47) Kristin was shopping in New York last week and saw a Coach purse for $210. When she
returned to London, she saw that same purse for £105. She knew that the exchange rate was one
pound for every two dollars. Her shopping experience demonstrates
A) hedging.
B) arbitrage.
C) currency swap.
D) exchange rate risk.
E) the law of one price.
48) The law of one price states that
A) by comparing the prices of identical products in different currencies, it would be possible to
determine the “real” or PPP exchange rate that would exist if markets were efficient.
B) a country’s “nominal” interest rate (i) is the sum of the required “real” rate of interest (r) and the
expected rate of inflation over the period for which the funds are to be lent (I).
C) a country in which price inflation is running wild should expect to see its currency depreciate
against that of countries in which inflation rates are lower.
D) when the growth in a country’s money supply is faster than the growth in its output, price
inflation is fueled.
E) in competitive markets free of transportation costs and trade barriers, identical products sold in
different countries must sell for the same price when their price is expressed in terms of the same
currency.
49) The euro/dollar exchange rate is €1 = $1.20. According to the law of one price, how much
would a camera that retails for $300 in New York sell for in Germany?
A) €320
B) €300
C) €250
D) €360
E) €150
50) Shantal saw a Hermes scarf at the Amsterdam airport when she was catching a flight back
home to New York. She noticed that the scarf sold for 100 euros. Assume that the euro/dollar
exchange rate is €1 = $1.20. According to the law of one price, at what price would it make sense
to buy the scarf in New York?
A) $150
B) $140
C) $120
D) $105
E) $100
51) A(n) ________ has no impediments to the free flow of goods and services, such as trade
barriers.
A) economic union
B) currency board
C) efficient market
D) carry trade
E) European Monetary System
52) To express the PPP theory in symbols, let P$ be the U.S. dollar price of a basket of particular
goods and P¥ be the price of the same basket of goods in Japanese yen. What does the purchasing
power parity (PPP) theory predict to be the equivalent of the dollar/yen exchange rate, E$/¥?
A) E$/¥ = (1 + P¥) ÷ P$
B) E$/¥ = (1 + P$) ÷ P¥
C) E$/¥ = P¥ ÷ P$
D) E$/¥ = P$ ÷ P¥
E) E$/¥ = (1 + P$) ÷ (1 + P¥)
53) If a basket of goods costs $100 in the United States and €120 in Europe, what would the
purchasing power parity theory’s prediction of the dollar/euro exchange rate be?
A) $1 = €1.20
B) $1 = €1
C) $1 = €0.80
D) $1 = €0.90
E) $1 = €1.10
54) A base model Schwinn bike costs $100 in the United States and €125 in Europe. What would
the purchasing power parity theory’s prediction of the dollar/euro exchange rate be based on this
example?
A) $1 = €1.25
B) $1 = €1
C) $1 = €0.80
D) $1 = €0.90
E) $1 = €1.10
55) According to purchasing power parity (PPP) theory, the price of a “basket of goods” should be
A) the sum of the required “real” rate of interest.
B) unchangeable based on the forward exchange rate.
C) roughly equivalent in each country in relatively efficient markets.
D) discounted to reflect trade barriers.
E) focused strictly on consumer and not industrial goods.
56) Assume that a Big Mac costs $4.93 in the United States and that the Brazilian real is
undervalued by 23 percent. According to the Big Mac Index published by The Economist, a Big
Mac would
A) cost a bit more in Brazil than in the United States.
B) cost less in Brazil than in the United States.
C) cost the same in both countries.
D) would cost twice as much in Brazil.
E) would cost less than half of the United States price in Brazil.
57) In theory, if inflation is at an all-time high in the United States, then its currency will
A) increase in value when trading with countries in a political union.
B) appreciate against that of other countries where inflation is lower.
C) not be affected.
D) depreciate against that of other countries where inflation is lower.
E) increase faster than the money supply.
58) To jumpstart its slow economy, Greece increased the money supply. What is a likely
consequence of this action?
A) It results in an overall decrease in credit.
B) It makes it difficult for individuals and companies to borrow from banks.
C) It makes it easier for banks to borrow from the government.
D) It causes a decrease in demand for goods and services.
E) It causes price deflation as the money supply exceeds goods and services output.
59) The purchasing power parity (PPP) theory tells us that a country with a high inflation rate will
see
A) appreciation in its currency exchange rate.
B) a decrease in interest rates.
C) the collapse of the gold standard.
D) depreciation in its currency exchange rate.
E) no change in its exchange rates.
60) Suppose that the government of Venezuela decided to give everyone in the country the
equivalent of $20,000. Upon receipt of the money, people raced to the stores to buy furniture,
electronics, and new clothes. There was such high demand for goods that producers raised prices.
What is this an example of?
A) isolationism
B) inflation
C) spot exchange
D) recession
E) a planned economy
61) What happens to the value of money when hyperinflation exists?
A) Money loses value very rapidly.
B) Foreign currency is valued against the U.S. dollar.
C) The value of all currency increases faster than gross national income.
D) There are more goods to purchase and it costs less to buy them.
E) All currency continues to be valued at the same amount across trade channels.
62) The purchasing power parity (PPP) theory best predicts exchange rate changes for countries
with
A) low rates of inflation.
B) stable currencies.
C) underdeveloped capital markets.
D) small differentials in inflation rates.
E) industrialized economies.
63) The purchasing power parity puzzle represents the failure to find a strong link between relative
inflation rates and
A) trade agreements.
B) entrepreneurial activity.
C) exchange rate movements.
D) the bandwagon effect.
E) monopolistic competition.
64) One reason for the failure of the purchasing power parity (PPP) theory to predict exchange
rates accurately is because it
A) assumes away transportation costs and trade barriers.
B) does not take into account the law of one price.
C) does not take into account arbitration.
D) assumes that the markets are not efficient.
E) does not consider government influence on a nation’s money supply.
65) Gold Brands is the industry leader in golf equipment and not only has a degree of pricing
power amongst its competition but also sets different prices in different markets based on demand
conditions. Gold Brands is practicing
A) price discrimination.
B) premium pricing.
C) psychological pricing.
D) price skimming.
E) price leadership.
66) What is one way an enterprise with some market power might limit arbitrage so that their price
discrimination policy works?
A) price its products identically despite huge differences in demand across different markets
B) differentiate otherwise identical products among nations along some line, such as design or
packaging
C) adopt a pricing strategy that matches what competitors charge in each of the different national
markets
D) limit sales of its products to only a few nations
E) sell its products at higher prices than normal to break even by selling fewer units
67) In countries where inflation is expected to be high, interest rates also will be high, because
investors want compensation for the decline in the value of their money. This relationship is
referred to as the
A) purchasing power parity puzzle.
B) lead strategy.
C) Fisher effect.
D) bandwagon effect.
E) international Fisher effect.
68) The Fisher effect is used to demonstrate a strong correlation between inflation rates and
A) interest rates.
B) competition.
C) entrepreneurial activity.
D) spot exchange rates.
E) forward rates.
69) According to the Fisher effect, if the “real” rate of interest in a country is 3 percent and the
expected annual inflation is 8 percent, what would the “nominal” interest rate be?
A) 5.5 percent
B) 11 percent
C) 9 percent
D) 24 percent
E) 2.25 percent
70) The ________ states that for any two countries, the spot exchange rate should change in an
equal amount but in the opposite direction to the difference in nominal interest rates between the
two countries.
A) bandwagon effect
B) law of one price
C) international Fisher effect
D) Helms-Burton Act
E) purchasing power parity (PPP) theory
71) The nominal interest rate is 9 percent in Brazil and 6 percent in Japan. Applying the
international Fisher effect, the Brazilian real should
A) appreciate by 3 percent against the Japanese yen.
B) depreciate by 3 percent against the Japanese yen.
C) appreciate by 1.5 percent against the Japanese yen.
D) depreciate by 1.5 percent against the Japanese yen.
E) appreciate by 15 percent against the Japanese yen.
72) Traders at a stock exchange notice that five traders on the floor seem to be selling more yen
and purchasing more euros because of an expected decline in the yen. As a result, all other traders
started to do the same. This is an example of the ________ that creates a self-fulfilling prophecy
when the yen does decline in value.
A) spot exchange rate
B) arbitration process
C) bandwagon effect
D) difference principle
E) tragedy of the commons
73) One reason for the failure of purchasing power parity theory and international Fisher effect in
predicting short-term movements in exchange rates is due to the
A) impact of investor psychology on short-run exchange rate movements.
B) strong relationship between inflation rates and interest rates.
C) impact of interest rates and short-term exchange rate movements.
D) strong relationship between interest rate differentials and subsequent changes in spot exchange
rates.
E) government intervention in cross-border trade that violates the assumption of efficient markets.
74) When discussing exchange rate forecasting, the inefficient market school of thought would
agree that
A) forward exchange rates are the best possible predictors of future spot exchange rates.
B) forward exchange rates represent market participants’ collective predictions of likely spot
exchange rates.
C) companies cannot beat the markets because forward rates reflect all available information about
likely future changes in exchange rates.
D) investing in forecasting services can improve the foreign exchange market’s estimate of future
exchange rates.
E) the foreign exchange market is efficient at setting forward rates, which are unbiased predictors
of future spot rates.
75) According to the efficient market school, ________ do the best job at predicting future spot
exchange rates.
A) forecasting services
B) government institutions
C) inflationary trends
D) forward exchange rates
E) arbitration results
76) ________ draw(s) on economic theory to construct sophisticated econometric models for
predicting exchange rate movements.
A) Technical analysis
B) Purchasing power parity
C) The Sullivan principles
D) Fundamental analysis
E) The Treaty of Lisbon
77) The ________ is a variable used in exchange rate forecasting models based on fundamental
analysis.
A) PPP index
B) moving average
C) inflation rate
D) business cycle
E) regression rate
78) The Brazilian government decided to analyze price and volume data to determine past trends in
exchange rate movements for the country. What approach does this represent?
A) technical analysis
B) PPP index
C) efficient market
D) fundamental analysis
E) inefficient market
79) A country that relies on technical analysis for forecasting exchange rate movements would
know that
A) price and volume data cannot be used to determine past trends.
B) econometric models drawn from economic theory are best suited to predict exchange rate
movements.
C) the foreign exchange market is efficient and forward exchange rates are the best predictors of
future spot exchange rates.
D) previous market trends and waves can be used to predict future market trends and waves.
E) since forward exchange rates are the best predictors of future spot rates, it makes no sense to
invest in forecasting.