Instructor’s Manual
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in
1. Market fundamentals and market expectations. Long run exchange rates are best explained by factors
including real income differentials, inflation rate differentials, productivity changes, and the like. In the
2. The nominal interest rate refers to the interest rate, unadjusted for inflation. The real interest rate
equals the nominal interest rate minus the inflation rate. International investors are especially
3. The purchasing-power-parity theory predicts that a country’s currency will depreciate by an amount
equal to the excess of domestic inflation over foreign inflation. The theory also predicts that a country’s
Instructor’s Manual
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in
4. An overvalued currency tends to lead to a balance–of-payments deficit for the home country, while an
undervalued currency leads to a balance–of-payments surplus.
5. In the long run, four key factors account for changes in exchange rates: relative productivity levels,
6. In the short run, changes in exchange rates are caused by relative interest rates and expected
changes in exchange rates.
7. The dollar’s exchange rate will:
a. Depreciate
b. Appreciate
8. An exchange rate is said to overshoot when its short-run response (depreciation/appreciation) to a
change in market fundamentals is greater than its long-run response. Exchange rate overshooting
occurs because exchange rates tend to be more flexible than other prices; exchange rates often
9. Currency forecasters generally use one of three methods to predict future exchange rates: (1)
10. Supply of Demand for Exchange rate
pounds pounds ($ per pound)
a. ——– decrease decrease
b. decrease increase increase
c. increase decrease decrease
11. a. False
b. True
12. More expensive, less expensive, increased, decreased
13. a. Dollar depreciates by 10 percent, to approximately $0.55 per franc.
Instructor’s Manual
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in
b. Dollar appreciates by 10 percent, to approximately $0.45 per franc.
14. a. – 2 percent in the U.S., 2 percent in the U.K.
b. Investment would flow from the U.S. to the U.K.