Deck 19: What Determines Exchange Rates

Question 1

The _____ approach to exchange rates emphasizes the role of portfolio repositioning by international financial investors.

A)elasticity
B)asset market
C)monetary
D)balance of payments

Answer 1

B

Question 2

Which of the following is NOT linked together by uncovered interest parity?

A)The domestic interest rate
B)The foreign interest rate
C)The current spot exchange rate
D)The current forward exchange rate

Answer 2

D

Question 3

"High-income countries have a price level which is much higher than the low-income countries." Which of the following is most likely to explain this price differential?

A)With the development process of a nation, its productivity in making traded goods rises much faster than that in making non-traded goods.
B)Traded goods are much more sensitive to the income levels than are non-traded goods and services.
C)Prices of non-traded goods and services are relatively stable across high and low-income nations.
D)Labor involved in production of non-traded goods and services in high-income nations receive lower wages than the labor producing traded goods.

Answer 3

A

Question 4

If investors expect a decrease in the value of the Thai baht vis-à-vis other currencies, their actions will cause:

A)a decrease in Thai interest rates.
B)the expected depreciation to occur much faster.
C)the Thai baht to appreciate immediately.
D)a large inflow of foreign capital into Thailand.

Question 5

The law of _____ states that a product that is easily and freely traded in a perfectly competitive global market should cost the same everywhere once the prices at different places are expressed in the same currency.

A)international trade
B)one price
C)diminishing returns
D)relative PPP

Question 6

If the expected future spot exchange rate value of the foreign currency decreases, with the interest rate differential unchanged, the current spot exchange rate value of the domestic currency:

A)increases.
B)decreases.
C)remains unchanged.
D)overshoots.

Question 7

The law of one price works better if:

A)transportation costs for the product are close to zero.
B)there is incomplete information.
C)there are few buyers and sellers.
D)the governments of the trading countries implement adequate trade barriers.

Question 8

Absolute PPP holds for a product bundle if:

A)the law of diminishing returns holds for all the goods in the bundle.
B)the goods are traded with minimum transportation costs.
C)there exists free trade in all the commodities.
D)the law of one price holds for each of the goods in the bundle.

Question 9

The exchange rate value of a foreign currency is _____ in the short run by a rise in the expected future spot exchange rate value.

A)raised
B)lowered
C)made volatile
D)not affected

Question 10

A decrease in the foreign interest rate relative to the domestic interest rate _____ the exchange rate value of a foreign currency in the short run.

A)raises
B)lowers
C)does not affect
D)causes fluctuations in

Question 11

_____ purchasing power parity states that a bundle of tradable products will have the same cost in different countries if the cost is stated in the same currency.

A)Full
B)Partial
C)Relative
D)Absolute

Question 12

Which of the following statements is true?

A)If the domestic interest rate rises, there will be international financial repositioning toward domestic-currency assets, thereby causing the domestic currency to appreciate.
B)If the expected future spot exchange rate value of the foreign currency decreases, there will be international financial repositioning toward foreign-currency assets, thereby causing the domestic currency to depreciate.
C)If foreign interest rates increase, the domestic interest rate remaining unchanged, there will be international financial repositioning toward domestic-currency assets and the domestic currency will appreciate.
D)If the expected future spot dollar per euro exchange rate increases, there will be international financial repositioning toward the dollar-denominated assets thereby causing the euro to depreciate.

Question 13

If the domestic interest rate decreases, with the foreign interest rate and the expected future spot rate remaining unchanged, the value of the domestic currency vis-à-vis the foreign currency is expected to:

A)increase.
B)decrease.
C)remain unchanged.
D)converge to its PPP value.

Question 14

Other things equal, an expected depreciation in the euro will lead to:

A)an inflow of capital to Europe.
B)an increase in official exchange market intervention by the euro area monetary authorities.
C)a lowering of exports of European goods and services.
D)a decrease in the demand for euro-denominated financial assets.

Question 15

The asset market approach to exchange rate determination seeks to predict:

A)the forward exchange rate premiums.
B)the long-run trends in exchange rates.
C)the possibility of retaining a pegged exchange rate by the government.
D)the short-term pressures on exchange rates.

Question 16

There is more empirical evidence in the literature to suggest that:

A)the absolute version of purchasing power parity holds in the short run.
B)the relative version of purchasing power parity holds in the short run.
C)the absolute version of purchasing power parity holds in the long run.
D)the relative version of purchasing power parity holds in the long run.

Question 17

Everything else remaining unchanged, an increase in interest rates in the United States is most likely to result in:

A)depreciation of the dollar.
B)outflows of capital from the United States.
C)capital inflows into the United States.
D)a decrease in the demand for dollar-denominated financial assets.

Question 18

The _____ effect suggests that speculations can sometimes be destabilizing as the actions of the international investors move the exchange rate away from the long-run equilibrium value consistent with fundamental economic influences.

A)bandwagon
B)overshooting
C)exchange rate
D)arbitrage

Question 19

The law of one price works well for _____ traded commodities.

A)all
B)rarely
C)heavily
D)domestically

Question 20

_____ purchasing power parity states that the difference between changes over time in product-price levels in two countries will be offset by the change in the exchange rate over this time.

A)Full
B)Partial
C)Relative
D)Absolute

Question 21

Exchange rate overshooting suggests that an unexpected increase in the domestic money supply by 10 percent will cause the short-run exchange rate value of the domestic currency to:

A)depreciate by more than 10 percent.
B)depreciate by less than 10 percent.
C)appreciate by more than 10 percent.
D)appreciate by less than 10 percent.

Question 22

Based on PPP and the quantity theory of money, everything else remaining unchanged, if Japan's real income rises relative to real income in the U.S., there would be a(n):

A)appreciation of the dollar.
B)appreciation of the yen.
C)interest rate parity.
D)decrease in the demand for yen in the foreign exchange market.

Question 23

The _____ exchange rate is the market rate between two currencies.

A)nominal bilateral
B)real bilateral
C)nominal effective
D)real effective

Question 24

Suppose that U.S. prices rise 4 percent over the next year while prices in Mexico rise 6 percent. According to the purchasing power parity theory of exchange rates, which of the following should happen?

A)The dollar will depreciate
B)The peso will be worth 1.5 dollars in the foreign exchange market
C)The peso will depreciate
D)The dollar will be worth 1.5 pesos in the foreign exchange market

Question 25

The quantity theory of the demand for money states that a country's money demand is proportional to:

A)the domestic interest rate.
B)the level of domestic consumption.
C)the exchange rate.
D)the money value of gross domestic product.

Question 26

The weighted average exchange rate value of a country's currency is called the _____ exchange rate.

A)nominal bilateral
B)real bilateral
C)nominal effective
D)real effective

Question 27

Overshooting occurs when exchange rates:

A)become volatile suddenly.
B)continually diverge away from the long-run equilibrium.
C)adjust faster in the long-run than they do in the short-run.
D)adjust faster in the short-run than they do in the long-run.

Question 28

Economists believe that the _____ determines the price level in the long run.

A)money supply
B)asset market approach
C)exchange rate
D)marginal tax rate

Question 29

Exchange rate overshooting occurs:

A)because interest rates are sticky.
B)because product prices are sticky in the short run.
C)only if investors and speculators react irrationally to any change in the monetary policies of the domestic or the foreign government.
D)when one of the nations has a very high rate of inflation.

Question 30

The monetary approach predicts that an increase in the money supply by 12 percent in both China and Thailand will:

A)result in an appreciation of the Thai baht against the Yuan.
B)result in a depreciation of the Thai baht against the Yuan.
C)have no effect on the baht per Yuan exchange rate.
D)lower the volume of trade between Thailand and China.

Question 31

The _____ exchange rate incorporates both the market exchange rate and the product price levels for two countries.

A)nominal bilateral
B)real bilateral
C)nominal effective
D)real effective

Question 32

Which of the following is an immediate effect of an increase in money supply by the European Central Bank by 10 percent?

A)There will be an inflow of foreign capital in the countries belonging to the European Union.
B)The expected exchange rate value of the foreign currencies vis-à-vis the Euro will increase.
C)The interest rate in the EU countries will increase.
D)The product prices in the EU countries will decline drastically.

Question 33

Other things equal, the domestic currency _____ when the domestic money supply increases relative to the foreign money supply.

A)depreciates in the long-run
B)appreciates in the long-run
C)remains unchanged in the long-run.
D)appreciates in the short-run but returns to its initial value in the long-run.

Question 34

The _____ approach to exchange rates emphasizes the importance of the supply and demand for money as a key to understanding the determinants of exchange rates.

A)purchasing-power-parity
B)asset market
C)monetary
D)balance of payments

Question 35

Suppose the average price of a Big Mac in the United States is $3.50 while in Japan the average price is 400 yen. If the market exchange rate is that 1 dollar is exchanged for 100 yen, the purchasing power parity model of exchange rate determination suggests that:

A)the yen is overvalued.
B)the yen value is about correct.
C)the price of a Big Mac in Japan will rise.
D)the dollar will depreciate against the yen.

Question 36

If a strong, persistent trend in the exchange rate appears to be inconsistent with any form of economic fundamentals, it is called:

A)exchange rate parity.
B)a speculative bubble.
C)overshooting.
D)uncovered speculation.

Question 37

Given the combination of PPP with quantity theory equations, which of the following statements is true?

A)Everything else remaining unchanged, the price of the foreign currency (e) would be reduced by an increase in the relative size of the money supply in the domestic economy.
B)Everything else remaining unchanged, the price of the foreign currency (e) would be raised by an increase in the relative size of foreign production.
C)As long as the money supplies in the two countries are the same, the exchange rate will be equal to one
D)The exchange rate would remain unaffected as long as the relative growth in productivity between the two nations remains constant, even if the relative money supply varies between the two economies.

Question 38

According to the relative version of purchasing power parity, when the inflation differential between the foreign country and the home country is positive:

A)the domestic currency tends to depreciate.
B)the domestic currency tends to appreciate.
C)the inflation rate in the home country tends to decrease.
D)the inflation rate in the home country overshoots.

Question 39

Everything else fundamental remaining unchanged, the monetary approach predicts that a 5 percent cut in the money supply by the Fed will result in:

A)inflation in the U.S.economy.
B)a decrease in the market rate of interest in the U.S.
C)an increase in foreign investments by the Americans.
D)an appreciation of the U.S.dollar vis-à-vis other currencies.

Question 40

The phenomenon of overshooting is based on the existence of:

A)covered interest parity.
B)irrational investor behavior.
C)sticky prices and the belief that PPP and the monetary approach hold in the long-run.
D)perfectly competitive global markets and flexible prices.

Question 41

The following current rates have been observed:
Spot exchange rate: $1.25/SFr
Expected future spot rate in 90 days: $1.2625/SFr
Annual interest rate on 90-day U.S.-dollar-denominated bonds: 10%
Annual interest rate on 90-day SFr-denominated bonds: 6%
At these initial rates, does uncovered interest parity hold? Then, if the U.S. money supply unexpectedly increases by 10 percent, what is likely to be the effect on the spot exchange rate? In your answer assume that the asset market clears faster than the goods market (i.e. prices adjust slowly and interest rates adjust quickly). Also in your answer address short-run changes in the exchange rate as well as long-run changes.

Question 42

Why does exchange rate overshooting occur?

Question 43

The asset market approach seeks to explain exchange rates by focusing on demands and supplies of national moneys.

Question 44

Why is our ability limited in using economic fundamentals to predict exchange rate movements for short periods into the future? Why is there some success in predicting exchange rates in the long run?