International Economics, 7e (Gerber)
Chapter 10 Exchange Rates and Exchange Rate Systems
10.1 Introduction: Fixed, Flexible, or In-Between?
1) There are no questions for this section.
Topic: Introduction: Fixed, Flexible, or In-Between?
10.2 Exchange Rates and Currency Trading
1) A firm that buys foreign exchange in order to take advantage of higher foreign interest rates is
A) speculating.
B) demonstrating purchasing power parity.
C) engaging in interest rate arbitrage.
D) responding to fluctuations in the business cycle.
2) Suppose the dollar is subject to a floating exchange rate system and that R is the number of
dollars per unit of foreign exchange. If R increases, then the dollar
A) depreciates.
B) appreciates.
C) is devalued.
D) is revalued.
3) When an individual or firm in the United States requests that a bank sell foreign exchange, the
bank will probably
A) call a foreign bank and arrange a purchase.
B) call the central bank and arrange a purchase.
C) call another bank customer with foreign exchange holdings.
D) call a foreign exchange broker and arrange a purchase.
4) In order to protect against foreign exchange risk, firms can use
A) the spot market for foreign exchange.
B) interest rate arbitrage.
C) the forward market for foreign exchange.
D) the J-curve.
5) Covered interest arbitrage involves both
A) the purchase of a foreign asset and a forward contract in the market for foreign exchange.
B) the purchase of a domestic asset and a spot contract in the market for foreign exchange.
C) the sale of a foreign asset and the purchase of a forward contract in the market for foreign
exchange.
D) the sale of domestic stocks and the purchase of foreign bonds.
6) Which of the following institutions is the most important participant in foreign currency
markets?
A) A retail customer
B) A commercial bank
C) A foreign exchange broker
D) A central bank
7) The spot rate is the rate at which foreign currencies will be exchanged a specified number of
days in the future.
8) A forward exchange market contract obligates the owner to make a trade at a specified
exchange rate a fixed number of days in the future.
9) If Juana contracts to buy U.S. office equipment in U.S. dollars and her domestic currency
depreciates against the U.S. dollar between the time the contract is signed and the bill is paid, she
will wind up paying less for the equipment because she stayed in the spot market.
10) When Jeneva went to Costa Rica in July 2008, a U.S. dollar was worth 550 colones. If today
a U.S. dollar is worth 650 colones, it means that the U.S. dollar has depreciated against the
colone.
11) If the Costa Rican colone is expected to depreciate in the future, it will temporarily
appreciate as people move to take advantage based on this expectation.
12) Speculation would involve using forward contracts and options to reduce the exchange rate
risk on future foreign exchange transactions.
13) Most currency trades in London do not involve the British pound.
14) What is the largest center for currency trading?
15) How does the growth in the daily volume of foreign currency transactions compare with the
growth rate of the global economy?
16) Which currency is most commonly traded?
17) If the forward rate is greater than the spot rate, what are markets signaling about their
expectations for the future spot rates for the home currency?
18) The most important participants in foreign exchange markets are ________.
19) Would each of the following groups be happy or unhappy if the Mexican peso appreciates
against the U.S. dollar? Answer the question for each of the following:
(a) The U.S. pension funds holding Mexican government bonds
(b) U.S. tourists planning a trip to Mexico
(c) Mexican exporting manufacturers
(d) A Mexican firm trying to buy properties overseas
20) Suppose that the U.S. Open ticket costs $100 and the British Open ticket costs £50 and the
exchange rate is $1.43. How much does the British Open ticket cost for an American attending
the British Open?
10.3 The Supply and Demand for Foreign Exchange
1) All else equal and given the current system of exchange rates, if the United States enters a
period of exceptionally strong growth,
A) the pressure on the dollar is to revalue.
B) the pressure on the dollar is to devalue.
C) the pressure on the dollar is to depreciate.
D) the pressure on the dollar is to appreciate.
2) All else equal, if Canada raises its interest rates,
A) the dollar depreciates.
B) the U.S. demand for Canadian dollars decreases.
C) the Canadian supply of Canadian dollars increases.
D) the Canadian dollar will depreciate.
3) An American firm that buys foreign exchange because its managers expect the dollar to
depreciate is
A) increasing the supply of foreign exchange.
B) decreasing the demand for foreign exchange.
C) speculating.
D) hedging.
4) Suppose the exchange rates between the United States and Canada are in long-run equilibrium
as defined by the idea of purchasing power parity. If the law of one price holds perfectly, then
differences between U.S. and Canadian rates of inflation would
A) have no effect on nominal exchange rates.
B) be completely offset by changes in the real exchange rate.
C) be completely offset by changes in the nominal exchange rate.
D) lead to a change in the real purchasing power of each country’s currency when it is converted
to the other country’s currency.
5) Which of the following is a FALSE statement concerning purchasing power parity?
A) Purchasing power parity states that dollars will tend to exchange for pounds at a rate that
maintains a constant purchasing power of a given quantity of a currency.
B) It is rare to see deviations from the purchasing power parity value of currencies.
C) Over the long run, purchasing power parity exerts influence over exchange rates.
D) An overvalued dollar buys more in Britain than it does in the United States.
6) An increase in the U.S. demand for the Mexican peso
A) causes an increase in the U.S. dollar price of a Mexican peso.
B) causes the Mexican peso to appreciate.
C) causes the U.S. dollar to depreciate.
D) causes Mexican goods to be cheaper.
7) According to the text, which of the following factors may make the theory of purchasing
power parity unrealistic?
A) Trading countries may stop exchanging goods once prices between them equalize.
B) Shipping, insurance, and transaction costs may reduce the implication of purchasing power
parity.
C) Prices may not equalize if goods arbitrage is reduced by trade barriers.
D) The effects of purchasing power parity may not show up until many years have passed.
8) Which of the following would NOT be a cause for an increased American demand for the
Mexican peso?
A) The United States having lower interest rates than Mexico
B) Increased American demand for Mexican goods
C) The expectation by speculators that the value of the peso is edging up
D) Greater economic growth in the United States
9) Suppose that there are only two countries, the U.S. and Japan. If real interest rates rise in
Japan, which of the following is NOT true?
A) More Japanese yen will be supplied in exchange for dollars.
B) More U.S. dollars will be supplied in exchange for yen.
C) The volume of yen traded will increase.
D) Japanese borrowers will be worse off.
10) If the dollar/pound exchange rate is $2/£, a Big Mac costs $5 in New York City and costs £4
in London, the pound is ________, and U.S. tourists will be ________.
A) overvalued; better off in London
B) overvalued; better off in New York
C) undervalued; better off in London
D) undervalued; better off in New York
11) If the dollar/pound exchange rate is $2/£, a Big Mac costs $5 in New York City and costs £2
in London, the pound is ________, and U.S. tourists will be ________.
A) overvalued; better off in London
B) overvalued; better off in New York
C) undervalued; better off in London
D) undervalued; better off in New York
12) In the short run, exchange rates are most directly affected by which of the following?
A) flows of financial capital
B) purchasing power parity
C) trade barriers
D) imports and exports
13) The nominal interest rate in the U.S. is 5% and the nominal interest rate in Canada is 3%.
The spot value of the U.S. dollar is 1 ($/Canadian dollar) and the forward rate is 1.2 ($/Canadian
dollar). Which of the following is NOT true?
A) The dollar is likely to appreciate in spot markets.
B) The interest parity condition does not hold.
C) The dollar is trading at a forward discount.
D) Money will flow into the Canada.
14) A weak U.S. dollar leads to a higher volume of U.S. imports.
15) If inflation in the rest of the world is lower than inflation in Brazil, Brazil’s currency (the
real) would tend to appreciate.
16) If Mexicans increasingly lose confidence in their domestic financial markets and move their
assets to other countries, the peso will depreciate.
17) Imports tend to fall whenever a nation’s currency appreciates because foreign products
become more expensive to domestic consumers.
18) A country that experiences higher real interest rates than other countries would expect its
currency to depreciate.
19) If more European and Japanese firms want to build factories and expand their offshore
investments in the United States, the supply of U.S. dollars on foreign exchange markets will
increase as a result of this investment activity.
20) If U.S. consumers increase their demand for foreign products and foreign travel, the U.S.
dollar would tend to depreciate as more dollars are supplied to foreign exchange markets.
21) If the Japanese central bank sells yen and buys U.S. dollars, the U.S. dollar will appreciate.
22) If inflation is higher in the home market, what is expected to happen to the real value of the
home currency as time passes?
23) How does rapid economic growth at home affect foreign exchange markets?
24) Draw the demand for and supply of the U.S. dollar in each of the following cases. Diagram
and explain in words the effect of each of the following events in the short run. Make sure to
properly label the axes. In each case, assume the two countries under consideration are important
trading partners.
(a) There is an increase in the real interest rates in the United States relative to Japan.
(b) Investment returns in the United States decrease relative to expected returns in Japan.
(c) Inflation in Japan fell relative to the inflation rate in the United States.
(d) The Japanese expect the value of the U.S. dollar to decline.
(e) The Federal Reserve raised interest rates fearing the inflationary pressures of a booming U.S.
economy.
25) The nominal interest rate in the U.S. is 5% and the nominal interest rate in Canada is 3%.
The spot value of the U.S. dollar is 1 ($/Canadian dollar) and the forward rate is 1.2 ($/Canadian
dollar). Calculate the forward discount or premium for the dollar. Does the interest parity
condition hold? If not explain what is likely to occur in foreign exchange markets. Assume that
interest rates cannot change.