Question 1

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

Accepted Answer

According to the IFE, the expected change in the exchange rate is equal to the difference in nominal interest rates. Therefore, the British pound is expected to appreciate by about 2.9% (6% - 3%).

Question 2

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

Accepted Answer

The theory that suggests that the percentage change in spot exchange rate of a currency should be equal to the inflation differential between two countries is purchasing power parity (PPP). Triangular arbitrage involves exploiting pricing discrepancies in the foreign exchange market, while the international Fisher effect (IFE) states that the nominal interest rate differential between two countries equals the expected percentage change in the exchange rate over the same period. Interest rate parity (IRP) suggests that the difference in interest rates between two countries should reflect the expected change in exchange rates.

Question 3

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 4

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 answer of The following regression analysis was conducted for...

Question 5

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 takes into account market imperfections that can affect the prices of goods and services and therefore impact exchange rates, such as transportation costs, tariffs, and quotas. This approach to PPP attempts to account for these factors in order to establish a more accurate relationship between inflation rates and exchange rate changes.

Question 6

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 7

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

Accepted Answer

Interest rate parity is the theory that the difference in interest rates between two currencies determines the exchange rate between them. Purchasing power parity is the theory that the exchange rate between two currencies should equal the ratio of the price levels in the two countries. While interest rate parity can be influenced by factors such as inflation expectations, it does not necessarily rely on purchasing power parity holding true. Therefore, interest rate parity can hold even if purchasing power parity does not hold.

Question 8

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. The other choices are incorrect because they refer to different concepts. Purchasing power parity (PPP) refers to the idea that the exchange rate between two currencies should adjust to reflect changes in price levels between the two countries. Triangular arbitrage involves exploiting pricing inconsistencies in the currency market. The international Fisher effect (IFE) suggests that the expected change in the exchange rate between two countries is equal to the difference in their nominal interest rates.

Question 9

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 interest rate differential between two countries. The international Fisher effect states that the difference between the nominal interest rate and the expected inflation rate should be equal across countries. If both of these theories hold, a foreign currency with a relatively higher interest rate should have a forward discount, as the market expects the currency to depreciate to offset the higher interest rate. Therefore, option A is correct.

Question 10

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. IRP states that the difference between the interest rates of two countries should be equal to the percentage difference between their respective currencies’ forward and spot exchange rates. This can be calculated using interest rate and exchange rate data that exists at one specific point in time. On the other hand, purchasing power parity (PPP) and international Fisher effect (IFE) require data collected over a period of time.

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

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 13

Assume that the inflation rate in Singapore is 3%, while the inflation rate in the U.S. is 8%. According to PPP, the Singapore dollar should ____ by ____%.

Accepted Answer

According to Purchasing Power Parity (PPP), the currency of the country with the lower inflation rate (Singapore) should appreciate relative to the currency of the country with the higher inflation rate (U.S.). The appreciation rate is calculated as (1 + inflation rate of U.S.) / (1 + inflation rate of Singapore) - 1, which equals approximately 4.85%.

Question 14

The inflation rate in the U.S. is 3%, while the inflation rate in Japan is 10%. The current exchange rate for the Japanese yen (¥) is $0.0075. After supply and demand for the Japanese yen has 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 U.S. is...

Question 15

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

Accepted Answer

The answer of Which of the following is not true...

Question 16

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

Accepted Answer

Research suggests that deviations from PPP are reduced in the long run, indicating a tendency towards convergence in exchange rates. However, PPP may not hold in the short run due to factors such as transaction costs and incomplete adjustment of prices.

Question 17

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 U.S. According to purchasing power parity (PPP), this will result in a(n) ____ of the New Zealand dollar (NZ$).

Accepted Answer

Higher U.S. inflation makes U.S. goods more expensive relative to New Zealand goods, leading U.S. consumers to increase imports from New Zealand. Conversely, New Zealand consumers will reduce imports from the U.S. due to relatively higher prices. According to PPP, this will lead to an appreciation of the New Zealand dollar.

Question 18

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 suggests that the exchange rate percentage change should be approximately equal to the differential in nominal interest rates between two countries, not income levels.

Question 19

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

Accepted Answer

Empirical studies have shown that deviations from PPP tend to decrease over time, suggesting that currencies eventually converge to a common level of purchasing power. However, this convergence process may take years or even decades to occur fully.

Question 20

The interest rate in the U.K. is 7%, while the interest rate in the U.S. is 5%. The spot rate for the British pound is $1.50. According to the international Fisher effect (IFE), the British pound should adjust to a new level of:

Accepted Answer

According to the IFE, the exchange rate should adjust in such a way that the interest rate differential is equalized by the expected change in exchange rates. Thus, the expected change in the exchange rate between the U.K. and the U.S. can be calculated as follows: (1 + 0.07)/(1 + 0.05) - 1 = 0.0191 or 1.91%. Therefore, the new exchange rate between the British pound and the U.S. dollar should be: $1.50 x (1 + 0.0191) = $1.47.

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

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

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

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

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:

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.

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

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

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?

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.

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

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.

Assume that the inflation rate in Singapore is 3%, while the inflation rate in the U.S. is 8%. According to PPP, the Singapore dollar should by %.

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

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

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

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.

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

The interest rate in the U.K. is 7%, while the interest rate in the U.S. is 5%. The spot rate for the British pound is $1.50. According to the international Fisher effect (IFE) , the British pound should adjust to a new level of:

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

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

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

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

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:

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.

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

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

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?

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.

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

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.

Assume that the inflation rate in Singapore is 3%, while the inflation rate in the U.S. is 8%. According to PPP, the Singapore dollar should ____ by ____%.

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

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

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

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.

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

The interest rate in the U.K. is 7%, while the interest rate in the U.S. is 5%. The spot rate for the British pound is $1.50. According to the international Fisher effect (IFE) , the British pound should adjust to a new level of:

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

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:

Assume that the inflation rate in Singapore is 3%, while the inflation rate in the U.S. is 8%. According to PPP, the Singapore dollar should by %.