Chapter 04: Exchange Rate Determination
1. The value of the Australian dollar (A$) today is $0.73. Yesterday, the value of the Australian dollar was $0.69. The
Australian dollar ____ by ____ percent
a.
depreciated; 5.80
b.
depreciated; 4.00
c.
appreciated; 5.80
d.
appreciated; 4.00
($0.73 − $0.69)/$0.69 = 5.80%
2. If a currency’s spot rate market is ____, its exchange rate is likely to be ____ to a single large purchase or sale
transaction.
a.
b.
c.
d.
3. ____ are not a factor that causes currency supply and demand schedules to change.
a.
Relative inflation rates
b.
Relative interest rates
c.
Relative income levels
d.
Expectations
e.
All of the above are factors that cause currency supply and demand schedules to change.
4. A large increase in the income level in Mexico along with no growth in the U.S. income level is normally expected to
cause (assuming no change in interest rates or other factors) a(n) ____ in Mexican demand for U.S. goods, and the
Mexican peso should ____.
a.
increase; appreciate
b.
increase; depreciate
Chapter 04: Exchange Rate Determination
c.
decrease; depreciate
d.
decrease; appreciate
5. An increase in U.S. interest rates relative to German interest rates would likely ____ the U.S. demand for euros and
____ the supply of euros for sale.
a.
reduce; increase
b.
increase; reduce
c.
reduce; reduce
d.
increase; increase
6. Investors from Germany, the United States, and the United Kingdom frequently invest in each other’s currencies based
on prevailing interest rates. If British interest rates increase, German investors are likely to buy ____ dollar-denominated
securities, and the euro is likely to ____ relative to the dollar.
a.
fewer; depreciate
b.
fewer; appreciate
c.
more; depreciate
d.
more; appreciate
7. When the “real” interest rate is relatively low in a given country, then the currency of that country is typically expected
to be:
a.
weak, since the country’s quoted interest rate would be high relative to the inflation rate.
b.
strong, since the country’s quoted interest rate would be low relative to the inflation rate.
c.
strong, since the country’s quoted interest rate would be high relative to the inflation rate.
d.
weak, since the country’s quoted interest rate would be low relative to the inflation rate.
8. Assume that the inflation rate becomes much higher in the United Kingdom relative to the United States. This will
place ____ pressure on the value of the British pound. Also, assume that U.K. interest rates begin to rise relative to U.S.
interest rates. The change in interest rates will place ____ pressure on the value of the British pound.
a.
upward; downward
b.
upward; upward
c.
downward; upward
d.
downward; downward
9. In general, when speculating on exchange rate movements, the speculator will borrow the currency that is expected to
appreciate and invest in the country whose currency is expected to depreciate.
a.
True
b.
False
10. Assume the following information regarding U.S. and European annualized interest rates:
Currency
Lending Rate
Borrowing Rate
U.S. Dollar ($)
6.73%
7.20%
Euro (€)
6.80%
7.28%
Trensor Bank can borrow either $20 million or €20 million. The current spot rate of the euro is $1.13. Furthermore,
Trensor Bank expects the spot rate of the euro to be $1.10 in 90 days. What is Trensor Bank’s dollar profit from
speculating if the spot rate of the euro is indeed $1.10 in 90 days?
a.
$579,845.
b.
$583,800.
c.
$588,200.
d.
$584,245.
e.
$980,245.
11. The equilibrium exchange rate of pounds is $1.70. At an exchange rate of $1.72 per pound, U.S. demand for pounds
would ________ the supply of pounds for sale and there would be a _______ of pounds in the foreign exchange market.
a.
exceed; shortage
b.
be less than; shortage
c.
exceed; surplus
d.
be less than; surplus
e.
be equal to; shortage
12. The real interest rate adjusts the nominal interest rate for:
a.
exchange rate movements.
b.
income growth.
c.
inflation.
d.
government controls.
e.
none of the above
13. If U.S. inflation suddenly increased while European inflation stayed the same, there would be:
a.
an increased U.S. demand for euros and an increased supply of euros for sale.
b.
a decreased U.S. demand for euros and an increased supply of euros for sale.
c.
a decreased U.S. demand for euros and a decreased supply of euros for sale.
d.
an increased U.S. demand for euros and a decreased supply of euros for sale.
14. If inflation in New Zealand suddenly increased while U.S. inflation stayed the same, there would be:
a.
an inward shift in the demand schedule for NZ$ and an outward shift in the supply schedule for NZ$.
b.
an outward shift in the demand schedule for NZ$ and an inward shift in the supply schedule for NZ$.
c.
an outward shift in the demand schedule for NZ$ and an outward shift in the supply schedule for NZ$.
d.
an inward shift in the demand schedule for NZ$ and an inward shift in the supply schedule for NZ$.
15. Assume that British corporations begin to purchase more supplies from the United States as a result of several labor
strikes by British suppliers. This action reflects:
a.
an increased demand for British pounds.
b.
a decrease in the demand for British pounds.
c.
an increase in the supply of British pounds for sale.
d.
a decrease in the supply of British pounds for sale.
16. The exchange rates of smaller countries are very stable because the market for their currency is very liquid.
a.
True
b.
False
17. The phrase “the dollar was mixed in trading” means that:
a.
the dollar was strong in some periods and weak in other periods over the last month.
b.
the volume of trading was very high in some periods and low in other periods.
c.
the dollar was involved in some currency transactions, but not others.
d.
the dollar strengthened against some currencies and weakened against others.
18. Assume that the United States places a strict quota on goods imported from Chile and that Chile does not retaliate.
Holding other factors constant, this event should immediately cause the U.S. demand for Chilean pesos to ____ and the
value of the peso to ____.
a.
increase; increase
b.
increase; decline
c.
decline; decline
d.
decline; increase
19. Any event that increases the U.S. demand for euros should result in a(n) ____ in the value of the euro with respect to
____, other things being equal.
a.
increase; the U.S. dollar
b.
increase; nondollar currencies
c.
decrease; nondollar currencies
d.
decrease; the U.S. dollar
20. Any event that reduces the U.S. demand for Japanese yen should result in a(n) ____ in the value of the Japanese yen
with respect to ____, other things being equal.
a.
increase; the U.S. dollar
Chapter 04: Exchange Rate Determination
b.
increase; nondollar currencies
c.
decrease; nondollar currencies
d.
decrease; the U.S. dollar
21. Any event that increases the supply of British pounds to be exchanged for U.S. dollars should result in a(n) ____ in the
value of the British pound with respect to ____, other things being equal.
a.
increase; the U.S. dollar
b.
increase; nondollar currencies
c.
decrease; nondollar currencies
d.
decrease; the U.S. dollar
22. Any event that reduces the supply of Swiss francs to be exchanged for U.S. dollars should result in a(n) ____ in the
value of the Swiss franc with respect to ____, other things being equal
a.
increase; the U.S. dollar
b.
increase; nondollar currencies
c.
decrease; nondollar currencies
d.
decrease; the U.S. dollar
23. Assume that the United States experiences a significant decline in income, while Japan’s income remains steady. This
event should place ____ pressure on the value of the Japanese yen, other things being equal. (Assume that interest rates
and other factors are not affected.)
a.
upward
b.
downward
c.
no
d.
upward and downward (offsetting)
24. News of a potential surge in U.S. inflation and zero Chilean inflation places ____ pressure on the value of the Chilean
peso. The pressure will occur ____.
a.
upward; only after the U.S. inflation surges
b.
downward; only after the U.S. inflation surges
c.
upward; immediately
d.
downward; immediately
25. Assume that Canada places a strict quota on goods imported from the United States and that the United States does not
retaliate. Holding other factors constant, this event should immediately cause the supply of Canadian dollars to be
exchanged for U.S. dollars to ____ and the value of the Canadian dollar to ____.
a.
increase; increase
b.
increase; decline
c.
decline; decline
d.
decline; increase
26. Assume that Japan places a strict quota on goods imported from the United States and the United States places a strict
quota on goods imported from Japan. This event should immediately cause the U.S. demand for Japanese yen to ____, and
the supply of Japanese yen to be exchanged for U.S. dollars to ____.
a.
increase; increase
b.
increase; decline
c.
decline; decline
d.
decline; increase
27. Which of the following is not mentioned in the text as a factor affecting exchange rates?
a.
relative interest rates
b.
relative inflation rates
c.
government controls
d.
expectations
e.
all of the above are mentioned in the text as factors affecting exchange rates.
28. If a country experiences high inflation relative to the United States, its exports to the United States should ____, its
imports should ____, and there is ____ pressure on its currency’s equilibrium value
a.
decrease; increase; upward
b.
decrease; decrease; upward
c.
increase; decrease; downward
d.
decrease; increase; downward
e.
increase; decrease; upward
29. If a country experiences an increase in interest rates relative to U.S. interest rates, the inflow of U.S. funds to purchase
its securities should ____, the outflow of its funds to purchase U.S. securities should ____, and there is ____ pressure on
its currency’s equilibrium value.
a.
increase; decrease; downward
b.
decrease; increase; upward
c.
increase; decrease; upward
d.
decrease; increase; downward
e.
increase; increase; upward
30. An increase in U.S. inflation relative to Singapore inflation places upward pressure on the Singapore dollar.
a.
True
Chapter 04: Exchange Rate Determination
b.
False
31. When expecting a foreign currency to depreciate, a possible way to speculate on this movement is to borrow dollars,
convert the proceeds to the foreign currency, lend in the foreign country, and use the proceeds from this investment to
repay the dollar loan.
a.
True
b.
False
32. Since supply and demand for a currency are constant (primarily due to government intervention), currency values
seldom fluctuate.
a.
True
b.
False
33. Relatively high Japanese inflation may result in an increase in the supply of yen for sale and a reduction in the demand
for yen.
a.
True
b.
False
34. The main effect of interest rate movements on exchange rates is through their effect on international trade.
a.
True
b.
False
Chapter 04: Exchange Rate Determination
35. Country X frequently engages in trade flows with the United States (such as imports and exports). Country Y
frequently engages in capital flows with the United States (such as financial investments). Everything else held constant,
an increase in U.S. interest rates would affect the exchange rate of Country X’s currency more than the exchange rate of
Country Y’s currency.
a.
True
b.
False
36. Increases in relative income in one country versus another result in an increase in the first country’s currency value.
a.
True
b.
False
37. Trade-related foreign exchange transactions are more responsive to news than financial flow transactions.
a.
True
b.
False
38. Expectations of a currency crisis may trigger actions by investors and speculators that make the crisis worse.
a.
True
b.
False
39. When investors engage in the “carry trade,” they attempt to capitalize on the difference in interest rates between two
countries by borrowing a currency with a low interest rate and investing the funds in a currency with a high interest rate.
a.
True
b.
False
40. A currency’s liquidity can affect the extent to which speculation can impact the currency’s value.
a.
True
b.
False
41. Forecasting a currency’s future value is difficult, because it is difficult to identify how the factors affecting the
currency’s value will change, and how they will interact to impact the currency’s value
a.
True
b.
False
42. The standard deviation should be applied to values rather than percentage movements when comparing volatility
among currencies.
a.
True
b.
False
43. Movements of foreign currencies tend to be more volatile for shorter time horizons.
a.
True
b.
False
44. Capital flows have become _______ over time; a significant portion of capital flows are due to _______ .
a.
remained about the same; large institutional investors
b.
smaller; international trade
c.
larger; large institutional investors
d.
larger; international trade
45. The value of the euro was $1.30 last week. During last week the euro depreciated by 5 percent. What is the value of
the euro today?
a.
$1.365
b.
$1.235
c.
$1.330
d.
$1.30
$1.3 (1 − .05) = $1.235
46. Government controls can affect only the supply of a given currency for sale and not the demand.
a.
True
b.
False
47. If one foreign currency appreciates against the dollar, then all foreign currencies will appreciate against the dollar but
by different degrees.
a.
True
b.
False
48. Assume that income levels in the United Kingdom start to rise, while U.S. income levels remain unchanged. This will
place ____ pressure on the value of the British pound. Also, assume that U.S. interest rates rise, while British interest rates
remain unchanged and that no inflation is expected in either country.. This will place ____ pressure on the value of the
British pound.
a.
downward; downward
b.
upward; downward
c.
upward; upward
d.
downward; upward
49. If the Fed announces that it will decrease U.S. interest rates, and the European Central Bank takes no action, then the
value of the euro will ____ against the value of U.S. dollar (holding other factors constant).
a.
be unchanged
b.
depreciate
c.
appreciate
d.
depreciate but only briefly
50. Assume that the total value of investment transactions between United States and Mexico is minimal. Also assume
that the total dollar value of trade transactions between these two countries is very large. Now assume that Mexico’s
inflation has suddenly increased, and Mexican interest rates have suddenly increased. Overall, this would put ____
Chapter 04: Exchange Rate Determination
pressure on the value of Mexican peso. The inflation effect should be ____ pronounced than the interest rate effect.
a.
downward; more
b.
upward; more
c.
downward; less
d.
upward; less
51. If the United States experiences a sudden surge in inflation and a surge in interest rates while Japanese inflation and
interest rates remain unchanged, the value of the Japanese yen will ____ against the U.S. dollar.
a.
appreciate
b.
depreciate
c.
remain unchanged
d.
cannot be determined from the information provided
52. If the Japanese yen is expected to appreciate against the U.S. dollar and interest rates in the United States and Japan
are similar, banks may try speculating on this anticipated exchange rate movement by borrowing ____ and investing in
____.
a.
yen; dollars
b.
yen; yen
c.
dollars; yen
d.
dollars; dollars
53. British investors frequently invest in the United States or Italy, depending on the prevailing interest rates. If Italian
interest rates suddenly rise high above U.S. rates, the investors will ____ the supply of pounds to be exchanged for dollars
and thus put ____ pressure on the value of the pound against the U.S. dollar.
a.
increase; downward
b.
decrease; upward
c.
increase; upward
Chapter 04: Exchange Rate Determination
d.
decrease; downward
54. The equilibrium exchange rate of the Swiss franc is $0.90. At an exchange rate $.87, U.S. demand for Swiss francs
would ______ the supply of francs for sale and there would be a ______ of francs in the foreign exchange market.
a.
exceed; shortage
b.
be less than; shortage
c.
exceed; surplus
d.
be less than; surplus
55. Financial flow foreign exchange transactions are more responsive to news than trade-related transactions are.
a.
True
b.
False
56. Assume that the British government eliminates all controls on imports by British companies. Other things being equal,
the U.S. demand for pounds would ____, the supply of pounds for sale would ____, and the equilibrium value of the
pound would ____.
a.
increase; increase; increase
b.
decrease; increase; decrease
c.
remain unchanged; increase; decrease
d.
remain unchanged; increase; increase
57. Country X frequently engages in trade flows with the United States (such as imports and exports). Country Y
frequently engages in capital flows with the United States (such as financial investments). Everything else held constant,
an increase in U.S. inflation would affect the exchange rate of Country Y’s currency more than the exchange rate of
Country X’s currency.
a.
True
b.
False
58. Assume that U.S. inflation is expected to surge in the near future. The expectation of a surge in inflation will most
likely place ____ pressure on the U.S. dollar immediately.
a.
upward
b.
downward
c.
no
d.
cannot be determined
59. When the Japanese yen appreciates against the U.S. dollar, this means that the U.S. dollar is strengthening relative to
the yen.
a.
True
b.
False
60. Illiquid currencies tend to exhibit less volatile exchange rate movements than liquid currencies.
a.
True
b.
False
61. The supply curve for a currency is downward sloping since U.S. corporations would be encouraged to purchase more
foreign goods when the foreign currency is worth less.
a.
True
b.
False
62. Relatively high Japanese inflation may result in an increase in the supply of yen for sale and a reduction in the demand
for yen, other things being equal.
a.
True
b.
False
63. If the British government desires an appreciation in its currency with respect to the U.S. dollar, it would consider
intervening in the foreign exchange market by buying dollars with pounds.
a.
True
b.
False
64. A financial institution that expects a particular foreign currency to appreciate may try to benefit from its expectation
by borrowing funds in that currency and repaying the loan after the exchange rate changes in the expected manner.
a.
True
b.
False
65. Illiquid currencies tend to exhibit ____ volatile exchange rate movements, as the equilibrium prices of their currencies
adjust to ____ changes in supply and demand conditions.
a.
less; even minor
b.
less; only large
c.
more; even minor
d.
more; only large
e.
none of the above
66. Which of the following events would most likely result in an appreciation of the U.S. dollar?
a.
U.S. inflation is very high.
b.
The Fed indicates that it will raise U.S. interest rates.
c.
Future U.S. interest rates are expected to decline.
d.
Japan is expected to increase interest rates in the near future.
67. Which of the following situations is most likely to strengthen the yen’s value against the dollar? Assume everything
else is held constant.
a.
a reduction in U.S. inflation accompanied by an increase in Japan’s inflation
b.
a reduction in U.S. inflation accompanied by an increase in U.S. interest rates
c.
an increase in U.S. inflation accompanied by no change in U.S. nominal interest rates
d.
a reduction in Japan’s inflation accompanied by an increase in Japan’s interest rates
68. If a country experiences low inflation relative to the United States, its exports to the United States should ____, and
there is ____ pressure on its currency’s equilibrium value.
a.
decrease; downward
b.
decrease; upward
c.
increase; downward
d.
increase; upward
Chapter 04: Exchange Rate Determination
69. If a country experiences a reduction in interest rates relative to U.S. interest rates, and there is no change in
inflationary conditions, that country’s investors will ____ their investments in U.S. securities, and there is ____ pressure
on its currency’s equilibrium value.
a.
increase; downward
b.
decrease; upward
c.
increase; upward
d.
decrease; downward