Download CHAPTER 12—EXCHANGE-RATE DETERMINATION MULTIPLE

CHAPTER 12—EXCHANGE-RATE DETERMINATION
MULTIPLE CHOICE
1. The relationship between the exchange rate and the prices of tradable goods is known as the:
a. Purchasing-power-parity theory
b. Asset-markets theory
c. Monetary theory
d. Balance-of-payments theory
ANS: A
PTS: 1
2. If the exchange rate between Swiss francs and British pounds is 5 francs per pound, then the number of
pounds that can be obtained for 200 francs equals:
a. 20 pounds
b. 40 pounds
c. 60 pounds
d. 80 pounds
ANS: B
PTS: 1
3. Low real interest rates in the United States tend to:
a. Decrease the demand for dollars, causing the dollar to depreciate
b. Decrease the demand for dollars, causing the dollar to appreciate
c. Increase the demand for dollars, causing the dollar to depreciate
d. Increase the demand for dollars, causing the dollar to appreciate
ANS: A
PTS: 1
4. High real interest rates in the United States tend to:
a. Decrease the demand for dollars, causing the dollar to depreciate
b. Decrease the demand for dollars, causing the dollar to appreciate
c. Increase the demand for dollars, causing the dollar to depreciate
d. Increase the demand for dollars, causing the dollar to appreciate
ANS: D
PTS: 1
5. Assume that the United States faces an 8 percent inflation rate while no (zero) inflation exists in Japan.
According to the purchasing-power parity theory, the dollar would be expected to:
a. Appreciate by 8 percent against the yen
b. Depreciate by 8 percent against the yen
c. Remain at its existing exchange rate
d. None of the above
ANS: B
PTS: 1
6. In the presence of purchasing-power parity, if one dollar exchanges for 2 British pounds and if a VCR
costs $400 in the United States, then in Great Britain the VCR should cost:
a. 200 pounds
b. 400 pounds
c. 600 pounds
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d. 800 pounds
ANS: D
PTS: 1
7. If wheat costs $4 per bushel in the United States and 2 pounds per bushel in Great Britain, then in the
presence of purchasing-power parity the exchange rate should be:
a. $.50 per pound
b. $1.00 per pound
c. $2.00 per pound
d. $8.00 per pound
ANS: C
PTS: 1
8. A primary reason that explains the appreciation in the value of the U.S. dollar in the 1980s is:
a. Large trade surpluses for the United States
b. Relatively high inflation rates in the United States
c. Lack of investor confidence in the U.S. monetary policy
d. Relatively high interest rates in the United States
ANS: D
PTS: 1
9. The high foreign exchange value of the U.S. dollar in the early 1980s can best be explained by:
a. Additional investment funds made available from overseas
b. Lack of investor confidence in U.S. fiscal policy
c. Market expectations of rising inflation in the United States
d. American tourists overseas finding costs increasing
ANS: A
PTS: 1
10. When the price of foreign currency (i.e., the exchange rate) is below the equilibrium level:
a. An excess demand for that currency exists in the foreign exchange market
b. An excess supply of that currency exists in the foreign exchange market
c. The demand for foreign exchange shifts outward to the right
d. The demand for foreign exchange shifts backward to the left
ANS: A
PTS: 1
11. When the price of foreign currency (i.e., the exchange rate) is above the equilibrium level:
a. An excess supply of that currency exists in the foreign exchange market
b. An excess demand for that currency exists in the foreign exchange market
c. The supply of foreign exchange shifts outward to the right
d. The supply of foreign exchange shifts backward to the left
ANS: A
PTS: 1
12. The appreciation in the value of the dollar in the early 1980s is explained by all of the following
except:
a. The United States being considered a safe haven by foreign investors
b. Relatively high real interest rates in the United States
c. Confidence of foreign investors in the U.S. economy
d. Relatively high inflation rates in the United States
ANS: D
PTS: 1
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13. Suppose Mexico and the United States were the only two countries in the world. There exists an
excess supply of pesos on the foreign exchange market. This suggests that:
a. Mexico's current account is in surplus
b. Mexico's current account is in deficit
c. The U.S. current account is in deficit
d. The U.S. current account is in equilibrium
ANS: B
PTS: 1
14. If Canada runs a trade surplus with Mexico and exchange rates are floating:
a. The peso will depreciate relative to the dollar
b. The dollar will depreciate relative to the peso
c. The prices of all foreign goods will fall for Canadians
d. The prices of all foreign goods will rise for Canadians
ANS: A
PTS: 1
15. If Mexico's labor productivity rises relative to Europe's labor productivity:
a. The peso tends to depreciate against the euro in the short run
b. The peso tends to appreciate against the euro in the short run
c. The peso tends to depreciate against the euro in the long run
d. The peso tends to appreciate against the euro in the long run
ANS: D
PTS: 1
16. The international exchange value of the U.S. dollar is determined by:
a. The rate of inflation in the United States
b. The number of dollars printed by the U.S. government
c. The international demand and supply for dollars
d. The monetary value of gold held at Fort Knox, Kentucky
ANS: C
PTS: 1
17. For the United States, suppose the annual interest rate on government securities equals 8 percent while
the annual inflation rate equals 4 percent. For Japan, suppose the annual interest rate on government
securities equals 10 percent while the annual inflation rate equals 7 percent. These variables would
cause investment funds to flow from:
a. The United States to Japan, causing the dollar to depreciate
b. The United States to Japan, causing the dollar to appreciate
c. Japan to the United States, causing the yen to depreciate
d. Japan to the United States, causing the yen to appreciate
ANS: C
PTS: 1
18. For the United States, suppose the annual interest rate on government securities equals 12 percent
while the annual inflation rate equals 8 percent. For Japan, suppose the annual interest rate equals 5
percent. These variables would cause investment funds to flow from:
a. The United States to Japan, causing the dollar to depreciate
b. The United States to Japan, causing the dollar to appreciate
c. Japan to the United States, causing the yen to depreciate
d. Japan to the United States, causing the yen to appreciate
ANS: A
PTS: 1
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19. Given a system of floating exchange rates, stronger U.S. preferences for imports would trigger:
a. An increase in the demand for imports and an increase in the demand for foreign currency
b. An increase in the demand for imports and a decrease in the demand for foreign currency
c. A decrease in the demand for imports and an increase in the demand for foreign currency
d. A decrease in the demand for imports and a decrease in the demand for foreign currency
ANS: A
PTS: 1
20. Given a system of floating exchange rates, weaker U.S. preferences for imports would trigger:
a. An increase in the demand for imports and an increase in the demand for foreign currency
b. An increase in the demand for imports and a decrease in the demand for foreign currency
c. A decrease in the demand for imports and an increase in the demand for foreign currency
d. A decrease in the demand for imports and a decrease in the demand for foreign currency
ANS: D
PTS: 1
21. Under a system of floating exchange rates, relatively low productivity and high inflation rates in the
United States result in:
a. An increase in the demand for foreign currency, a decrease in the supply of foreign
currency, and a depreciation in the dollar
b. An increase in the demand for foreign currency, an increase in the supply of foreign
currency, and an appreciation in the dollar
c. A decrease in the demand for foreign currency, a decrease in the supply of foreign
currency, and a depreciation in the dollar
d. A decrease in the demand for foreign currency, an increase in the supply of foreign
currency, and an appreciation in the dollar
ANS: A
PTS: 1
22. Under a system of floating exchange rates, relatively high productivity and low inflation rates in the
United States result in:
a. An increase in the demand for foreign currency, a decrease in the supply of foreign
currency, and a depreciation in the dollar
b. An increase in the demand for foreign currency, an increase in the supply of foreign
currency, and an appreciation in the dollar
c. A decrease in the demand for foreign currency, a decrease in the supply of foreign
currency, and a depreciation in the dollar
d. A decrease in the demand for foreign currency, an increase in the supply of foreign
currency, and an appreciation in the dollar
ANS: D
PTS: 1
23. Which example of market expectations causes the dollar to appreciate against the yen--expectations
that the U.S. economy will have:
a. Faster economic growth than Japan
b. Higher future interest rates than Japan
c. More rapid money supply growth than Japan
d. Higher inflation rates than Japan
ANS: B
PTS: 1
24. Which example of market expectations causes the dollar to depreciate against the yen--expectations
that the U.S. economy will have:
a. Faster economic growth than Japan
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b. Higher future interest rates than Japan
c. Less rapid money supply growth than Japan
d. Lower inflation rates than Japan
ANS: A
PTS: 1
25. For an American investor, the expected rate of return on European securities depends on all of the
following factors except the:
a. Rate of return on equivalent American securities
b. The current exchange rate between the dollar and the pound
c. Exchange rate anticipated to prevail when the securities mature
d. Interest rate paid on European securities
ANS: A
PTS: 1
26. Which of the following is likely to result in long-run depreciation of the U.S. dollar relative to the
euro?
a. Relatively low interest rates in the United States
b. Relatively high labor productivity in the United States
c. Tariffs levied by the United States on steel imports from Europe
d. Stronger American preferences for goods produced in Europe
ANS: D
PTS: 1
27. Which of the following is likely to result in long-run appreciation of the U.S. dollar relative to the
peso?
a. Relatively high interest rates in Mexico
b. Relatively high labor productivity in Mexico
c. Tariffs applied by Mexico on computer imports from the United States
d. Stronger Mexican preferences for goods produced in the United States
ANS: D
PTS: 1
28. Long-run determinants of the dollar's exchange value include all of the following except:
a. Preferences of Americans for foreign produced goods
b. U.S. tariffs placed on imports of foreign produced goods
c. Productivity of the American worker
d. Interest rates in U.S. financial markets
ANS: D
PTS: 1
29. Which theory of exchange-rate determination best views the foreign exchange market as being similar
to a stock exchange where future expectations are important and prices are volatile?
a. Balance-of-payments approach
b. Purchasing-power-parity approach
c. Asset-markets approach
d. Monetary approach
ANS: C
PTS: 1
30. According to the purchasing-power-parity theory, the U.S. dollar maintains its purchasing-power
parity if it depreciates by an amount equal to the excess of:
a. U.S. interest rates over foreign interest rates
b. Foreign interest rates over U.S. interest rates
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c. U.S. inflation over foreign inflation
d. Foreign inflation over U.S. inflation
ANS: C
PTS: 1
31. An exchange rate is said to ____ when its short-run response to a change in market fundamentals is
greater than its long-run response.
a. Overshoot
b. Undershoot
c. Depreciate
d. Appreciate
ANS: A
PTS: 1
32. Concerning exchange rate forecasting, ____ is a common sense approach based on a wide array of
political and economic data.
a. Econometric analysis
b. Technical analysis
c. Judgmental analysis
d. Sunspot analysis
ANS: C
PTS: 1
33. Concerning exchange rate forecasting, ____ involves the use of historical exchange rate data to
estimate future values, while ignoring the economic determinants of exchange rate movements.
a. Econometric analysis
b. Judgmental analysis
c. Technical analysis
d. Sunspot analysis
ANS: C
PTS: 1
34. Concerning exchange rate forecasting, ____ relies on econometric models which are based on
macroeconomic variables likely to affect currency values.
a. Fundamental analysis
b. Technical analysis
c. Judgmental analysis
d. Sunspot analysis
ANS: A
PTS: 1
35. Concerning exchange-rate determination, "market fundamentals" include all of the following except:
a. Monetary policy and fiscal policy
b. Profitability and riskiness of investments
c. Speculative opinion about future exchange rates
d. Productivity changes affecting production costs
ANS: C
PTS: 1
36. In the short run, exchange rates respond to market forces such as:
a. Inflation rates
b. Expectations of future exchange rates
c. Investment profitability
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d. Government trade policy
ANS: B
PTS: 1
37. Long-run exchange rate movements are governed by all of the following except:
a. National productivity levels
b. Consumer tastes and preferences
c. Rates of inflation
d. Interest rate levels
ANS: D
PTS: 1
38. Exchange rate determination in the short run is underlied by which of the following assumptions:
a. Tariffs and quotas affect trade patterns only in the short run
b. Prices of goods and services affect trade patterns only in the short run
c. Expected returns on financial assets affect investment flows in the short run
d. Preferences for goods and services affect trade flows only in the short run
ANS: C
PTS: 1
39. That identical goods should cost the same in all nations, assuming it is costless to ship goods between
nations and there are no barriers to trade, is a reflection of the:
a. Monetary approach to exchange-rate determination
b. Law of one price
c. Fundamentalist approach to exchange-rate determination
d. Exchange-rate-overshooting principle
ANS: B
PTS: 1
40. The Canadian dollar would depreciate on the foreign exchange market if:
a. Canadian consumer tastes change in favor of goods produced domestically
b. The profitability of assets in Canada rises relative to the profitability of assets abroad
c. Canada experiences a disastrous wheat-crop failure, leading to imports of more wheat
d. Canada realizes technological improvements in the production of manufactured goods,
leading to relatively low costs for Canada
ANS: C
PTS: 1
41. The demand in the United States for yen will increase if, other things remaining equal:
a. Labor costs rise in Japan
b. Income rises in Japan
c. Prices rise in Japan
d. Interest rates rise in Japan
ANS: D
PTS: 1
42. The quantity of Canadian dollars supplied to the foreign exchange market would increase if, other
things remaining equal:
a. Preferences for imports rise in Canada
b. Labor productivity increases in Canada
c. Prices of goods and services decrease in Canada
d. Import tariffs rise in Canada
ANS: A
PTS: 1
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43. The U.S. demand for pesos would shift to the right if there occurred a (an):
a. Change in preferences toward U.S. manufactured goods
b. Increase in the dollar/peso exchange rate
c. Decrease in the U.S. population
d. Increase in the U.S. price level
ANS: D
PTS: 1
44. The supply of francs, would shift to the right for all of the following reasons except:
a. An increase in Swiss real income
b. An increase in Swiss prices
c. An increase in the Swiss population
d. An increase in Swiss interest rates
ANS: D
PTS: 1
The figure below illustrates the supply and demand schedules of Swiss francs in a market of
freely-floating exchange rates.
Figure 12.1 The Market for Francs
45. Refer to Figure 12.1. Should preferences for imports rise in the United States and fall in Switzerland,
there would occur a (an):
a. Increase in the demand for francs--decrease in the supply of francs-depreciation of the
dollar
b. Increase in the demand for francs--decrease in the supply of francs-appreciation of the
dollar
c. Decrease in the demand for francs--decrease in the supply of francs-appreciation of the
dollar
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d. Decrease in the demand for francs--increase in the supply of francs-depreciation of the
dollar
ANS: A
PTS: 1
46. Refer to Figure 12.1. Should real interest rates in the United States rise relative to real interest rates in
Switzerland, there would occur a (an):
a. Increase in the demand for francs--decrease in the supply of francs-depreciation of the
dollar
b. Increase in the demand for francs--decrease in the supply of francs-appreciation of the
dollar
c. Decrease in the demand for francs--increase in the supply of francs-appreciation of the
dollar
d. Decrease in the demand for francs--decrease in the supply of francs-depreciation of the
dollar
ANS: C
PTS: 1
47. Refer to Figure 12.1. Should the U.S. price level rise relative to the Swiss price level, there would
occur a (an):
a. Increase in the demand for francs--increase in the supply of francs-appreciation of the
dollar
b. Decrease in the demand for francs--decrease in the supply of francs-depreciation of the
dollar
c. Increase in the supply of francs--decrease in the demand for francs-appreciation of the
dollar
d. Decrease in the supply of francs--increase in the demand for francs-depreciation of the
dollar
ANS: D
PTS: 1
48. Refer to Figure 12.1. Should the United States impose tariffs on imports from Switzerland, there
would occur a (an):
a. Increase in the demand for francs and a depreciation of the dollar
b. Decrease in the demand for francs and an appreciation of the dollar
c. Decrease in the supply of francs and an appreciation of the dollar
d. Increase in the supply of francs and a depreciation of the dollar
ANS: B
PTS: 1
49. Refer to Figure 12.1. Should Swiss labor productivity rise, leading to a decrease in Swiss
manufacturing costs, there would occur a (an):
a. Increase in the supply of francs and a depreciation of the dollar
b. Increase in the supply of francs and an appreciation of the dollar
c. Decrease in the demand for francs and an appreciation of the dollar
d. Increase in the demand for francs and a depreciation of the dollar
ANS: D
PTS: 1
50. Refer to Figure 12.1. If Switzerland experienced a disastrous wheat-crop failure, leading to additional
wheat imports from the United States, there would occur an:
a. Increase in the supply of francs and an appreciation of the dollar
b. Increase in the supply of francs and a depreciation of the dollar
c. Increase in the demand for francs and a depreciation of the dollar
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d. Increase in the demand for francs and an appreciation of the dollar
ANS: A
PTS: 1
51. Given floating exchange rates, if Japan increases its demand for Canadian goods at the same time that
Canada increases its demand for Japanese goods, then we would expect the yen's exchange value to:
a. Appreciate against the dollar
b. Depreciate against the dollar
c. Remain constant against the dollar
d. Appreciate, depreciate, or remain constant against the dollar
ANS: D
PTS: 1
52. Given floating exchange rates, assume that the Swiss decrease their import purchases from Italy while
at the same time the Italians increase their purchases of Swiss government securities. The first action
by itself would lead to a (an) ____ of the franc against the lira while the second action by itself would
lead to a (an) ____ of the franc against the lira.
a. Appreciation, appreciation
b. Depreciation, depreciation
c. Appreciation, depreciation
d. Depreciation, appreciation
ANS: A
PTS: 1
53. Given floating exchange rates, a simultaneous decrease in the Canadian demand for British products
and increase in the British desire to invest in Canadian government securities would cause a (an):
a. Appreciation of the pound against the dollar
b. Depreciation of the pound against the dollar
c. Unchanged pound/dollar exchange rate
d. None of the above
ANS: B
PTS: 1
54. Assume a system of floating exchange rates. Due to a high savings rate, suppose the level of savings in
Japan is in excess of domestic investment needs. If Japanese residents invest abroad, the yen's
exchange value will ____ and the Japanese trade balance will move toward ____.
a. Appreciate, deficit
b. Appreciate, surplus
c. Depreciate, deficit
d. Depreciate, surplus
ANS: D
PTS: 1
55. Given a system of floating exchange rates, assume that Boeing Inc. of the United States places a large
order, payable in yen, with a Japanese contractor for jet engine parts. The immediate effect of this
transaction will be a shift in the:
a. Supply curve of yen to the left which causes the dollar to appreciate against the yen
b. Supply curve of yen to the right which causes the dollar to depreciate against the yen
c. Demand curve for yen to the left which causes the dollar to appreciate against the yen
d. Demand curve for yen to the right which causes the dollar to depreciate against the yen
ANS: D
PTS: 1
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56. For purchasing-power parity to exist:
a. Flows of currency in the trade account must be offset by flows of currency in the capital
account
b. The nominal interest rate must be equal to the real interest rate in all countries
c. Converting a sum of funds from one currency to another does not alter its purchasing
power
d. A country's trade account must always be in balance
ANS: C
PTS: 1
57. Assume that interest rates in the United States and Britain are the same. If a U.S. resident anticipates
that the exchange value of the dollar is going to appreciate against the pound, she should:
a. Borrow needed funds from British banks rather than U.S. banks
b. Borrow needed funds from U.S. banks rather than British banks
c. Convert U.S. dollars into British pounds
d. Any of the above
ANS: A
PTS: 1
58. Given a system of floating exchange rates, if Canada's labor productivity rises relative to the labor
productivity of its trading partners:
a. Canadian imports will fall and the dollar will appreciate
b. Canadian imports will fall and the dollar will depreciate
c. Canadian imports will rise and the dollar will appreciate
d. Canadian imports will rise and the dollar will depreciate
ANS: A
PTS: 1
59. Assume that labor productivity growth is slower in the United States than in its trading partners. Given
a system of floating exchange rates, the impact of this growth differential for the United States will be:
a. Increased exports and an appreciation of the dollar
b. Increased exports and a depreciation of the dollar
c. Increased imports and an appreciation of the dollar
d. Increased imports and a depreciation of the dollar
ANS: D
PTS: 1
60. Suppose the exchange rate between the U.S. dollar and the Japanese yen is initially 90 yen per dollar.
According to purchasing-power parity, if the price of traded goods rises by 10 percent in the United
States and remains constant in Japan, the exchange rate will become
a. 72 yen per dollar
b. 81 yen per dollar
c. 99 yen per dollar
d. 108 yen per dollar
ANS: B
PTS: 1
61. Suppose the exchange rate between the U.S. dollar and the Japanese yen is initially 90 yen per dollar.
According to purchasing-power parity, if the price of traded goods rises by 5 percent in the United
States and 15 percent in Japan, the exchange rate will become:
a. 72 yen per dollar
b. 81 yen per dollar
c. 99 yen per dollar
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d. 108 yen per dollar
ANS: C
PTS: 1
62. Suppose the exchange rate between the U.S. dollar and the Japanese yen is initially 90 yen per dollar.
According to purchasing power parity, if the price of traded goods falls by 5 percent in the United
States and rises by 5 percent in Japan, the exchange rate will become:
a. 72 yen per dollar
b. 81 yen per dollar
c. 99 yen per dollar
d. 108 yen per dollar
ANS: B
PTS: 1
63. Suppose that the yen-dollar exchange rate changes from 85 yen per dollar to 80 yen per dollar. One
can say that the:
a. Yen has appreciated against the dollar and the dollar has depreciated against the yen
b. Yen has depreciated against the dollar and the dollar has appreciated against the yen
c. Yen has appreciated against the dollar and the dollar has appreciated against the yen
d. Yen has depreciated against the dollar and the dollar has depreciated against the yen
ANS: A
PTS: 1
64. Given a floating exchange rate system an increase in ____ would cause the dollar to appreciate against
the euro.
a. U.S. labor costs
b. The U.S. money supply
c. U.S. prices of goods
d. U.S. real interest rates
ANS: D
PTS: 1
65. Under a system of floating exchange rates, a Japanese trade surplus against Canada would result in a
(an):
a. Rise in the dollar price of the yen
b. Fall in the dollar price of the yen
c. Rise in the yen price of the dollar
d. Unchanged dollar/yen exchange rate
ANS: A
PTS: 1
66. When deciding between U.S. and British government securities, an American investor typically
considers:
a. U.S. and British interest rates and anticipated changes in the exchange rate
b. Budget deficits of the U.S. government and British government
c. Shifts in the demand for U.S. goods and British goods
d. U.S. and British inflation rates and anticipated changes in the exchange rate
ANS: A
PTS: 1
67. In the long run, exchange rates are primarily determined by:
a. Agreements among governments of the world's industrial countries
b. Relative interest rates in developing countries and industrial countries
c. Economic fundamentals such as relative productivity levels
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d. The rate at which country's currencies exchange for gold
ANS: C
PTS: 1
68. Increased tariffs on U.S. steel imports cause the dollar to ____ in the ____.
a. Appreciate, long run
b. Depreciate, long run
c. Appreciate, short run
d. Depreciate, short run
ANS: A
PTS: 1
69. Lower tariffs on U.S. agricultural imports cause the dollar to ____ in the ____.
a. Appreciate, long run
b. Depreciate, long run
c. Appreciate, short run
d. Depreciate, short run
ANS: B
PTS: 1
70. Relatively high interest rates in the United States causes the dollar to ____ in the ____.
a. Appreciate, long run
b. Depreciate, long run
c. Appreciate, short run
d. Depreciate, short run
ANS: C
PTS: 1
71. The asset market theory of exchange rate determination suggests that the most important factor
influencing the demand for domestic and foreign securities is:
a. Expected return on these assets relative to one another
b. Ability of these assets to easily be converted into cash
c. Riskiness of these assets relative to one another
d. Level of government restrictions on trade and investment flows
ANS: A
PTS: 1
72. With floating exchange rates, easy credit and low short term interest rates lead to
a. Exchange rate depreciation in the short run
b. Exchange rate appreciation in the short run
c. Exchange rate depreciation in the long run
d. Exchange rate appreciation in the long run
ANS: A
PTS: 1
73. With floating exchange rates, relatively high productivity growth for a nation leads to
a. Exchange rate depreciation in the short run
b. Exchange rate appreciation in the short run
c. Exchange rate depreciation in the long run
d. Exchange rate appreciation in the long run
ANS: D
PTS: 1
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from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
74. All of the following are important long-run determinants of exchange rates except
a. Consumer tastes
b. Trade policy
c. Labor productivity
d. Interest rates
ANS: D
PTS: 1
75. The purchasing-power parity theory suffers from the problem
a. Of choosing the appropriate price index
b. That it overlooks the influence of capital flows
c. That government policy may modify exchange rates
d. All of the above
ANS: D
PTS: 1
TRUE/FALSE
1. In a free market, exchange rates are determined by market fundamentals and market expectations.
ANS: T
PTS: 1
2. Concerning exchange-rate determination, market fundamentals include inflation rates, productivity
levels, and speculative opinion about future exchange rates.
ANS: F
PTS: 1
3. Market expectations include news about market fundamentals, speculative opinion about future
exchange rates, and profitability and riskiness of investments.
ANS: T
PTS: 1
4. In a free market, the equilibrium exchange rate occurs at the point where the quantity demanded of a
foreign currency equals the quantity of that currency supplied.
ANS: T
PTS: 1
5. Exchange rates are determined by the unregulated forces of supply and demand for foreign currencies
as long as central banks do not intervene in the foreign exchange markets.
ANS: T
PTS: 1
6. Over the long run, foreign exchange rates are determined by transfers of bank deposits that respond to
differences in real interest rates and to shifting expectations of future exchange rates.
ANS: F
PTS: 1
© 2011 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different
from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
The figure below illustrates the supply and demand schedules of Swiss francs under a system of
floating exchange rates.
Figure 12.2. The Market for Swiss Francs
7. Refer to Figure 12.2. If the United States decreases tariffs on imports from Switzerland, there would
occur a decrease in the demand for francs and a decrease in the dollar price of the franc.
ANS: F
PTS: 1
8. Refer to Figure 12.2. If Swiss manufacturing costs increase relative to those of the United States, there
would occur an increase in the supply of francs and an appreciation in the dollar's exchange value.
ANS: T
PTS: 1
9. Refer to Figure 12.2. If the Federal Reserve adopts a restrictive monetary policy that leads to relatively
high interest rates in the United States, the demand for francs would decrease, the supply of francs
would increase, and the dollar's exchange value would appreciate.
ANS: T
PTS: 1
10. Refer to Figure 12.2. As the profitability of assets in Switzerland rises relative to the profitability of
assets in the United States, U.S. residents make additional investments in Switzerland; this leads to an
increased demand for francs and a depreciation of the dollar's exchange value.
ANS: T
PTS: 1
11. Refer to Figure 12.2. If the rate of inflation in the United States is higher than the rate of inflation in
Switzerland, the demand for francs decreases, the supply of francs increases, and the dollar's exchange
value appreciates.
ANS: F
PTS: 1
© 2011 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different
from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
12. Under floating exchange rates, short-run exchange rates are primarily determined by national
differences in real interest rates and shifting expectations of future exchange rates.
ANS: T
PTS: 1
13. Day-to-day influences on foreign exchange rates always cause rates to move in the same direction as
changes in long-term market fundamentals.
ANS: F
PTS: 1
14. With floating exchange rates, a country experiencing faster economic growth than its trading partners
find its currency's exchange value appreciating.
ANS: F
PTS: 1
15. If U.S. labor productivity growth is 2 percent per annum and Swiss labor productivity growth is 6
percent per annum, the dollar will depreciate against the franc under a system of floating exchange
rates.
ANS: T
PTS: 1
16. In 1985 and 1986 U.S. interest rates fell relative to interest rates in Japan. Under floating exchange
rates, this would lead to the dollar's exchange value depreciating against the yen.
ANS: T
PTS: 1
17. A country having stronger preferences for imports than its trading partners have for its exports finds its
demand for foreign exchange rising more rapidly than its supply of foreign exchange.
ANS: T
PTS: 1
18. Economies with relatively high growth rates in labor productivity tend to find their currencies'
exchange values appreciating under a floating exchange-rate system.
ANS: T
PTS: 1
19. Under floating exchange rates, relatively low domestic interest rates tend to promote depreciation of a
currency's exchange value while relatively high domestic interest rates lead to currency appreciation.
ANS: T
PTS: 1
20. Suppose expansionary monetary policy in the United States leads to interest rates falling to 2 percent
while tight monetary policy in Switzerland leads to interest rates rising to 8 percent. With floating
exchange rates, the dollar would appreciate against the franc.
ANS: F
PTS: 1
21. The purchasing-power-parity theory is used to predict exchange-rate movements in the short run.
ANS: F
PTS: 1
© 2011 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different
from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
22. According to the law of one price, identical goods should cost the same in all nations, assuming there
are no shipping costs nor trade barriers.
ANS: T
PTS: 1
23. The purchasing- power-parity theory predicts that if the U.S. inflation rate exceeds the Japanese
inflation rate by 4 percent, the dollar's exchange value will appreciate by 4 percent against the yen.
ANS: F
PTS: 1
24. Assume the initial yen/dollar exchange rate to be 100 yen per dollar. If the U.S. inflation rate is 2
percent and the Japanese inflation rate is 7 percent, the exchange rate should move to 105 yen per
dollar according to the purchasing-power-parity theory.
ANS: F
PTS: 1
25. Assume the initial dollar/pound exchange rate to be $2 per pound. If the U.S. inflation rate is 8 percent
and the U.K. inflation rate is 3 percent, the exchange rate should move to $2.10 per pound according to
the purchasing-power-parity theory.
ANS: T
PTS: 1
26. If consumer tastes in the United States change in favor of goods produced in France, the demand for
francs will increase which causes an appreciation of the dollar against the franc under a floating
exchange rate system.
ANS: F
PTS: 1
27. As the profitability of Japanese assets rises relative to the profitability of Australian assets, Australian
residents will make additional investments in Japan; this results in an increased demand for yen and a
depreciation of the dollar under a system of floating exchange rates.
ANS: T
PTS: 1
28. If the United States experiences an enormous wheat crop failure, it will have to import more wheat and
the dollar's exchange value will depreciate under a system of floating exchange rates.
ANS: T
PTS: 1
29. If Japan realizes technological improvements in the production of automobiles, which lowers its
production costs relative to foreign producers, Japanese exports will rise and the yen's exchange value
will appreciate under a system of floating exchange rates.
ANS: T
PTS: 1
30. If Mexico applies tariffs to imports of manufactured goods, Mexico's demand for foreign exchange
will rise and the peso will depreciate under a system of floating exchange rates.
ANS: F
PTS: 1
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from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
31. According to the "Big Mac" index, if a Big Mac costs $2.28 in the United States and 25.75 krone in
Denmark (equivalent to $4.25), the Danish krone is an undervalued currency.
ANS: F
PTS: 1
32. According to the "Big Mac" index, if a Big Mac costs $2.28 in the United States and 48 baht in
Thailand (equivalent to $1.91), the baht is an undervalued currency.
ANS: T
PTS: 1
33. Long-run determinants of exchange rate include labor productivity levels, inflation rates, consumer
preferences for goods and services, and trade barriers.
ANS: T
PTS: 1
34. In the short run, exchange rates are primarily determined by investor expectations of returns on assets
such as government securities and bank accounts.
ANS: T
PTS: 1
35. Changes in market expectations have their greatest impact on exchange-rate changes over the long run
as opposed to the short run.
ANS: F
PTS: 1
36. If it is widely expected that the British economy will experience more rapid inflation than the
Australian economy, the pound will depreciate against the dollar under a system of floating exchange
rates.
ANS: T
PTS: 1
37. According to the asset-markets approach, adjustments among financial assets are a key determinant of
long-run movements in exchange rates.
ANS: F
PTS: 1
38. The asset-markets approach views exchange-rate determination as similar to the stock market in which
prices are volatile and expectations are important.
ANS: T
PTS: 1
39. According to the principle of exchange-rate overshooting, a short-run depreciation of a currency is
likely to be greater than a long-run depreciation of that currency.
ANS: T
PTS: 1
40. Exchange-rate overshooting is based on the notion that the supply schedule of a currency is more
elastic in the short run than in the long run.
ANS: F
PTS: 1
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from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
41. According to exchange-rate overshooting, an appreciation of the Australian dollar is likely to be
greater over a long time period than over a short time period.
ANS: F
PTS: 1
42. Concerning exchange rate forecasting, fundamental analysis involves consideration of a variety of
macroeconomic variables and policies that tend to affect currency values.
ANS: T
PTS: 1
43. Econometric models are best suited for forecasting long-run exchange rates rather than short-run
exchange rates.
ANS: F
PTS: 1
44. Concerning exchange rate forecasting, technical analysis extrapolates from past exchange-rate trends
while ignoring economic and political determinants of exchange rates.
ANS: T
PTS: 1
45. Given an efficient foreign exchange market, the spot rate is the rational approximation of the markets
expectation of the forward rate that will exist at the end of the forward period.
ANS: F
PTS: 1
46. A forward premium on the British pound serves as a rough benchmark of the expected rate of
appreciation in the pound's spot rate.
ANS: T
PTS: 1
47. A forward discount on Mexico's peso serves as a rough benchmark of the expected appreciation in the
peso's spot rate.
ANS: F
PTS: 1
48. If you were considering hiring a forecasting firm to predict future spot rates of the yen, you would
hope that the firm could predict better what would be implied by the yen's forward rate.
ANS: T
PTS: 1
49. Although the law of one price predicts that identical goods should cost the same in all nations,
transportation costs and tariffs tend to prevent this prediction from actually occurring.
ANS: T
PTS: 1
50. If real interest rates decline in the United States relative to real interest rates abroad, the dollar's
exchange value will appreciate under a floating exchange-rate system.
ANS: F
PTS: 1
© 2011 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different
from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
SHORT ANSWER
1. What is the purchasing power parity approach to exchange rate determination?
ANS:
The purchasing power parity approach asserts that changes in relative national price levels determine
changes in exchange rates over the long run. A currency maintains its purchasing power parity if it
depreciates (appreciates) by an amount equal to the excess of domestic (foreign) inflation over foreign
(domestic) inflation.
PTS: 1
2. What is exchange rate overshooting?
ANS:
An exchange rate is said to overshoot when its short-run response to a change in market fundamentals
is greater than its long-run response.
PTS: 1
ESSAY
1. In a free market, what determines exchange rates in the long run and the short run?
ANS:
The long-run determinants of exchange rates include market fundamentals such as consumer
preferences for domestic and foreign goods, government trade policies, productivity levels, and
relative price levels. In the short run, exchange rates are determined by interest rate differentials and
market expectations concerning economic growth, inflation rates, and interest rates.
PTS: 1
2. What is the asset market approach to exchange rate determination?
ANS:
Over short periods of time, decisions to hold domestic or foreign financial assets play a much greater
role in exchange rate determination than the demand for imports and exports does. According to the
asset market approach, investors consider two key factors when deciding between domestic and
foreign investments: relative interest rates and expected changes in exchange rates. Changes in these
factors, in turn, account for fluctuations in exchange rates that we observe in the short run.
PTS: 1
© 2011 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different
from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.