61.
According to the law of one price, if the exchange rate between the British
pound and the dollar is £1 = $1.50, a shirt that retails for $120 in New York
should sell for _____ in London.
A.
£180
B.
£50
C.
£60
D.
£80
The short will sell for £80 (120 ÷1.5). The law of one price states that in
competitive markets free of transportation costs and barriers to trade,
identical products sold in different countries must sell for the same price
when their price is expressed in terms of the same currency.
AACSB: Reflective Thinking
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
62.
Assume that the law of one price holds. A shirt that retails for $120 in New
York sells for £60 in London. The exchange rate between the British pound
and the dollar is £1 = $1.50. Assuming away transportation costs and trade
barriers, this creates a profit-making opportunity called _____.
A.
B.
arbitrage
C.
carry trade
D.
straddle
Arbitrage involves the purchase and sale of a commodity at the same time
to take advantage of pricing differentials in two markets.
AACSB: Reflective Thinking
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
63.
The _____ suggests that given relatively efficient markets, the price of a
“basket of goods” should be roughly equivalent in each country.
A.
random walk theory
B.
theory of competitive advantage
C.
theory of price inflation
D.
purchasing power parity theory
If the law of one price were true for all goods and services, the PPP
exchange rate could be found from any individual set of prices. 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.
AACSB: Analytic
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
64.
Suppose the price of a Big Mac in New York is $3.00 and the price of a Big
Mac in Paris is equivalent to $3.75 at the prevailing euro/dollar exchange
rate. Using the concept of purchasing power parity, the euro is:
A.
undervalued by 25 percent against the dollar.
B.
overvalued by 25 percent against the dollar.
C.
appreciating relative to the dollar.
D.
depreciating relative to the dollar.
According to the PPP theory, the prices in the two countries should be the
same. If they are not, it implies that the currency is either overvalued
against the dollar or undervalued.
AACSB: Reflective Thinking
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
65.
Identify the incorrect statement about the PPP theory.
A.
It predicts that exchange rates are determined by relative prices.
B.
It yields accurate predictions of short-run movements in exchange rates.
C.
It best predicts exchange rate changes for countries with high rates of
inflation.
D.
It assumes away transportation costs and barriers to trade.
While PPP theory seems to yield relatively accurate predictions in the long
run, it does not appear to be a strong predictor of short-run movements in
exchange rates covering time spans of five years or less.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
66.
Which of the following occurs when the quantity of money in circulation in a
country rises faster than the country’s stock of goods and services?
A.
Inflation
B.
Credit squeeze
C.
Deflation
D.
Production surplus
Inflation occurs when the quantity of money in circulation rises faster than
the stock of goods and services, that is, when the money supply increases
faster than output increases.
AACSB: Analytic
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
67.
Which of the following is referred to as the purchasing power parity puzzle?
A.
Reduced levels of inflation in countries where the growth in the money
supply is faster than the growth in its output.
B.
The reason why countries with high inflation rates see depreciation in
their currency exchange rates.
C.
Identical products being sold in different countries for the same price
when their price is expressed in terms of the same currency.
D.
The failure to find a strong link between relative inflation rates and
exchange rate movements.
The failure to find a strong link between relative inflation rates and
exchange rate movements has been referred to as the purchasing power
parity puzzle.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
68.
The _____ states that a country’s “nominal” interest rate is the sum of the
required “real” rate of interest and the expected rate of inflation over the
period for which the funds are to be lent.
A.
PPP theory
B.
efficient market theory
C.
law of one price
D.
Fisher Effect
The Fisher Effect states that 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).
AACSB: Analytic
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
69.
It follows from the Fisher Effect that if the real interest rate is the same
worldwide; any difference in interest rates between countries reflects
differing expectations about ______.
A.
foreign exchange rates
B.
inflation rates
C.
unemployment rates
D.
GDP growth rates
It follows from the Fisher Effect that if the real interest rate is the same
worldwide; any difference in interest rates between countries reflects
differing expectations about inflation rates.
AACSB: Analytic
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
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.
purchasing power parity theory
B.
efficient market theory
C.
International Fisher Effect
D.
law of one price
The International Fisher Effect 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.
AACSB: Analytic
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
71.
Which of the following occurs when traders start moving as a herd in the
same direction at the same time?
A.
Fisher effect
B.
Bandwagon effect
C.
Arbitrage
D.
Decoupling of markets
The bandwagon effect occurs when traders start moving as a herd in the
same direction at the same time.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-04 Understand the different theories explaining how currency exchange rates are determined and
their relative merits.
Topic: Economic Theories of Exchange Rate Determination
72.
The _____ school of thought argues that forward exchange rates do the best
possible job of forecasting future spot rates and therefore investing in
forecasting services would be a waste of money.
A.
inefficient market
B.
efficient market
C.
random walk
D.
speculative
The efficient market school argues that forward exchange rates do the best
possible job of forecasting future spot exchange rates, and, therefore,
investing in forecasting services would be a waste of money.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-05 Identify the merits of different approaches toward exchange rate forecasting.
Topic: Exchange Rate Forecasting
73.
Which of the following would a follower of the inefficient market school of
thought agree with?
A.
Companies would be better off investing in foreign exchange forecasting
services.
B.
Forward exchange rates do the best possible job of forecasting future
spot exchange rates.
C.
Companies can optimize their foreign exchange transactions by using
forward markets.
D.
Forward rates reflect all available information about likely future changes
in exchange rates.
The inefficient market school argues that companies can improve the
foreign exchange market’s estimate of future exchange rates (as contained
in the forward rate) by investing in forecasting services.
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 10-05 Identify the merits of different approaches toward exchange rate forecasting.
Topic: Exchange Rate Forecasting
74.
_____ uses price and volume data to determine past trends, which are
expected to continue into the future.
A.
Technical analysis
B.
Fundamental analysis
C.
Efficient market theory
D.
Value investing
Technical analysis is based on the premise that there are analyzable market
trends and waves and that previous trends and waves can be used to
predict future trends and waves.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-05 Identify the merits of different approaches toward exchange rate forecasting.
Topic: Exchange Rate Forecasting
75.
A currency is said to be freely convertible when:
A.
its exchange rate with respect to other currencies is decided by the
central bank of the country.
B.
residents alone are allowed to convert it into a foreign currency without
any limitations.
C.
neither residents nor nonresidents are allowed to convert it into a foreign
currency.
D.
both residents and nonresidents are allowed to purchase unlimited
amounts of a foreign currency with it.
A country’s currency is said to be freely convertible when the country’s
government allows both residents and nonresidents to purchase unlimited
amounts of a foreign currency with it.
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 10-05 Identify the merits of different approaches toward exchange rate forecasting.
Topic: Currency Convertibility
76.
_____ is most likely to occur when the value of the domestic currency is
depreciating rapidly because of hyperinflation or when a country’s economic
prospects are shaky in other respects.
A.
The random walk effect
B.
The Fisher Effect
C.
The International Fisher Effect
D.
Capital flight
Governments typically impose convertibility restrictions on their currency
when they fear that free convertibility will lead to a run on their foreign
exchange reserves. This occurs when residents and nonresidents rush to
convert their holdings of domestic currency into a foreign currency—a
phenomenon generally referred to as capital flight.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-05 Identify the merits of different approaches toward exchange rate forecasting.
Topic: Currency Convertibility
77.
_____ refers to a range of barter-like agreements by which goods and
services can be traded for other goods and services.
A.
Countertrade
B.
Carry trade
C.
Dumping
D.
Capital flight
Countertrade refers to a range of barter-like agreements by which goods
and services can be traded for other goods and services. Companies can
deal with the nonconvertibility problem by engaging in countertrade.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-05 Identify the merits of different approaches toward exchange rate forecasting.
Topic: Currency Convertibility
78.
The extent to which the income from individual transactions is affected by
fluctuations in foreign exchange values is known as:
A.
economic exposure.
B.
financial exposure.
C.
translation exposure.
D.
transaction exposure.
Transaction exposure is the extent to which the income from individual
transactions is affected by fluctuations in foreign exchange values. It
includes obligations for the purchase or sale of goods and services at
previously agreed prices and the borrowing or lending of funds in foreign
currencies.
AACSB: Analytic
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-06 Compare and contrast the differences between translation; transaction; and economic exposure;
and explain what managers can do to manage each type of exposure.
Topic: Implications for Managers