Deck 15: Exchange Rates and the Balance of Payments

Question 1

The US economy follows a _____.

A) ?xed exchange rate regime
B) ?oating exchange rate regime
C) dirty ?oat
D) crawling peg

Answer 1

?oating exchange rate regime

Question 2

A speculative attack on a currency will involve:

A) massive out?ows of the domestic currency from the economy.
B) a depreciation of the currency relative to other currencies.
C) an increase in demand for the currency that is expected to be devalued.
D) an appreciation of the currency relative to other currencies.

Answer 2

massive out?ows of the domestic currency from the economy.

Question 3

The demand for the UK pound in the foreign exchange market is derived from _____.

A) imports into the UK
B) the demand for the US dollar
C) the demand for the euro
D) exports from the UK

Answer 3

exports from the UK

Question 4

What is meant by purchasing power parity?

A) The nominal exchange rate will remain the same even as prices and interest rates change.
B) The nominal exchange rate will adjust in order to keep the real exchange rate constant.
C) Since exchange rates differ, the same amount of a currency will not buy the same level of goods in another country.
D) The real exchange rate will re?ect changes in prices while the nominal exchange rate will

Question 5

When a country o?cially decreases the value of its currency relative to other currencies, it is called currency _____.

A) appreciation
B) devaluation
C) depreciation
D) revaluation

Question 6

The price of a currency is the _____.

A) rate at which it can be converted into another currency
B) rate of interest that is paid on a loan taken out in the currency
C) total amount that will be received when goods are exported from a country
D) ratio of import prices to export prices for a particular country

Question 7

If an economy is following a ?xed exchange rate regime, its central bank's foreign currency reserves will increase when _____.

A) there is an excess supply of its currency in the foreign exchange market
B) there is an excess demand for its currency in the foreign exchange market
C) its imports are equal to its exports
D) its economy is experiencing low in?ation

Question 8

If exports from the US to Europe increase, it will result in a(n) _____.

A) appreciation of the euro
B) equalization in the exchange rates of the two currencies
C) appreciation of the US dollar
D) depreciation of the US dollar

Question 9

Under a _____, the government claims that the exchange rate ?oats, but it is in fact managed by the central bank.

A) ?xed exchange rate regime
B) ?oating
C) dirty ?oat
D) crawling peg

Question 10

For purchasing power parity to hold, _____.

A) the exchange rate must be ?xed
B) there should be negligible price differentials between economies
C) the cost of moving goods has to be lower than the price differential
D) the government should control in?ation by increasing government spending

Question 11

Suppose a UK ?rm that imports German wines writes a cheque for £10 000 to cover a bill of €27 500 for the latest shipment, the exchange rate between pounds and euros is _____.

A) £1.00 equals €1.00
B) £1.00 equals €2.75
C) €1.00 equals £2.00
D) €1.00 equals £4.50

Question 12

If in?ation was lower in the UK than in France, then under a ?oating exchange rate, which of the following would be true?

A) The nominal value of the euro will rise against the pound.
B) The nominal value of the euro will fall against the pound.
C) The nominal exchange rate of the euro against the pound will remain constant.
D) The real exchange rate and the nominal exchange rate will remain constant.

Question 13

When there is an increase in price in?ation in an economy with ?oating exchange rates:

A) imports into the country will fall.
B) exports from the country will increase.
C) imports into the country will increase.
D) imports into the country will equal exports from the country.

Question 14

Which of the following is true for an economy that forms a monetary union with other countries?

A) It becomes more ?exible in dealing with business cycles but less stable.
B) It becomes more stable but relatively in?exible in dealing with business cycles.
C) Its net exports will fall as price transparency in trade will reduce.
D) Since it faces increasing currency instability, private investment in the economy will fall.

Question 15

Under a ?xed exchange rate regime, when will the central bank be required to purchase the domestic currency to maintain the exchange rate?

A) When there is an excess demand for the domestic currency.
B) When there is an excess supply of the foreign currency.
C) When there is an excess supply of the domestic currency.
D) When there is a shortage of the domestic currency.

Question 16

Under a ?oating exchange rate regime, _____.

A) interest rates differentials will not be offset by changes in exchange rates
B) price differentials will not be offset by changes in exchange rates
C) the central bank's foreign currency reserves will not be affected
D) speculative attacks will take place in anticipation of currency depreciation

Question 17

Which of the following would increase the supply of US dollars in the foreign exchange market?

A) A German family travels to Disney World in the US on holiday.
B) An American family travels to Tokyo on holiday.
C) A German ?rm purchases some Ford trucks produced in China.
D) A group of British investors purchase an American bank.

Question 18

Under a _____, the exchange rate is determined by market forces.

A) dirty ?oat
B) managed ?oat
C) ?oating exchange rate regime
D) ?xed exchange rate regime

Question 19

What is meant by a ?xed exchange rate regime?

A) The government sets an exchange rate and then uses the central bank to maintain the value of the
Currency at that rate .
B) The exchange rate is set by the market forces of supply and demand.
C) The government claims that the exchange rate ?oats, but it is in fact managed by the central bank
D) The government uses the central bank to maintain the exchange rate within a wide band

Question 20

Under a ?xed exchange rate regime, which of the following statements will be true?

A) The central bank has an in?nite reserve of foreign currencies to use to maintain the value of the exchange rate.
B) There is a limit to the amount of domestic currency that the central bank can purchase to
C) Since the exchange rate is ?xed, the currency is not open to a speculative attack.
D) The government and the central bank do not intervene in the foreign exchange market.

Question 21

Which of the following is true for an economy that has adopted a ?xed exchange rate regime?

A) The demand for the domestic currency will always be equal to the supply of the domestic currency.
B) The smuggling of alcohol, cigarettes and drugs will be recorded under the current account.
C) Purchasing power parity is maintained through changes in the nominal exchange rate.
D) The nation's balance of payments will not always be equal to zero.

Question 22

The Chinese government is attempting to drive Chinese exports and protect jobs by:

A) allowing the Chinese yuan to ?oat freely.
B) undervaluing the Chinese yuan.
C) reducing the price differential between Chinese goods and foreign goods.
D) overvaluing the Chinese yuan.

Question 23

Under a ?xed exchange rate regime, the balance of payments account is adjusted for the extent of the government's intervention in the forex market. This is termed _____.

A) debt funding
B) portfolio investment
C) o?cial ?nancing
D) direct investment

Question 24

When interest parity holds _____.

A) the effectiveness of ?scal policy is reduced
B) the nominal exchange rate between all currencies is equal
C) interest rate differentials are offset by exchange rate differentials
D) there will be huge in?ation rate differentials in countries across the world

Question 25

Suppose the price of a UK good is £20 and the price of a eurozone good is €30. Given that the value of the euro/pound nominal exchange rate is 1.5, what is the value of the euro/pound real exchange rate?

A) 3
B) 1.5
C) 1
D) 0.5

Question 26

A London-based business consultant working for a French client is an example of a(n) _____ in the UK's balance of payments.

A) visible export
B) invisible import
C) invisible export
D) visible import

Question 27

Which of the following is true of a ?xed exchange rate regime?

A) It allows gradual adjustments in the value of the exchange rate.
B) It increases the volatility of the nominal exchange rate.
C) It ensures that governments follow ?nancial discipline.
D) It prevents speculative attacks on the domestic currency.

Question 28

If the nominal exchange rate between the pound and the euro changed from €1 = £2 to €1 = £3, then _____.

A) the level of foreign currency reserves in the UK will fall
B) French goods and UK goods will cost the same
C) UK goods will become more expensive in France
D) UK goods will become cheaper in France

Question 29

Net transfer payments like interest and pro?ts on foreign assets will be adjusted in a nation's _____.

A) current account
B) capital account
C) ?nancial account
D) net errors and omissions account

Question 30

Which of the following is true for an economy that has adopted a ?xed exchange rate regime?

A) Interest parity will hold in the economy.
B) Purchasing power parity will hold in the economy.
C) Monetary policy will be less effective than ?scal policy.
D) Fiscal policy will be less effective than monetary policy.

Question 31

_____ refers to the relative price of domestic and foreign goods measured in a common currency.

A) Purchasing power parity
B) The real exchange rate
C) Interest rate parity
D) The nominal exchange rate

Question 32

Which one of the following will be included in a nation's current account?

A) Merchandise exports.
B) Portfolio investment ?ows.
C) Government spending on social development projects.
D) Goods sold in the black market.

Question 33

Suppose the price of a UK good is £300 and the price of a eurozone good is €400. Given that the value of the euro/pound real exchange rate is 3, what is the value of the euro/pound nominal exchange rate?

A) 3
B) 1.5
C) 8
D) 4

Question 34

In a ?xed exchange rate regime, purchasing power parity is achieved through _____.

A) the adjustment of domestic prices
B) an appreciation of the currency
C) increases in exchange rate volatility
D) a depreciation of the currency

Question 35

Which of the following will be recorded in the ?nancial account of the UK's balance of payments?

A) The services of a London-based corporate lawyer to a US-based company.
B) The purchase of German cars by a UK-based ?rm.
C) The purchase of a French company by a UK-based ?rm.
D) The UK's contribution to EU for a new railway network connecting the EU nations.

Question 36

The purchase of foreign bonds by a company in the UK is called _____.

A) foreign direct investment
B) portfolio investment
C) tangible investment
D) equity participation

Question 37

Under a ?xed exchange rate regime, ?scal policy is:

A) less effective than monetary policy because the central bank prints money to counter in?ation.
B) more effective than monetary policy because the central bank cannot change interest
C) less effective than monetary policy as the central bank increases interest rates to counter in?ationary pressures.
D) more effective than monetary policy because exchange rate differentials are offset by

Question 38

Suppose an economy is operating under a ?xed exchange rate regime. If the central bank increases interest rates:

A) there will be an in?ow of the domestic currency into the forex market.
B) domestic ?nancial capital will ?ow out of the country.
C) the supply of money in the economy will fall.
D) there will be an excess demand for the domestic currency in the forex market.

Question 39

The balance of payments has to be shown with a balancing item because:

A) foreign portfolio investment usually goes unrecorded.
B) illegal transactions in the international trade market are not recorded.
C) under a dirty ?oat, the balance of payments is zero.
D) under a ?xed exchange rate regime, the balance of payments is zero.

Question 40

When there is perfect capital mobility across countries, _____.

A) global ?nancial in?ows and out?ows will increase
B) price levels across all countries will be the same
C) the nominal exchange rates between various currencies will become equal
D) the rates of return on ?nancial assets around the world will be the same

Question 41

Which of the following is true for countries that have formed a monetary union?

A) A monetary union allows the member countries to stabilize the business cycle.
B) A monetary union makes it easier to adjust interest rates according to the requirements of
C) In a monetary union, ?scal policy is more effective than monetary policy in increasing aggregate demand.
D) In a monetary union, member countries do not have monetary policy independence.

Question 42

The exchange rate now, or the rate at which a currency can be exchanged today, is called the _____.

A) arbitrage price
B) hedged exchange rate
C) forward exchange rate
D) spot price

Question 43

Which of the following is a bene?t to the UK from staying out of the euro?

A) Trade with other European countries will be less complex.
B) Price transparency in trade with other European countries is maintained due to common
C) The UK's monetary sovereignty is maintained.
D) Exchange rate risks are minimized.

Question 44

An optimal currency zone is a group of countries that _____.

A) keep their currencies pegged to the US dollar
B) are better off with a common currency than keeping separate currencies
C) better off with separate monetary and ?scal policies
D) have restrictions on the movements of persons involved in trade and commerce

Question 45

Assume that the spot price for converting pounds into dollars is £1 = $1. A speculator converts £1 million into dollars today and enters into a forward contract to convert the dollars back into pounds after six months. If the spot rate after six months is £1 = $1.25, which of the following statements will be true?

A) The speculator will make a pro?t of $0.25 million.
B) The speculator will make a loss of £0.2 million.
C) The speculator will make a loss of $0.8 million.
D) The speculator will make a pro?t of £0.2 million.

Question 46

Which of the following explains how the UK would bene?t by adopting the euro?

A) There will be no restrictions on ?scal policy in the UK.
B) The UK will be able to retain its monetary independence.
C) The UK can set low interest rates and boost exports and aggregate demand.
D) The risks associated with currency movements will be reduced.

Question 47

Which of the following statements correctly de?nes hedging?

A) Hedging is the transfer of a risky asset for a non-risky asset to protect against uncertainty.
B) Hedging is the pro?t earned by an exporter due to a fall in the exchange rate.
C) Hedging is the pro?t earned by accurately forecasting the value of an exchange rate.
D) Hedging is the loss made by an importer due to a fall in the currency value.

Question 48

Which of the following is a bene?t of a ?xed exchange rate regime?

A) Fixed exchange rates can have a strong disciplinary effect on domestic in?ation.
B) Countries that have a ?xed exchange rate have a higher level of GDP than countries that
C) Fixed exchange rates allow a gradual adjustment in the value of the exchange rate.
D) Under ?xed exchange rate regimes, the balance of payments always equals zero.

Question 49

Assume that interest rates are zero and the spot rate in the forex market is £1 = $1. If a speculator expects the spot rate at the end of three months to be £1 = $1.25, then which of the following will allow him to make a pro?t?

A) He converts dollars into pounds now and invests it in a time deposit in a UK bank.
B) He converts pounds into dollars now and invests it in a time deposit in an American bank.
C) He takes a loan in dollars now, converts it into pounds, reconverts it into dollars at the end of three months and repays the loan.
D) He takes a loan in pounds now, converts it into dollars, reconvert into pounds at the end of

Question 50

Which of the following is true for an economy that allows its currency to ?oat freely?

A) A reduction in interest rates is not offset by a reduction in the exchange rate.
B) Expansionary ?scal policy will be neutralized by rising interest rates and falling exports.
C) Monetary policy is more effective than ?scal policy in raising aggregate demand.
D) A reduction in interest rates depresses international demand for domestic goods and

Question 51

One of the preconditions for entry into the euro was that member countries should:

A) ensure that government budget de?cits were around 15-20 per cent of GDP.
B) devalue their currencies to optimally use the real exchange rate .
C) have low levels of in?ation and low interest rates.
D) ensure that overall debt to GDP ratio was 75 per cent.

Question 52

Which of the following criteria is important for the success of an optimal currency zone?

A) Similar geographical characteristics.
B) A high level of trade integration.
C) Similar labour force characteristics.
D) Diversity in industrial sectors.

Question 53

Under ?oating exchange rates, monetary policy will be:

A) less effective than ?scal policy in increasing aggregate demand.
B) neutralized by rising interest rates, a rising currency and falling exports.
C) more effective than ?scal policy in increasing aggregate demand.
D) neutralized by falling interest rates and rising imports.

Question 54

The stability pact of 1997 was designed to _____ among member nations in the European monetary union.

A) increase interest rates
B) control ?scal stances
C) change the level of money supply
D) adjust the real exchange rates

Question 55

The exchange rate at which people are willing to sell a currency at one month, three months or one year into the future is called a _____.

A) spot price
B) arbitrage price
C) forward exchange rate
D) hedged exchange rate

Question 56

What is a monetary union?

A) It refers to a group of countries that have decided to adopt a common ?scal policy.
B) It is the permanent ?xing of exchange rates between member countries.
C) It refers to a group of countries that have agreed to allow their exchange rates to ?oat freely.
D) It is the permanent ?xing of the quantity of imports and exports between member

Question 57

A fall in the value of the pound may NOT help drive export growth if:

A) the UK reduces interest rates.
B) the UK's trading partners are experiencing an economic boom.
C) the UK is a major exporter of goods, not services.
D) the demand for UK exports is price inelastic.

Question 58

During the period 1999 to 2010, the real exchange rate for _____ became weaker.

A) Greece
B) Germany
C) Spain
D) France

Question 59

An optimal currency zone is more likely to be successful if:

A) each country's central bank is allowed to change the money supply.
B) each member country has a diverse industrial structure.
C) each member country sets its own interest rate.
D) labour and capital in each country is mobile.

Question 60

Germany has built up a trade surplus over the last decade. This can be attributed to _____.

A) a strong real exchange rate
B) high rates of in?ation
C) high wage levels
D) a weak real exchange rate

Question 61

According to the Economist's Big Mac index, when purchasing power parity holds, the price of a Big Mac in the USA should be equal to the price of a Big Mac in other countries.

Question 62

A freely floating exchange rate system requires that the governments, and not central banks, maintain the value of the exchange rate.

Question 63

When a currency depreciates, imports into the country will fall.

Question 64

Under a fixed exchange rate, purchasing power parity is maintained through changes in domestic prices rather than exchange rate changes.

Question 65

Floating exchange rates force governments to take financial discipline seriously.

Question 66

Under a fixed exchange rate regime, the central bank can support the exchange rate as long as it has an adequate supply of foreign currency reserves.

Question 67

Under a fixed exchange rate regime, if there is an excess demand for pounds in the forex market, the central bank is committed to purchasing the additional pounds.

Question 68

The exchange rate between two currencies is the amount of one currency that has to be given up in order to get one unit of the other.

Question 69

When the pound appreciates against the dollar, more dollars can be purchased with the same amount of pounds.

Question 70

Fixed exchange rates are volatile in the short run while flexible exchange rates can lead to sudden and dramatic changes in the exchange price.

Question 71

Purchasing power parity requires the nominal exchange rate to adjust in order to maintain a constant real exchange rate.

Question 72

Speculative attacks on a currency usually occur when the currency is allowed to float freely.

Question 73

If £1 could buy €2 a year ago, but today it buys €3, then the Euro has depreciated against the pound.

Question 74

The Economist's Big Mac index has not been very accurate in predicting future exchange rate movements.

Question 75

Imports generate the supply of the domestic currency and exports generate the demand for the domestic currency in the forex market.

Question 76

Purchasing power parity will not exist when the cost of moving goods exceeds the price differential between them.

Question 77

Sharing a common currency gives countries greater flexibility in dealing with business cycles.

Question 78

If imports into the UK increase, the pound will appreciate against other countries.

Question 79

The correct policy response for aligning the fixed exchange rate with the long-term market rate for the currency is to devalue the currency.

Question 80

An increased preference for Japanese goods in the UK will shift the demand curve for pounds to the right.