Question 1

If a country sets a pegged exchange rate that is above the equilibrium exchange rate, how can the country maintain the peg?

Accepted Answer

When a country sets a pegged exchange rate above the equilibrium rate, it means the domestic currency is overvalued. To maintain this peg, the country can buy its own currency, using its foreign reserves, to reduce the supply of the domestic currency in the market, thereby supporting its higher value.

Question 2

China began pegging its currency, the yuan, to the U.S.dollar in 1994.Because the yuan has been ________ at the pegged exchange rate, the Chinese government ________ its reserves of U.S.dollars as the government purchased more ________ to maintain the pegged exchange rate.

Accepted Answer

The question states that the yuan has been pegged to the U.S. dollar, which means that the exchange rate has been fixed at a certain level. Since China is ultimately responsible for maintaining the exchange rate, it needs to buy or sell currencies as necessary to keep the exchange rate stable. If the yuan is undervalued relative to the U.S. dollar, then China can buy U.S. dollars to keep the exchange rate fixed, which means that China's reserves of U.S. dollars will increase. Therefore, choice A is the correct answer.

Question 3

How were countries whose industries competed with Chinese industry affected by a yuan that was pegged to the dollar?

Accepted Answer

Countries whose industries competed with Chinese industry were affected by a yuan that was pegged to the dollar because the undervaluation of the yuan at the pegged exchange rate resulted in Chinese exports remaining higher than they would have been if the exchange rate was allowed to float freely. This gave Chinese industries an unfair advantage and made it difficult for foreign competitors to compete with Chinese products.

Question 4

In the late 1990s, firms in Thailand that had borrowed dollars while the baht was pegged to the dollar faced interest payments that were ________ than they had planned while the Thai government continued trying to defend the peg, because the baht had been pegged ________ the equilibrium exchange rate for the baht.

Accepted Answer

The baht had been pegged above the equilibrium exchange rate for the baht, so when the baht was no longer pegged to the dollar, it depreciated, making the dollar-denominated debt more expensive to service.

Question 5

Figure 15.5  Alt text for Figure 15.5: In figure 15.5, a graph illustrates the quantity of yuan traded against the exchange rate.
Long description for Figure 15.5: The x-axis is labelled, quantity of yuan traded in millions per day.The y-axis is labelled, exchange rate, Canadian dollar against the yuan.Supply curve S, is a straight line which slopes up from the bottom left corner to the top right corner.Demand curve D, is a straight line which slopes down from the top left corner to the bottom right corner.The curves intersect at point A, (600, 0.13).Point A, and unmarked points (800, 0.11), (500, $0.14), (700, $0.14), and (400, 0.11)are all connected to their corresponding values on the x and y-axes with dotted lines.
-Refer to Figure 15.5.Suppose the pegged exchange rate is $0.11/yuan.Because of safety concerns and numerous product recalls, U.S.consumers lower their demand for Chinese products.Using the figure above, this would

Accepted Answer

The answer of Figure 15.5  Alt text for Figure...

Question 6

South Korea suffered a destabilizing speculation in the late 1990s.This had the effect of ________ for the won.South Korean government tried to counteract this by raising interest rates which should have ________ the won.

Accepted Answer

The destabilizing speculation would decrease demand for the won as investors lose confidence, leading to its depreciation. Raising interest rates is a measure to attract investment by offering higher returns, thereby increasing demand for the won.

Question 7

Although the pegged exchange rate between the yuan and the U.S.dollar has undervalued the yuan, China has been reluctant to abandon the peg for fear that abandoning the peg would

Accepted Answer

Abandoning the pegged exchange rate, which keeps the yuan artificially low, would make Chinese goods more expensive abroad, thus reducing exports and potentially slowing economic growth.

Question 8

Thailand's experience with pegging the baht to the dollar failed because the baht was ________ relative to the dollar, and China's experience with pegging the yuan to the dollar has run into difficulties because the yuan has been ________ relative to the dollar.

Accepted Answer

Thailand's experience with pegging the baht to the dollar failed because the baht was overvalued relative to the dollar, which made its exports more expensive and less competitive. In contrast, China's experience with pegging the yuan to the dollar has run into difficulties because the yuan has been undervalued relative to the dollar, which has created trade imbalances and accusations of currency manipulation. Therefore, the best choice is D as both situations involved a currency being pegged at an inappropriate value relative to the dollar, but in opposite directions.

Question 9

Destabilizing speculation refers to

Accepted Answer

Destabilizing speculation refers to the intentional selling of a country's currency by investors in anticipation of buying it back later at a lower price, which can lead to currency depreciation and economic instability.

Question 10

In the late 1990s, when foreign investors in Thailand began to realize that Thailand could not maintain its peg to the dollar indefinitely, they began to sell off their investments in Thailand and exchange the baht they received for dollars.This reduction in investment by foreigners is termed

Accepted Answer

The reduction in investment by foreigners due to a loss of confidence in Thailand's ability to maintain its peg to the dollar is known as capital flight. This phenomenon often leads to a sharp depreciation in the value of the local currency and can cause significant economic instability. None of the other options are directly relevant to this scenario.

Question 11

If purchasing power parity tells us that if the exchange rate is a pound for a dollar, then price of a haircut in London should cost the same as a haircut in Toronto.

Accepted Answer

Purchasing power parity (PPP) suggests that in the long run, exchange rates should adjust so that identical goods cost the same in different countries when priced in a common currency. However, it doesn't imply that specific services like haircuts, which are influenced by local factors, will have the same price.

Question 12

A depreciation of a country's currency always lowers the domestic firm's profits.

Accepted Answer

A depreciation of a country's currency can lower the profits of domestic firms that rely heavily on imported goods, as their costs will increase. However, it can also benefit domestic firms that export goods, as their products will become relatively cheaper on the global market. Therefore, it does not always lower a domestic firm's profits.

Question 13

In the late 1990s, as foreign investors began to sell off investments they had made in Thailand, they traded in their baht for dollars.The result of this was

Accepted Answer

The selling off of investments and exchanging of baht for dollars would create an increased supply of baht in the foreign exchange market, causing a decrease in the value of the baht due to the law of supply and demand. Thus, there would be pressure for the value of the baht to decline.

Question 14

An easy way to determine if a currency is undervalued at a point in time is to use the model of purchasing power parity.

Accepted Answer

The answer of An easy way to determine if a...

Question 15

One reason purchasing power parity does not exactly hold is that many goods are not traded internationally.

Accepted Answer

Not all goods are traded internationally, which means that their prices may not be comparable across different currencies and countries. This can result in deviations from purchasing power parity.

Question 16

The fact that the prices for McDonald's Big Mac sandwich are not the same around the world illustrates one reason why purchasing power does not hold: Many goods are not traded internationally.

Accepted Answer

The prices of goods are influenced by factors such as local production costs, taxes, and consumer demand, which can vary between countries. As a result, prices for the same product can differ significantly from one country to another. This illustrates that purchasing power does not hold universally because it is based on the assumption that goods are traded at the same price everywhere. However, many goods are not traded internationally and therefore their prices can diverge significantly between countries.

Question 17

Under pressure from Japan, the United States and Europe, China announced it switched from pegging the yuan against the dollar to linking the value of the yuan to a 'basket' of currencies.The result of this change was

Accepted Answer

Switching from pegging the yuan against the dollar to linking it to a basket of currencies resulted in a slight increase in the value of the yuan relative to the dollar.

Question 18

Which of the following did not help Thailand maintain its peg against the dollar in the 1990s?

Accepted Answer

Foreigners selling off new investments in Thailand would have put downward pressure on the baht, making it more difficult for Thailand to maintain its peg against the dollar. The other options, borrowing from the IMF, buying baht on the foreign exchange market, and increasing domestic interest rates, were all measures used by Thailand to try to support the baht's value and maintain its peg.

Question 19

Why would the Chinese government want the yuan to worth less than its market determined value?

Accepted Answer

An undervalued currency gives Chinese exporters an advantage over foreign competitors as their products become cheaper on the global market. This can increase demand for Chinese goods and boost their economy.

Question 20

Both countries involved in a pegging of currency must agree to the terms of the pegging.

Accepted Answer

Currency pegging is typically a unilateral decision by one country to fix its exchange rate to the currency of another country, and does not require formal agreement from the country whose currency is being pegged to.

Quiz 15: The International Financial System