Question 1

The theory that changes in the exchange rate reflect only changes in the price levels of two countries is called

Accepted Answer

Purchasing power parity theory states that the exchange rate between two countries is determined by the relative prices of goods and services between those countries, leading to equal purchasing power in both countries. This means that changes in the exchange rate reflect changes in the price levels of two countries.

Question 2

Speculators profit by taking risks,while the actions of arbitrageurs involve no risk.

Accepted Answer

The answer of Speculators profit by taking risks,while the actions...

Question 3

Exchange rates

Accepted Answer

Exchange rates fluctuate to equate the quantity of foreign exchange demanded with the quantity supplied. This means that the exchange rate will adjust until the amount of a currency that people want to buy (demand) is equal to the amount that people want to sell (supply). This results in a market-determined exchange rate, which is subject to change based on various economic factors.

Question 4

The purchasing power parity theory helps explain long-run trends in exchange rates,but not short-run fluctuations.

Accepted Answer

The purchasing power parity theory suggests that over the long run, exchange rates will adjust to equalize the prices of identical goods in different countries. However, in the short run, exchange rate fluctuations are influenced by a variety of factors such as interest rates, political events, and market sentiment. Therefore, the theory is more applicable to long-term trends rather than short-term fluctuations.

Question 5

If the same basket of goods costs $400 in the United States and 200 pounds in Britain,then according to the purchasing power parity theory,

Accepted Answer

According to the purchasing power parity theory, the exchange rate should be such that the same basket of goods costs the same amount in both countries when converted to the same currency. Thus, the exchange rate should be such that $400 is equivalent to 200 pounds, which is a rate of $2/pound.

Question 6

The fact that exchange rates are nearly identical in different markets around the world is due to

Accepted Answer

The nearly identical exchange rates in different markets around the world are due to the actions of arbitrageurs who take advantage of price differences in different markets to make profits. They buy low in one market and sell high in another until prices across markets have equalized. This process ensures that exchange rates remain nearly identical across markets.

Question 7

One difference between arbitrageurs and speculators is that

Accepted Answer

Arbitrageurs aim to profit from price discrepancies in different markets while taking very low risks, whereas speculators aim to profit from market fluctuations by taking high risks. Therefore, speculators take more risks than arbitrageurs. The other options are not true for all cases and are therefore incorrect.

Question 8

The purchasing power parity theory

Accepted Answer

The answer of The purchasing power parity theory
...

Question 9

According to the purchasing power parity theory,in the long run

Accepted Answer

Purchasing power parity theory states that the exchange rate between two currencies should reflect differences in price levels between the two countries. Therefore, the exchange rate between the Canadian dollar and the British pound should reflect differences in the price levels between Canada and Britain. The theory does not suggest that exchange rates should be equal all over the world or that the value of one currency should be equal to another currency. It also does not necessarily imply that inflation rates or interest rates should equalize around the world, although these factors may play a role in determining exchange rates.

Question 10

Suppose a basket of goods costs $400 in the United States and £200 in Britain.If the exchange rate is $1/pound,what will happen in the foreign exchange market,according to the purchasing power parity theory?

Accepted Answer

The answer of Suppose a basket of goods costs $400...

Question 11

Those who simultaneously buy and sell currency to take advantage of exchange rate differences are called

Accepted Answer

Those who simultaneously buy and sell currency to take advantage of exchange rate differences are called arbitrageurs. Speculators buy or sell currency in the hopes of making a profit from market movements, hedgers use currency to manage risk, entrepreneurs invest in foreign markets to grow their businesses, and underwriters assist with financial transactions.

Question 12

Suppose a basket of goods that costs $400 in the United States costs only £200 in Britain and the current exchange rate is $1/pound.According to the purchasing power parity theory,the equilibrium exchange rate should be higher than $1/pound.Why?

Accepted Answer

According to the purchasing power parity theory, the exchange rate should adjust to equalize the prices of a basket of goods between two countries. In this case, the basket costs $400 in the US and £200 in Britain. If the exchange rate was already in equilibrium at $1/pound, the basket would have the same cost in both countries (converting £200 to dollars at the exchange rate would give $200). However, since the basket costs more in the US, it implies that the dollar is overvalued relative to the pound. In this scenario, an arbitrage opportunity exists where one can buy the basket for £200 in Britain, sell it for $400 in the US, and convert the $400 to £400 at the current exchange rate. This would result in a profit of £200, which illustrates that the equilibrium exchange rate should be higher than $1/pound.

Question 13

Under a flexible exchange rate system,which one of the following would not directly affect the exchange rate?

Accepted Answer

The salary of the president of the United States does not have any direct impact on the exchange rate as it is not related to any economic or financial factors. The exchange rate is mainly affected by factors such as inflation rates, capital flows, and trade balances.

Question 14

Foreign exchange rates tend toward equality around the world because of the actions of

Accepted Answer

Arbitrageurs take advantage of differences in exchange rates between two or more markets by buying currency where it is undervalued and selling where it is overvalued, causing the rates to equalize. Central banks, stock markets, commodity markets, and the World Bank can all have an impact on exchange rates, but their actions are not solely responsible for ensuring equality around the world.

Question 15

Suppose the exchange rate is such that 1 U.S.dollar equals 1 euro in New York and 0.9 euros in Paris.An arbitrageur would sell euros

Accepted Answer

The answer of Suppose the exchange rate is such that...

Question 16

A speculator in foreign exchange is a person who

Accepted Answer

A speculator in foreign exchange buys foreign currency with the hope of selling it at a higher exchange rate at a later date to make a profit.

Question 17

The purchasing power parity (PPP)theory suggests the prices of identical items will equalize internationally.An illustration that supports this theory is the fact that the price of a McDonald's "Big Mac" is the same around the world.

Accepted Answer

The answer of The purchasing power parity (PPP)theory suggests the...

Question 18

Which of the following statements concerning speculators is true?

Accepted Answer

Speculators try to profit by buying a currency at a low price and selling it at a higher price in the future. This involves risk and uncertainty as they cannot predict future exchange rates. Unlike arbitrageurs, speculators do not engage in simultaneous buying and selling of currencies in different markets. Their actions can also affect exchange rates as their trading activity can influence the supply and demand of currencies.

Question 19

An arbitrageur in foreign exchange is a person who

Accepted Answer

An arbitrageur in foreign exchange simultaneously buys large amounts of a currency in one market and sells it in another market, taking advantage of differences in exchange rates between the two markets. This is a common practice in the forex market, and is not illegal or manipulative. The goal is to profit from the price differences between the two markets before they are equalized.

Question 20

The actions taken by arbitrageurs in the foreign exchange markets

Accepted Answer

The actions taken by arbitrageurs in the foreign exchange markets help assure that exchange rates are equalized across all markets. This is because arbitrageurs take advantage of discrepancies in exchange rates across different markets to buy low in one market and sell high in another, ultimately bringing the exchange rates in line with each other. This process helps to promote efficiency and stability in foreign exchange markets. Additionally, compared to speculators, arbitrageurs tend to have lower risk as they aim to profit from small price discrepancies rather than making directional bets on currency movements.

Quiz 20: International Finance