately 2.9%.

Question 10

Which of the following theories suggests that the percentage change in the spot exchange rate of a currency should be equal to the inflation differential between two countries?

Accepted Answer

Purchasing power parity (PPP) theory suggests that the percentage change in the spot exchange rate of a currency should be equal to the inflation differential between two countries. Triangular arbitrage refers to taking advantage of price discrepancies in three different currencies, international Fisher effect (IFE) theory suggests that the change in the spot exchange rate of a currency should be equal to the difference between the nominal interest rates in two countries, and interest rate parity (IRP) suggests that the difference in interest rates between two countries should be reflected in the forward exchange rate.

Question 11

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

The international Fisher effect states that the exchange rate percentage change should be approximately equal to the differential in nominal interest rates between two countries, not income levels. Therefore, the statement given in the question is false.

Question 12

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

Accepted Answer

Interest rate parity and purchasing power parity are separate concepts and one does not have a direct impact on the other. While interest rate parity governs the relationship between exchange rates and interest rates, purchasing power parity relates to the exchange rate between two currencies based on the relative prices of goods and services in each country. Therefore, interest rate parity can hold even if purchasing power parity does not hold.

Question 13

The following regression analysis was conducted for the inflation rate information and exchange rate of the British pound:
Regression results indicate that a₀ = 0 and a₁ = 1. Therefore:

Accepted Answer

The regression results indicate that the intercept (a₀) is 0 and the slope (a₁) is 1. This means that the inflation rate and exchange rate have a 1-to-1 relationship, which supports purchasing power parity. In other words, the exchange rate reflects the relative purchasing power of the two currencies, and there is no over- or under-estimation of the exchange rate change during the examined period. Therefore, the best choice is A, purchasing power parity holds. Option B and C are incorrect because the regression results do not indicate any over- or under-estimation of the exchange rate change. Option D is incorrect because there is no indication from the regression results that purchasing power parity will overestimate the exchange rate change in the future.

Question 14

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 over time. One can exist without the other necessarily holding true.

Question 15

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

Accepted Answer

The answer of If the IFE theory holds, that means...

Question 16

Which of the following theories suggests that the percentage difference between the forward rate and the spot rate depends on the interest rate differential between two countries?

Accepted Answer

Interest rate parity (IRP) suggests that the percentage difference between the forward rate and the spot rate depends on the interest rate differential between two countries.

Question 17

Which of the following is indicated by research regarding purchasing power parity (PPP)?

Accepted Answer

Research indicates that deviations from PPP are less pronounced in the long run, meaning that PPP holds more accurately over extended periods of time. However, in the short run, PPP may not always hold due to various factors such as transaction costs and market inefficiencies.

Question 18

Which of the following theories suggests the percentage change in spot exchange rate of a currency should be equal to the interest rate differential between two countries?

Accepted Answer

The international Fisher effect (IFE) suggests that the percentage change in the spot exchange rate of a currency should be equal to the interest rate differential between two countries. Therefore, option C is the correct answer. Option A (absolute form of PPP) suggests that the exchange rate between two currencies should adjust to ensure that the same basket of goods has the same price in both countries. Option B (relative form of PPP) suggests that changes in the exchange rate should reflect changes in the relative price levels between two countries. Option D (interest rate parity) suggests that the difference in interest rates between two countries should reflect the expected change in their exchange rate.

Question 19

Which of the following theories can be assessed using data that exists at one specific point in time?

Accepted Answer

Interest rate parity (IRP) can be assessed using data that exists at one specific point in time, as it only involves comparing interest rates at a specific point in time. The other theories, purchasing power parity (PPP) and international Fisher effect (IFE), involve the comparison of multiple data points over time.

Question 20

Which of the following is not true regarding IRP, PPP, and the IFE?

Accepted Answer

IRP (Interest Rate Parity) does not suggest that a currency's spot rate will change according to interest rate differentials; it suggests that the forward exchange rate should offset interest rate differentials to prevent arbitrage.

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

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.

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

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.

The following regression analysis was conducted for the inflation rate information and exchange rate of the British pound: Regression results indicate that a₀ = 0 and a₁ = 2. Therefore:

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

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.

If nominal British interest rates are 3 percent and nominal U.S. interest rates are 6 percent, then the British pound (£) is expected to by about percent, according to the international Fisher effect (IFE) .

Which of the following theories suggests that the percentage change in the spot exchange rate of a currency should be equal to the inflation differential between two countries?

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.

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

The following regression analysis was conducted for the inflation rate information and exchange rate of the British pound: Regression results indicate that a₀ = 0 and a₁ = 1. Therefore:

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

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

Which of the following theories suggests that the percentage difference between the forward rate and the spot rate depends on the interest rate differential between two countries?

Which of the following is indicated by research regarding purchasing power parity (PPP) ?

Which of the following theories suggests the percentage change in spot exchange rate of a currency should be equal to the interest rate differential between two countries?

Which of the following theories can be assessed using data that exists at one specific point in time?

Which of the following is not true regarding IRP, PPP, and the IFE?

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

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.

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

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.

The following regression analysis was conducted for the inflation rate information and exchange rate of the British pound: Regression results indicate that a₀ = 0 and a₁ = 2. Therefore:

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

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.

If nominal British interest rates are 3 percent and nominal U.S. interest rates are 6 percent, then the British pound (£) is expected to ____ by about ____percent, according to the international Fisher effect (IFE) .

Which of the following theories suggests that the percentage change in the spot exchange rate of a currency should be equal to the inflation differential between two countries?

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.

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

The following regression analysis was conducted for the inflation rate information and exchange rate of the British pound: Regression results indicate that a₀ = 0 and a₁ = 1. Therefore:

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

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

Which of the following theories suggests that the percentage difference between the forward rate and the spot rate depends on the interest rate differential between two countries?

Which of the following is indicated by research regarding purchasing power parity (PPP) ?

Which of the following theories suggests the percentage change in spot exchange rate of a currency should be equal to the interest rate differential between two countries?

Which of the following theories can be assessed using data that exists at one specific point in time?

Which of the following is not true regarding IRP, PPP, and the IFE?

If nominal British interest rates are 3 percent and nominal U.S. interest rates are 6 percent, then the British pound (£) is expected to by about percent, according to the international Fisher effect (IFE) .