Question 1

Suppose a Japanese bank offers a 4 percent interest rate and U.S. banks offer a 2 percent interest rate. People must expect the yen to

Accepted Answer

For investors to be indifferent between investing in Japan or the U.S. despite the higher Japanese interest rate, they must expect the yen to depreciate by the interest rate differential, which is 2 percent.

Question 2

Suppose the exchange rate for the U.S. dollar falls. This could be caused by

Accepted Answer

The answer of Suppose the exchange rate for the U.S....

Question 3

-Using the above figure, an increase in the demand for Dutch goods by U. S. consumers will lead to

Accepted Answer

An increase in demand for Dutch goods by U.S. consumers will lead to an appreciation of the Dutch currency because U.S. consumers will need to exchange more U.S. dollars for Dutch currency to purchase these goods, increasing the demand for the Dutch currency.

Question 4

Suppose a deposit in New York earns 6 percent a year and a deposit in London earns 4 percent a year. Interest rate parity holds if the

Accepted Answer

Interest rate parity holds when the difference in interest rates between two countries is equal to the expected rate of depreciation or appreciation of exchange rates between the countries' currencies. In this case, if a deposit in New York earns 6 percent a year and a deposit in London earns 4 percent a year, for interest rate parity to hold, the U.S. dollar must depreciate by 2 percent a year against the U.K. pound. This compensates for the higher interest rate in the U.S., ensuring that investors are indifferent between investing in either country when considering expected returns after currency adjustments.

Question 5

If there are equal rates of return between assets in two currencies, then there is

Accepted Answer

When there are equal rates of return between assets in two currencies, interest rate parity is achieved. This means that there is no advantage to holding one currency over the other because the interest earned is equal. Purchasing power parity relates to the relative price levels between two countries, while parity of exchange and foreign exchange parity are not commonly used terms in finance.

Question 6

If the prices in the United States rise faster than those in other countries,

Accepted Answer

If prices in the United States rise faster than those in other countries, it means that US goods are becoming relatively more expensive compared to goods from other countries. This reduces demand for US goods and services, leading to a decrease in exports and an increase in imports. To pay for these imports, the supply of dollars increases, leading to a fall in the exchange rate.

Question 7

The idea that the value of money is equal across countries is known as

Accepted Answer

Purchasing power parity (PPP) is the idea that the value of a currency should be the same across different countries, meaning that a given amount of money should be able to buy the same amount of goods and services regardless of where it is used. This concept is based on the law of one price, which states that in a competitive market, identical goods will have the same price in different countries when expressed in the same currency. The other choices, interest rate parity, expected profit parity effect, and exchange rate parity, do not relate specifically to the value of money across countries.

Question 8

Suppose that the U.S. interest rate is 5 percent and the Japanese interest rate is 1 percent. The effect of this difference in the foreign exchange market is that

Accepted Answer

Given the interest rate differential, where the U.S. interest rate is higher than Japan's, investors would move capital to the U.S. to gain higher returns. This capital movement would increase demand for the dollar, causing it to appreciate initially. However, to profit from the interest rate differential, investors would eventually need to convert their dollars back to yen. Anticipating this future conversion, investors would expect the yen to appreciate against the dollar over time to balance the initial difference in interest rates. This expectation is based on the International Fisher Effect, which suggests that currencies with lower interest rates will appreciate against those with higher rates, all else being equal.

Question 9

Suppose the exchange rate between the U.S. dollar and the Jamaican dollar was $1 U.S. = $40 Jamaican dollars. A beach towel sells for $20 in Miami and $60 Jamaican in Negril.

Accepted Answer

Purchasing power parity (PPP) suggests that in the absence of transportation costs and barriers to trade, identical goods should sell for the same price when price is expressed in a common currency. Here, the beach towel sells for $20 in Miami and, given the exchange rate, should sell for $800 Jamaican dollars in Negril to maintain PPP. However, it sells for only $60 Jamaican dollars, indicating PPP does not prevail. This discrepancy suggests the Jamaican dollar is undervalued or the U.S. dollar is overvalued, leading to expectations of the Jamaican dollar appreciating and the U.S. dollar depreciating to restore PPP.

Question 10

What factors can change expectations about the exchange rate?

Accepted Answer

Both interest rate parity and purchasing power parity can affect expectations about the exchange rate. Interest rate parity is the idea that the difference in interest rates between two countries will determine the exchange rate between their currencies. Purchasing power parity, on the other hand, relates to the relative prices of goods and services between two countries, and how these affect the exchange rate. Therefore, both options A and B are correct. Real GDP parity, however, does not have a direct impact on expectations about the exchange rate.

Question 11

-Using the above figure, which of the following is CORRECT?

Accepted Answer

At an exchange rate above $0.60, the quantity of guilders supplied exceeds the quantity demanded, leading to a surplus of guilders.

Question 12

If in Chicago the interest rate is 5 percent a year and in Vancouver it is 4 percent a year, ________.

Accepted Answer

The answer of If in Chicago the interest rate is...

Question 13

If people expect the dollar to depreciate, then the

Accepted Answer

When people expect the dollar to depreciate, they are likely to sell dollars and buy other currencies, leading to a decrease in demand for dollars and an increase in supply. This results in a fall in the exchange rate.

Question 14

Suppose that the U.S. interest rate is 5 percent and the Turkish interest rate is 50 percent. The effect of this difference in the foreign exchange market is that

Accepted Answer

The difference in interest rates indicates that investors can earn a higher return on their investment in Turkey compared to the US. As a result, there will be an increase in demand for the Turkish currency, causing it to appreciate against the dollar. This means that investors will receive more dollars when they convert their Turkish currency back into dollars, making their investment profitable. Therefore, investors expect the Turkish currency to fall in value (depreciate) against the dollar.

Question 15

Adjusted for risk, interest rate parity

Accepted Answer

Interest rate parity is an economic concept that states that the difference in interest rates between two countries should be equal to the difference between the forward exchange rate and the spot exchange rate. Adjusted for risk means taking into account the risk associated with each investment opportunity. Interest rate parity holds true regardless of the size or economic status of a country or whether purchasing parity holds or not. Therefore, option D, that always holds, is the best choice.

Question 16

Arbitrage in the foreign exchange market, international loans markets, and goods markets results in

Accepted Answer

Purchasing power parity (PPP) refers to the idea that exchange rates should adjust to reflect the relative prices of goods between two countries. Interest rate parity (IRP) suggests that differences in interest rates between two countries should be reflected in the exchange rate. The law of one price states that identical goods should have the same price in different markets when converted into a common currency. These three concepts are used to explain arbitrage opportunities in the foreign exchange, international loans, and goods markets.

Question 17

Suppose the exchange rate between the U.S. dollar and the Mexican peso was $1 = 5 pesos. A can of Pepsi sells for $2 in Boston and for 12 pesos in Mexico City.

Accepted Answer

Purchasing power parity (PPP) states that the exchange rate between two currencies should adjust to equalize the prices of identical goods in both countries. In this case, if PPP prevailed, the price of the can of Pepsi would be the same in both Boston and Mexico City. However, the can of Pepsi is cheaper in Mexico City when the exchange rate is taken into account, suggesting that PPP does not prevail.

Question 18

-In the figure above, an increase in the U.S. interest rate relative to that in Canada shifts the demand curve for U.S. dollars ________ and shifts the supply curve of U.S. dollars ________.

Accepted Answer

An increase in the U.S. interest rate relative to that in Canada makes U.S. investments more attractive, increasing the demand for U.S. dollars (shifting the demand curve rightward) and decreasing the supply of U.S. dollars as fewer investors are willing to exchange their U.S. dollars for Canadian dollars (shifting the supply curve leftward).

Question 19

According to interest rate parity, if the interest rate is 1 percent in the European Union and the euro is expected to appreciate 3 percent, the comparable interest rate in the United States will be

Accepted Answer

Interest rate parity suggests that the difference in interest rates between two countries is equal to the expected change in exchange rates between the countries' currencies. Here, if the euro is expected to appreciate by 3 percent against the dollar and the interest rate in the EU is 1 percent, then the interest rate in the US should be 4 percent (1% EU interest rate + 3% expected appreciation of the euro) to maintain parity.

Question 20

Suppose a British bank offers a 3 percent interest rate while a U.S. bank offers a 7 percent interest rate. People must expect the U.S. dollar will

Accepted Answer

If people expect the U.S. dollar to depreciate by 4 percent, it offsets the higher interest rate in the U.S. (7 percent) compared to the UK (3 percent), equalizing the return on investments in both currencies. This is based on the concept of interest rate parity in international finance.

Quiz 9: The Exchange Rate and the Balance of Payments