Question 1

China has used a fixed yuan exchange rate and a crawling peg exchange rate. In both cases, China pegs its currency to the

Accepted Answer

China has historically pegged its currency to the U.S. dollar. In the case of the crawling peg exchange rate, the yuan is still pegged to a basket of currencies that is heavily weighted towards the U.S. dollar.

Question 2

Figure 25.3.1
Refer to the figure below to answer the following questions.
 
-In Figure 25.3.1, suppose the demand for dollars temporarily increases so that the demand curve shifts to D₁. To maintain the target exchange rate, the Bank of Canada

Accepted Answer

The answer of Figure 25.3.1
Refer to the figure below to...

Question 3

Arbitrage is

Accepted Answer

Arbitrage is the practice of buying and selling assets or securities in different markets in order to make a profit from the difference in price. This can include buying a security in one market and then selling it in another market at a higher price, or buying a commodity in one region and then selling it in another region where the price is higher. It is not illegal, and is a common practice in financial markets.

Question 4

Figure 25.3.1
Refer to the figure below to answer the following questions.
 
-In Figure 25.3.1, suppose the demand for dollars permanently decreases to D₂. To maintain the target, the Bank of Canada

Accepted Answer

The answer of Figure 25.3.1
Refer to the figure below to...

Question 5

The Bank of Canada

Accepted Answer

The Bank of Canada follows a flexible exchange rate policy, meaning that the exchange rate is determined by market forces of supply and demand. However, the Bank's actions, such as changes in interest rates or monetary policy, can impact the exchange rate indirectly. Therefore, while the Bank does not actively buy or sell Canadian dollars to influence the exchange rate, its decisions can still have an effect.

Question 6

Speculation is

Accepted Answer

Speculation refers to trading on the expectation of making a profit, often by taking risks in the market. Arbitrage, on the other hand, refers to taking advantage of price differences in different markets to make a profit. Speculation is legal in Canada. It can either appreciate or depreciate the Canadian dollar depending on the actions taken by speculators.

Question 7

One consequence of China operating a crawling peg is that China

Accepted Answer

With a crawling peg exchange rate system, the value of the yuan is allowed to fluctuate within a narrow band against a basket of currencies, including the US dollar. As China maintains its currency's value within this narrow range, it accumulates US dollar reserves by buying dollars to prevent the yuan from appreciating too much. This makes option A the correct answer.

Question 8

The exchange rate equals

Accepted Answer

The exchange rate is determined by the ratio of the prices of goods and services in two countries. The real exchange rate reflects the relative prices of goods and services between the two countries, while the nominal exchange rate reflects the prices of the currencies. Therefore, the exchange rate can be calculated as the real exchange rate multiplied by the foreign price level, divided by the domestic price level. Choice A is incorrect because the foreign price level should be divided by the real exchange rate instead of multiplied. Choices C, D, and E are incorrect because they do not reflect the calculation of the exchange rate based on the relative prices of goods and services between two countries.

Question 9

Which of the following exchange rate policies uses a target exchange rate, but allows the target to change?

Accepted Answer

A crawling peg system allows for a target exchange rate to be set, but this target can change over time to reflect changes in the market. This allows for some flexibility while still maintaining a level of stability in the exchange rate. The other options (B, C, D, E) either do not utilize a target exchange rate or do not allow for flexibility in the target.

Question 10

For a given real exchange rate, a change in the quantity of money

Accepted Answer

The answer of For a given real exchange rate, a...

Question 11

Suppose the Bank of Canada follows a fixed-exchange rate of 0.50 U.K. pounds per Canadian dollar. If the demand for dollars temporarily decreases, to maintain the target exchange rate, the Bank can

Accepted Answer

If the demand for dollars decreases, it means there is an excess supply of Canadian dollars in the foreign exchange market. To maintain the fixed exchange rate, the Bank of Canada will have to buy Canadian dollars and sell U.K. pounds. This will increase the demand for Canadian dollars and reduce the excess supply, thereby supporting the exchange rate at 0.50 U.K. pounds per Canadian dollar. Selling dollars (choice A) would be counterproductive as it would further reduce the value of the Canadian dollar, leading to an exchange rate below the target rate. Increasing Canadian exports (choice C) and imports (choice D) may ultimately affect the balance of trade and the exchange rate in the long run, but they are not immediate options for correcting a temporary decrease in the demand for dollars. Violating purchasing power parity (choice E) means that the exchange rate no longer reflects the relative price levels between the two countries, which would undermine the credibility of the fixed exchange rate regime.

Question 12

The market fundamentals that determine the exchange rate in the long run are

Accepted Answer

The answer of The market fundamentals that determine the exchange...

Question 13

If a country's central bank does not intervene in the foreign exchange market, the country has

Accepted Answer

If a country's central bank does not intervene in the foreign exchange market, the country has a flexible exchange rate policy. Under this policy, market forces determine the exchange rate of a country's currency. The central bank may occasionally intervene to stabilize the exchange rate, but in general, it does not actively manipulate the value of the currency.

Question 14

If the Bank of Canada sets a target exchange rate that is higher than the current exchange rate, then

Accepted Answer

If the Bank of Canada sets a target exchange rate that is higher than the current exchange rate, it means it wants to increase the value of the Canadian dollar. To do this, it must buy Canadian dollars on the foreign exchange market, which would increase demand for the dollar and raise its value. Therefore, the Bank must buy dollars.

Question 15

Arbitrage in the foreign exchange market and international loans markets and goods markets achieves all of the following except

Accepted Answer

Arbitrage in the foreign exchange market and international loans markets and goods markets can achieve the law of one price, no round-trip profit, interest rate parity, and purchasing power parity. However, it does not necessarily result in depreciation across all currencies. In fact, arbitrage opportunities can cause temporary appreciation or depreciation of certain currencies until the market equalizes.

Question 16

If a nation's central bank increased domestic interest rates, the nation's exchange rate would change if the country's exchange rate was

Accepted Answer

If a country has a flexible exchange rate, the exchange rate will change when the central bank increases domestic interest rates. This is because higher interest rates attract foreign investment which in turn increases demand for the domestic currency causing its value to appreciate. On the other hand, if a country has a fixed or nominally fixed exchange rate, the central bank would need to intervene in the foreign exchange market to maintain the exchange rate at the set level, and thus changing interest rates would not directly lead to a change in the exchange rate. A crawling peg system involves regular, pre-announced adjustments to the exchange rate, so the effect of a change in interest rates would depend on the specific details of the crawling peg.

Question 17

If the price level in Canada is 120, the price level in South Africa is 140, and the exchange rate is 7 South African rands per dollar, then the real exchange rate is

Accepted Answer

The answer of If the price level in Canada is...

Question 18

If the exchange rate is higher than the Bank of Canada's target exchange rate, the Bank

Accepted Answer

If the exchange rate is higher than the Bank of Canada's target exchange rate, it means the Canadian dollar is overvalued. To correct this, the Bank of Canada will sell Canadian dollars and buy foreign currency (in this case, US dollars). By doing so, the supply of Canadian dollars on the foreign exchange market will increase, causing the value of the Canadian dollar to depreciate and bringing it closer to the Bank of Canada's target exchange rate.

Question 19

Suppose the Bank of Canada follows a fixed exchange rate of $1 U.S. per Canadian dollar. If the demand for Canadian dollars temporarily increases, to maintain the target exchange rate, the Bank can

Accepted Answer

The answer of Suppose the Bank of Canada follows a...

Question 20

Figure 25.3.1
Refer to the figure below to answer the following questions.
 
-In Figure 25.3.1, suppose the demand for dollars temporarily decreases so that the demand curve shifts to D₂. To maintain the target exchange rate, the Bank of Canada

Accepted Answer

To maintain the target exchange rate, the Bank of Canada must buy dollars to offset the decrease in demand and keep the exchange rate stable. If the Bank of Canada were to sell dollars, it would cause the exchange rate to depreciate, which would violate the target exchange rate. Options C, D, and E are not necessary because the Bank of Canada can maintain the target exchange rate by buying dollars without violating interest rate parity or purchasing power parity.

Quiz 25: The Exchange Rate and the Balance of Payments