Question 1

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 2

What three real-world complications keep purchasing power parity from being a complete explanation of exchange rate fluctuations in the long run? Explain.

Accepted Answer

The answer of What three real-world complications keep purchasing power...

Question 3

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 answer of South Korea suffered a destabilizing speculation in...

Question 4

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

Accepted Answer

A pegged exchange rate between the yuan and the dollar kept the yuan undervalued compared to what it would have been if left to a free-floating system. This allowed Chinese exports to remain relatively cheap, making it harder for competing firms from other countries to compete with Chinese industry.

Question 5

South Korea recovered from the exchange rate crisis much more quickly than Thailand and Indonesia.Which of the following is not a reason why South Korea recovered quickly?

Accepted Answer

The answer of South Korea recovered from the exchange rate...

Question 6

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

Accepted Answer

Purchasing power parity assumes that the same goods can be purchased for the same price in different countries. However, many goods are not traded internationally, which can affect their prices and make it difficult to equate purchasing power across different countries. Therefore, purchasing power parity may not hold exactly in practice.

Question 7

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

When foreign investors begin to sell off investments and exchange their baht for dollars, there is an increase in the supply of the baht in foreign exchange markets. This increase in supply puts pressure on the value of the baht to decline. Therefore, choice A is the correct answer.

Question 8

Destabilizing speculation refers to

Accepted Answer

Destabilizing speculation refers to actions taken by investors who sell a country's currency in anticipation of buying it back later at a lower price. This can lead to a rapid depreciation of the currency and can destabilize the country's economy.

Question 9

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

Accepted Answer

A depreciation of a country's currency can actually benefit domestic firms as it makes their exports more competitive and increases demand for their products. However, it can also increase the cost of imported materials and goods, which can reduce profits for firms that rely on imports. Therefore, the effect of a currency depreciation on domestic firm's profits is not always negative.

Question 10

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 failed because the baht was overvalued (worth more than its true value) relative to the dollar, while China's experience has run into difficulties because the yuan has been undervalued (worth less than its true value) relative to the dollar. Therefore, the best choice is D, with the baht being overvalued and the yuan being undervalued.

Question 11

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.

Question 12

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

Accepted Answer

Since the yuan has been undervalued at the pegged exchange rate, the government would need to increase its reserves of dollars to purchase more dollars to maintain the pegged exchange rate.

Question 13

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

When foreign investors sell off their investments and exchange the local currency for a more stable currency, it is called capital flight. This is usually the result of a lack of confidence in the local currency and can lead to a currency crisis.

Question 14

The "Big Mac Theory of Exchange Rates" tests the accuracy of purchasing power parity theory.In July 2011,the Economist reported that the average price of a Big Mac in the United States was $4.07.In Mexico,the average price of a Big Mac at that time was 32 pesos.If the exchange rate between the dollar and the peso was 13.60 pesos per dollar,how would purchasing power parity predict the exchange rate will change in the long run? Support your answer graphically.

Accepted Answer

The answer of The "Big Mac Theory of Exchange Rates"...

Question 15

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 answer of Firms in Thailand that had borrowed dollars...

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 statement is true. The prices of many goods, including the Big Mac sandwich, vary around the world due to factors such as local production costs, taxes, and import/export regulations. Differences in prices can impact purchasing power and illustrate why it may not hold across different countries.

Question 17

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

Accepted Answer

The answer of Although the pegged exchange rate between the...

Question 18

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

By linking the value of the yuan to a basket of currencies rather than solely to the dollar, the value of the yuan increased slightly relative to the dollar. This change made the exchange rate more flexible and allowed for greater responsiveness to changes in demand and supply in the foreign currency market. However, it did not result in a dramatic increase in the value of the yuan or a significant reduction in the trade imbalance between the United States and China.

Question 19

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 New York.

Accepted Answer

The answer of If purchasing power parity tells us that...

Question 20

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 decrease demand for baht and put pressure on the peg. The other options were strategies used by Thailand to maintain the peg.

Quiz 30: The International Financial System