Question 1

What approach assumes that assets are imperfect substitutes internationally because investors perceive foreign exchange risk to be attached to foreign assets?

Accepted Answer

The portfolio-balance approach assumes that assets are imperfect substitutes internationally because investors perceive foreign exchange risk to be attached to foreign assets. This approach emphasizes the role of capital flows in determining exchange rates, and suggests that the demand for a country's assets is primarily based on the attractiveness of its interest rates and economic conditions.

Question 2

In general, the basic Monetary Approach to Exchange Rate MAER) does not capture the short run volatility of:

Accepted Answer

The basic MAER assumes that exchange rates adjust in the long run to changes in the money supply, prices, and other economic variables. However, it does not account for the short term fluctuations in exchange rates which can be influenced by various factors such as speculation, geopolitical events, and unexpected changes in economic policies. Therefore, short term volatility in exchange rates cannot be captured by the basic MAER.

Question 3

If the portfolio balance approach is true then which of the following will directly lead to changes in the exchange rate?

Accepted Answer

C

Question 4

According to the general equilibrium approach of open-economy macroeconomic model, if South Korea had a significant technological progress in the past decade, which allowed them to produce more goods at much lower prices than the rest of the world, then we would expect the Korean won to __________.

Accepted Answer

The answer of According to the general equilibrium approach of...

Question 5

The following example supports which extension to the Monetary Approach to Exchange rates: The chairman of a central bank announces a new monetary policy. Immediately, there is a change in the exchange rate.

Accepted Answer

The News approach to exchange rates suggests that expectations about future monetary policies can cause immediate changes in exchange rates. In this example, the announcement of a new monetary policy by the central bank chairman leads to an immediate change in the exchange rate, illustrating how news or expectations about future policies can impact exchange rates right away.

Question 6

If a country has a trade surplus, the domestic holdings of foreign currency will tend to _______ and the foreign currency will _______.

Accepted Answer

If a country has a trade surplus, it means that it is exporting more goods and services than importing. This results in an inflow of foreign currency into the country's economy. As the domestic holdings of foreign currency increase, the demand for the domestic currency decreases. This puts downward pressure on the domestic currency's exchange rate against foreign currencies, causing it to depreciate. Therefore, the domestic holdings of foreign currency will tend to increase while the foreign currency will tend to depreciate.

Question 7

___________ assumes that domestic and foreign bonds are imperfect substitutes.

Accepted Answer

The portfolio-balance approach assumes that domestic and foreign bonds are imperfect substitutes because investors will have a preference for holding assets in their own currency, which will impact the demand and supply of that currency in the foreign exchange market. The other options do not make this assumption.

Question 8

The following example supports which extension to the Monetary Approach to Exchange rates: Suppose the money supply increases. The initial change of the spot price exceeds that of its long-run value.

Accepted Answer

The statement describes the phenomenon of overshooting, which is a short-term movement of the exchange rate that exceeds the level consistent with long-term fundamentals in response to a monetary shock. This extension to the Monetary Approach to Exchange rates recognizes that exchange rates may deviate from their long-run equilibrium values in the short run due to imperfect adjustment mechanisms.

Question 9

According to the _______, high exchange rate volatility is explained by the failure of PPP to hold in the short run.

Accepted Answer

The Overshooting approach explains that exchange rate volatility is caused by the short-term failure of the Purchasing Power Parity (PPP) theory to hold.

Question 10

Which of the following is correct about the 'news' approach to exchange rate determination?

Accepted Answer

News affects people's expectations about the future, which can cause high swings in exchange rates. People may react impulsively to news, leading to large fluctuations in exchange rates.

Question 11

If people expect the domestic currency to depreciate against foreign currency in the near future, they will immediately shift from _______ currency to ______ currency, causing an immediate _________ of the foreign currency.

Accepted Answer

When people expect their domestic currency to depreciate, they tend to exchange it for foreign currency, believing the foreign currency will hold its value better or even appreciate. This increased demand for the foreign currency leads to its appreciation.

Question 12

The following example supports which extension to the Monetary Approach to Exchange rates: Due to changes in the pricing of risk premiums, investors adjust holdings of foreign assets causing an appreciation of domestic currency.

Accepted Answer

The statement refers to the Portfolio balance approach, which emphasizes the role of asset demand in exchange rate determination. Under this approach, changes in risk premiums can affect the demand for foreign assets, leading to an appreciation of the domestic currency.

Question 13

If the currency substitution approach is true, then a change to domestic money supply that causes currency depreciation could mean:

Accepted Answer

The currency substitution approach suggests that individuals may switch to foreign currencies or substitute currencies in response to a decrease in the value of domestic currency. Therefore, a change in domestic money supply that causes currency depreciation could lead to further depreciation as individuals switch to substitute currencies.

Question 14

According to the ________, if the cost of holding one currency rises relative to the cost of holding another, then demand will shift to the lower relative cost currency.

Accepted Answer

The Currency substitution approach suggests that if the cost of holding one currency increases compared to another, investors will shift their demand towards the currency with the lower relative cost. This approach emphasizes the choice between different currencies based on their holding costs.

Question 15

The following example supports which extension to the Monetary Approach to Exchange rates: Due to a sudden increase in American productivity, the U.S. dollar depreciated.

Accepted Answer

The answer of The following example supports which extension to...

Question 16

When a high degree of currency substitution exists, in order to prevent currencies from becoming too variable:

Accepted Answer

When a high degree of currency substitution exists, countries need international coordination of monetary policy in order to prevent currencies from becoming too variable. Without such coordination, countries may pursue policies that lead to competitive devaluations, which can destabilize the global economy. In order to avoid this, countries must work together to harmonize their monetary policies, so that they are mutually reinforcing and promote stable exchange rates.

Question 17

The following example supports which extension to the Monetary Approach to Exchange rates: The announcement of a new trade deal between South Korea and Japan, lead investors to predict that Japan may be a path to a trade deficit. Thus, the Japanese yen saw an immediate decline in value.

Accepted Answer

The answer of The following example supports which extension to...

Question 18

According to the ________, the current exchange rate is affected by changes in expectation about future trade flow.

Accepted Answer

The answer of According to the ________, the current exchange...

Question 19

In the ________, changes in exchange rates occur because of changes in tastes or technology and are part of the adjustment to a shock to the world economy.

Accepted Answer

The answer of In the ________, changes in exchange rates...

Question 20

The following example supports which extension to the Monetary Approach to Exchange rates: The cost of holding a U.S. dollar rises relative to the cost of holding U.K. Pounds. The demand shifts away from dollars to Pounds.

Accepted Answer

The scenario describes a situation where individuals shift their preference from holding one currency to another due to changes in holding costs, which aligns with the currency substitution approach. This approach focuses on the choices between different currencies for transactions and reserves, influenced by changes in relative costs or returns.

Quiz 15: Exchange Rates, Interest Rates, and Interest Parity