Deck 7: The Foreign Exchange Market and the International Monetary System

Question 1

Why has the value of the Brazilian Real sharply decreased against the U.S. dollar?

Answer 1

The Brazilian Real fell sharply against the U.S. dollar due to skepticism that Brazilian President Dilma Rousseff would be able to fix the country's budget and avoid more credit-rating cuts. The Real fell to 4.06665, the weakest intraday level since its creation. Standard & Poor downgraded the nation to junk bond status and the currency has led emerging-market currency declines. The Real continues to decline due to political instability and government corruption related to its state-owned oil company.

Question 2

Why has Brazil kept its interest rates high in the midst of political turmoil?

Answer 2

Brazil has kept its interest rates high due to uncertainty that a rate adjustment would benefit the country's economy. Brazil is on the brink of "fiscal dominance," an economic scenario in which the country's poor finances have made monetary policy ineffective. Furthermore, Brazil's central bank is dependent upon the government. The institution enjoys a low degree of operational autonomy and there are major fears of government interference from the president of the ruling Workers' party. Analysts suspect that the current president may comply with these calls in exchange for support against Congress's motion for impeachment.

Question 3

What are the main lessons for other BRICs to learn from the recent debacle of the Brazilian Real?

Answer 3

Other BRICs countries should be wary of government corruption, ensuring that the current political system does not influence officials to take self-serving actions that would subject the country to economic harm. Furthermore, these countries should learn that it is necessary to keep central bank and government operations separate or government may exert undue influence by restricting operational autonomy and enact measures that conflict with forecasted monetary policy. Finally, these countries must know the point in time at which its economy is on the brink of "fiscal dominance," where rendering any type of monetary policy would be ineffective. If the country has reached this point, it will just continue to spiral into a depression and may need to look to outside sources for economic revival and stability.

Question 4

What is the Big Mac Index and why is it useful?

Question 5

Overall, why has the value of other currencies vis-à-vis the U.S. dollar recently been undervalued? In particular, what are the main reasons for undervaluation of the currencies of many developing countries such as China and Venezuela?

Question 6

What is a gourmet version of Burgernomics? Does it make more sense to you than the original version and if so, why?

Question 7

Why has the PBOC recently depreciated the Chinese yuan and why has the U.S. government accused this move of being currency manipulation?

Question 8

Who will benefit and lose most from the currency depreciation? In particular, please evaluate the impacts of the depreciation on Chinese exporters, overseas markets, and foreign exporters to China.

Question 9

China has been using the fixed exchange rate system that pegged its value to the U.S. dollar. Why do you think that the Chinese government has considered dropping its link to the U.S. dollar and allowing it to float freely?

Question 10

What is Abenomics and why has this economic policy failed to achieve its original goal?

Question 11

How have major Japanese companies like Toyota responded to Abenomics? Why are they keeping manufacturing offshore instead of returning home?

Question 12

What types of reshoring policy options are available for the Japanese government to lure Japanese companies back home?

Question 13

What is currency swap? Why does the IMF want to introduce currency swap?

Question 14

Why has the U.S. opposed the IMF's proposed introduction of currency swaps as a new emergency-financing tool to help emerging economies overcome short-term financial crises?

Question 15

What action did the U.S. Senate take to increase the voice of emerging economies at the IMF? What is the significance of this action?

Question 16

How can an individual insure against the fluctuations of the foreign exchange rates? How does a company manage foreign exchange exposures?

Question 17

What are the key economic variables that influence the determination of exchange rates? How is the absolute purchasing power parity theory different from the relative purchasing power parity theory?

Question 18

How are the exchange rates determined in the short run?

Question 19

What is the International Monetary Fund (IMF) and why has the IMF been subject to mounting criticism? What measures can be taken to improve the effectiveness of the IMF's prescription?

Question 20

Which of the following is a key function of the foreign exchange market?

A) Insuring against currency exchange risk
B) Currency conversion
C) Foreign exchange conversion
D) Monetary diversification

Question 21

Which of the following is not a form of currency conversion?

A) Foreign exchange rates
B) Forward exchange
C) Currency speculation
D) Backward exchange

Question 22

Which of the following is not an economic theory to determine exchange rates?

A) Purchasing Power Parity (PPP) Theory
B) Fisher Effect (FE) and International Fisher Effect (IFE)
C) Investor Psychology and Bandwagon Effect
D) All of the above

Question 23

Which of the following is a factor that influences changes in exchange rates?

A) Recurring trade deficits
B) Political instability
C) High interest rates
D) All of the above

Question 24

Which of the following is not a characteristic of purchasing power parity?

A) Long-run exchange rates move toward rates that would equalize the price of an identical basket of goods in any two countries
B) Focuses on flows of export and import goods
C) Short-run exchange rates move toward rates that would equalize the price of an identical basket of goods in any two countries
D) Exchange rate determined by demand and supply of certain currency relative to another currency

Question 25

Which of the following is not a feature of the absolute purchasing parity theory?

A) Theoretical exchange rate at which producers determine how much will be needed to manufacture the same amount of goods and services in different countries
B) Assesses price at home vs. price in foreign country
C) Optimal exchange rate at which consumers are indifferent to a purchase
D) Determines how much currency will be needed to buy the same amount of goods and services in different countries

Question 26

Which of the following is not an effect of an undervalued currency?

A) Makes exports more competitive
B) Home country can sell low-price products to global consumers
C) Increases cost of importing
D) All of the above

Question 27

Which of the following is not a feature of the relative purchasing power parity theory?

A) Factors inflation differentials across countries
B) Exchange rate adjusted from base year to reflect inflation differential over time in both home and foreign countries
C) Compares the prices of an identical product at a certain time
D) Predicts that exchange rates will change due to changes in relative prices between countries

Question 28

Which of the following statements best describes the Fisher Effect?

A) Advocates real interest rates should be the same across countries
B) Concentrates on trade flow
C) Countries with high inflation rates have low nominal interest rates so that real interest rates are equal
D) All of the above

Question 29

Which of the following assertions reflects the International Fisher Effect?

A) Combines absolute PPP theory and Fisher Effect
B) Drives relationship between interest differentials and changes in future exchange
C) Combines relative PPP theory and Fisher Effect
D) Drives relationship between interest differentials and currency conversion

Question 30

Which of the following is an example that best describes the "Bandwagon Effect"?

A) A first-time investor reads a blog and withdraws money from the currency market, avoiding a market downturn
B) An investor group listens to market commentary and simultaneously purchase a recommended currency which appreciates in value
C) A well-known investor and speculator makes a move in the currency market and other investors take the same position, resulting in the loss of all investors
D) A well-known investor and speculator takes a position in the market and other investors take an opposing position in which they profit greatly

Question 31

Which of the following does exchange rate fluctuation not impact?

A) Transaction exposure
B) Economic exposure
C) Translation exposure
D) Currency exposure

Question 32

Which of the following does not accurately describe transaction exposure?

A) Measures the extent to which income from the individual transaction is affected by currency fluctuations
B) Measures gains or losses from past financial obligations specified in a foreign currency
C) Hedges against exposure by utilizing lead and lag strategies
D) All of the above

Question 33

Which of the following statement characterizes translation exposure?

A) Also known as economic exposure
B) Measures accounting gains or losses from exchange rate changes
C) Not affected by market volatility
D) Does not address impact of currency exchanges on balance sheets

Question 34

Which of the following is not a component of a fixed exchange system?

A) Countries agreed to link currencies to U.S dollar
B) Specific currency pegged to another currency (or basket of currencies)
C) Central bank promises to exchange currency at a specified rate against other currency
D) None of the above

Question 35

Which is a component of a floating exchange system?

A) No market intervention
B) Provides monetary policy dependence
C) Provides trade imbalance
D) Government must maintain exchange rate parity

Question 36

Which of the following is not a primary responsibility of the International Monetary Fund (IMF)?

A) Monitors exchange rate policies of member countries
B) Offers technical assistance for afflicted countries
C) Provides long-term credit and loans
D) Avoids banking, debt, and currency crises

Question 37

Which of the following best describes the role of the World Bank?

A) Helps member countries get out of financial crises by extending short-term loans and credits
B) Acts as the world economic watchdog, providing economic resources to developed countries
C) Supports the economic development of developing countries through long-term public-sector loans
D) Holds monetary reserves for developing and developed nations

Question 38

Which of the following is not among the common causes of a financial crisis that often call for an International Monetary Fund (IMF) bailout program?

A) Hyper inflation
B) Shrinking trade deficit
C) Overvalued currency
D) Large fiscal deficit

Question 39

Which of the following is not a measure utilized by the International Monetary Fund (IMF) as part of its austerity program?

A) Reduced government spending
B) Interest rate increase
C) Currency devaluation
D) Quantitative easing

Question 40

Compare forward exchange rates and currency swaps

Question 41

What are the key differences between the Fisher Effect (FE) and International Fisher Effect (IFE)?

Question 42

Describe investor psychology and the bandwagon effect.

Question 43

What are the types of financial crises countries face? What solutions does the IMF provide to remedy these situations?

Question 44

What are the various strategies that MNCs have adopted to deal with exchange rate fluctuation?

Question 45

Compare and analyze the differences in a fixed exchange rate system and a floating exchange rate system

Question 46

What do critics and proponents say regarding IMF's prescriptions for a country that experiences a crisis?