Deck 17: America in the World: International Finance

Question 1

What is meant by a floating exchange rate? A fixed exchange rate?

Answer 1

A floating exchange rate, also known as a flexible exchange rate, is a type of exchange rate regime in which the value of a currency is allowed to fluctuate according to the foreign exchange market. The value of the currency is determined by supply and demand factors, which include interest rates, inflation rates, trade balances, economic performance, and other market forces. Governments and central banks may intervene in the market occasionally to stabilize or influence the currency's value, but generally, the currency's value is left to be determined by market dynamics.

In contrast, a fixed exchange rate, also known as a pegged exchange rate, is a regime where a country's currency value is tied or pegged to another major currency like the US dollar, euro, or a basket of currencies, or to a measure of value such as gold. The central bank of the country with a fixed exchange rate regime will buy and sell its own currency on the foreign exchange market in return for the currency to which it is pegged to maintain its currency's value within a narrow band. This provides stability in exchange rates, which can facilitate international trade and investment, but it also requires the country to maintain large reserves of foreign currency to manage its exchange rate and can limit the central bank's ability to adjust monetary policy to respond to domestic economic conditions.

Question 2

Use diagrams to illustrate appreciation and depreciation of a currency when the demand for it changes on foreign exchange markets.

Answer 2

Appreciation and depreciation of a currency can be illustrated using diagrams to show how changes in demand for the currency affect its value on foreign exchange markets.

When there is an increase in demand for a currency, its value appreciates. This can be shown on a diagram by shifting the demand curve for the currency to the right. As demand increases, the equilibrium exchange rate rises, leading to a higher value for the currency in terms of other currencies.

Conversely, when there is a decrease in demand for a currency, its value depreciates. This can be illustrated by shifting the demand curve for the currency to the left. As demand decreases, the equilibrium exchange rate falls, resulting in a lower value for the currency in terms of other currencies.

In both cases, the diagrams demonstrate how changes in demand for a currency impact its value on foreign exchange markets. Appreciation and depreciation of a currency are important concepts in international trade and finance, and understanding how they are affected by changes in demand is crucial for analyzing and predicting currency movements.

Question 3

What effect does currency appreciation and depreciation have upon exports and imports? Explain.

Answer 3

Currency appreciation and depreciation have significant effects on exports and imports.

When a country's currency appreciates, it becomes stronger relative to other currencies. This means that the country's goods and services become more expensive for foreign buyers, leading to a decrease in exports. On the other hand, imports become cheaper for domestic consumers, leading to an increase in imports.

Conversely, when a country's currency depreciates, it becomes weaker relative to other currencies. This makes the country's goods and services cheaper for foreign buyers, leading to an increase in exports. At the same time, imports become more expensive for domestic consumers, leading to a decrease in imports.

In summary, currency appreciation tends to decrease exports and increase imports, while currency depreciation tends to increase exports and decrease imports. These effects can have significant implications for a country's trade balance and overall economic performance.

Question 4

Why do flexible exchange rates pose some risks for those parties engaged in international transactions? What types of contracts are used to hedge against these risks?

Question 5

The present system of international trade is based upon fixed exchange rates

Question 6

The United States goods balance of trade has been in surplus since 1976.

Question 7

The United States balance on the income account has been in surplus for decades.

Question 8

Direct foreign investment in the United States tends to worsen the goods balance of trade.

Question 9

A trade deficit occurs when imports exceed exports.

Question 10

The Bretton Woods system attempted to administer fixed exchange rates among currencies.

Question 11

A currency has depreciated when its value in terms of other currencies has fallen in the international exchange market.

Question 12

Other things being equal, an increase in the demand for a currency in the foreign exchange market will cause its exchange rate to fall.

Question 13

The balance on the current account reports the value of all currently produced goods and services that were imported and exported as well as net transfer payments and the balance on income.

Question 14

The rise to prominence of the use of financial derivatives prompted the development of a separate international transactions account to account for transactions in derivatives.

Question 15

A system of flexible exchange rates can be expected to correct a country's balance of payments deficit through:

A) a decline in the value of the country's currency relative to the currencies of other nations
B) a rise in the value of the country's currency relative to the currencies of other nations
C) the receipt of gold from countries with the surplus
D) declining import prices

Question 16

The relatively fixed exchange rates of the Bretton Woods systems were maintained because:

A) the dollar was backed by gold
B) the dollar could not be redeemed for gold
C) all countries had roughly equal endowments of gold
D) the world had opted for a bimetallic system

Question 17

President Nixon had to suspend gold conversion and effectively eliminate the fixed exchange rates of the Bretton Woods system because:

A) he wanted the gold for himself
B) the United States had no gold
C) there had been an excessive drain of United States gold reserves
D) Nixon was confused about international economics
E) the world was moving toward a silver standard

Question 18

In a system of flexible exchange rates, if the price level in Japan remains stable while the United States experiences substantial inflation:

A) the yen will depreciate against the dollar
B) the dollar will depreciate against the yen
C) the value of each currency will remain unchanged
D) no prediction can be made

Question 19

The financial account of the balance of payments:

A) records transactions in financial assets and liabilities
B) reports the exchange value of all currently produced goods and services
C) measures investment income
D) is not part of the balance of payments

Question 20

When the United States experiences a trade deficit:

A) exports of goods and services exceed imports of goods and services
B) federal revenues are less than expenditures
C) there are not enough workers in a particular occupation
D) imports of goods and services exceed exports of goods and services

Question 21

The balance on the current account:

A) has been a positive figure for the United States since 1983
B) measures inflows and outflows of real and financial capital
C) has served as a macroeconomic automatic stabilizer
D) has been in deficit for the United States after 1991

Question 22

Flexible exchange rates mean that:

A) currency exchange rates fluctuate according to demand and supply in the foreign exchange market
B) a currency trades for a fixed number of units of another currency
C) all countries' currencies are pegged to gold
D) governments require convergence to a narrow band of exchange rates
E) unscrupulous currency traders at big investment banks rig exchange rates to profit

Question 23

In a regime of flexible exchange rates, an increase in the demand for dollars relative to the euro would mean that:

A) fewer euros are required to buy the dollar
B) more euros are required to buy a dollar
C) more dollars are required to buy the euro
D) the euro will appreciate
E) vacationing in the eurozone is to be avoided

Question 24

Generally speaking, stronger growth in the United States will:

A) have no effect on the exchange rate for the dollar
B) cause the dollar to depreciate
C) cause the dollar to appreciate
D) raise tariffs
E) be met by an oil embargo

Question 25

The balance of payments:

A) equals real GDP
B) is divided into the expenditures account and the income account
C) is the difference between merchandise exports and imports
D) is an accounting statement of payments made and payments received
Between one country and other countries
E) is a declining balance card issued by the International Monetary Fund to member countries

Question 26

The "dark matter" proposition:

A) is used to explain the U.S. deficit in income in the balance of payments while having a negative net international investment position
B) suggests that the U.S. exports inferior managerial knowhow, which bolsters income flows in return to the United States
C) states that greater returns are earned on assets abroad
D) is used to explain the U.S. surplus in income in the balance of payments while having a negative net international investment position
E) postulates that experiments at CERN might be mysteriously affecting international transactions

Question 27

Which of the following is a determinant of a currency's exchange rate?

A) growth in real GDP
B) the change in relative prices between trading partners
C) changes in demand for domestic versus foreign goods
D) relative real interest rates between trading partners
E) all of the above

Question 28

Currency forward, futures, and options contracts:

A) evolved because of the need to hedge against fluctuating exchange rates
B) ceased to be used after fixed exchange rates were abandoned
C) were developed by currency speculators for the sole purpose of establishing the means for currency traders and brokers to get rich
D) none of the above

Question 29

Which of the following statement is true?

A) The United States has run a current account deficit since the early 1990s.
B) The United States has run a negative balance in goods and services since the early 1990s.
C) The United States has run a positive balance on income for several decades.
D) all of the above
E) none of the above