Multinational Business Finance, 14e (Eiteman)
Chapter 9 Foreign Exchange Rate Determination
9.1 Exchange Rate Determination: The Theoretical Thread
1) An important thing to remember about foreign exchange rate determination is that parity
conditions, asset approach, and balance of payments approaches are ________ theories rather
than ________ theories.
A) competing; complementary
B) competing; contemporary
C) complementary; contiguous
D) complementary; competing
2) Which of the following did NOT contribute to the exchange rate collapse in emerging markets
in the 1990s?
A) infrastructure weaknesses
B) speculation on the part of market participants
C) the sharp reduction of cross-border foreign direct investment
D) All of the above contributed to the emerging markets exchange rate collapse of the 1990s.
3) The ________ provides a means to account for international cash flows in a standardized and
systematic manner.
A) parity conditions
B) asset approach
C) balance of payments
D) International Fisher Effect
4) The ________ approach argues that equilibrium exchange rates are achieved when the net
inflow of foreign exchange arising from current account activities is equal to the net outflow of
foreign exchange arising from financial account activities.
A) balance of payments
B) monetary
C) asset market
D) law of one price
5) The ________ approach states that the exchange rate is determined by the supply and demand
for national currency stocks, as well as the expected future levels and rates of growth of
monetary stock.
A) balance of payments
B) monetary
C) asset market
D) law of one price
6) The ________ approach argues that exchange rates are determined by the supply and demand
for a wide variety of financial assets
A) balance of payments
B) monetary
C) asset market
D) law of one price
7) The ________ approach to the determination of spot exchange rates hypothesizes that the
most important factors are the relative real interest rate and a country’s outlook for economic
growth and profitability.
A) balance of payments
B) parity conditions
C) managed float
D) asset market
8) The asset market approach to forecasting assumes that whether foreigners are willing to hold
claims in monetary form depends on an extensive set of investment considerations. These
include all but which of the following choices?
A) relative real interest rates
B) capital market liquidity
C) political safety
D) All of the above are considered by investors in their decision process.
9) ________ is defined as the spread of a crisis in one country to its neighboring countries and
other countries with similar characteristics.
A) Speculation
B) Contagion
C) Capital market liquidity
D) Political science
10) Critics of the balance of payments approach to exchange rate determination point to the
emphasis on ________ of currency and capital rather than ________ of money or financial
assets.
A) flows; stocks
B) stocks; flows
C) import; export
D) export; import
11) Which of the following versions of PPP is thought to be the most relevant to possibly
explaining what drives exchange rate values?
A) The Law of One Price
B) Absolute Purchasing Power Parity
C) Relative Purchasing Power Parity
D) The International Fisher Effect
12) It is safe to say that most determinants of the spot exchange rate are also affected by changes
in the spot rate. i.e., they are linked AND mutually determined.
13) The balance of payments approach of exchange rate theory is largely dismissed by the
academic community today, while the practitioner public still rely on different variations of the
theory for their decision making.
14) Technical analysis of exchange rates developed in part due to the forecasting inadequacies of
fundamental exchange rate theories.
15) The authors claim that theoretical and empirical studies appear to show that fundamentals do
apply to the long-term for foreign exchange.
16) The authors claim that random events, institutional frictions, and technical factors may cause
currency values to deviate significantly from their long-term fundamental path.
17) The asset market approach to forecasting is not applicable to emerging markets.
18) Most theories of technical analysis differentiate fair value from market value.
19) Describe the asset market approach to exchange rate determination. How is this consistent
with economic theory of (say, security) prices in general?
1) ________ is the active buying and selling of the domestic currency against foreign currencies.
A) Indirect Intervention
B) Direct Intervention
C) Foreign Direct Investment
D) Federal Funding
2) ________ is the alteration of economic or financial fundamentals that are thought to be drivers
of capital to flow in and out of specific currencies.
A) Indirect Intervention
B) Direct Intervention
C) Foreign Direct Investment
D) Capital Controls
3) ________ is the restriction of access to foreign currency by government.
A) Indirect Intervention
B) Direct Intervention
C) Foreign Direct Investment
D) Capital Controls
4) Which of the following is NOT a technique used by governments or central banks to impact
domestic currency valuation?
A) Indirect Intervention
B) Direct Intervention
C) Capital Controls
D) All of the above are techniques used to control currency valuation.
5) Which of the following is NOT a motivation for a government or central bank to manipulate
domestic currency valuation?
A) fight inflation
B) slow too rapid economic growth
C) spur too slow economic growth
D) All of the above are motivations for the government or central bank to manipulate currency
values.
6) If the goal were to decrease the value of a country’s currency – to fight an appreciation of the
domestic currency in exchange for foreign currency – the central bank would:
A) buy its own currency in exchange for foreign currency.
B) follow a restrictive monetary policy.
C) drive real rates of interest up.
D) sell its own currency in exchange for foreign currency.
7) If the goal were to increase the value of a country’s currency – to fight an depreciation of the
domestic currency in exchange for foreign currency – the central bank would:
A) buy its own currency in exchange for foreign currency.
B) follow a expansive monetary policy.
C) drive real rates of interest down.
D) sell its own currency in exchange for foreign currency.
8) Slow economic growth and continued unemployment problems are common reasons for
central banks to hold currency values down.
9) The fall in the value of the domestic currency will sharply reduce the purchasing power of
foreign tourists in the country whose currency values are falling.
10) The International Monetary Fund, as one of its basic principles (Article IV), encourages
members to pursue “currency manipulation” to gain competitive advantages over other members
as opposed to engaging in military action to achieve the same advantage.
11) If a central bank wishes to “defend its currency,” it might follow an expansive monetary
policy, which would drive real rates of interest up.
12) A country wishing for its currency to fall in value, particularly when confronted with a
continual appreciation of its value against major trading partner currencies, the central bank may
work to lower real interest rates, reducing the returns to capital.
13) Indirect intervention for domestic currency valuation typically uses tools of monetary policy
as opposed to using tools of fiscal policy.
14) Direct intervention for currency valuation involves limiting the ability to exchange domestic
currency for foreign currency.
15) Explain how a central bank would engage in direct intervention to decrease the value of its
domestic currency. Since the 1970s it has been difficult for central banks alone to engage in
direct intervention to alter the value of their domestic currency. Identify and explain at least two
other activities in which a central bank could engage to alter the value of their domestic
currency.