Deck 20: Exchange Rate Determination Iinominal Exchange Rates and Asset Markets

Question 1

The difference between covered and uncovered interest parity is that

A) the former equates real interest rates across nations; the latter equates nominal interest rates
B) the former compares bonds or bank accounts of equal maturity; the latter compares instruments of different maturity
C) arbitrage is possible in the former but not in the latter
D) the former uses forward contracts to eliminate interest rate risk; the latter does not
E) the former holds in the short run; the latter holds in the long run

Answer 1

the former uses forward contracts to eliminate interest rate risk; the latter does not

Question 2

Which of the following would most likely cause the spot market value of the dollar to appreciate relative to the Mexican peso?

A) an increase in Mexican interest rates
B) the expectation that the dollar will depreciate versus the peso in the coming months
C) weakening in the US stock market
D) increasing popularity of Mexican goods in the US
E) the expectation of persistently high Mexican inflation relative to US inflation

Answer 2

the expectation of persistently high Mexican inflation relative to US inflation

Question 3

The next questions refer to the following.
Suppose prices in the US are twice as high as those in England, but the US interest rate is 4% while the interest rate in England is 8%. No inflation is expected in either country.
In the long run,PPP theory predicts that the exchange rate should be

A) $1.04 = £2.16
B) $1 = £2
C) £1 = $2
D) £1.08 = $2.08
E) £1.04 = $2.08

Answer 3

£1 = $2

Question 4

The next questions refer to the following.
Suppose currency traders expect that one year from now, £1 will be worth $1.50, and the one-year risk-free interest rate in the UK is 7% while the one-year risk-free rate in the US is 3%.
If the one-year UK interest rate rises to 10% while the one-year US rate remains 3% and the one-year forward exchange rate remains £1 = $1.50,then the spot market value of £1 should become approximately

A) $1.30
B) $1.40
C) $1.50
D) $1.60
E) $1.70

Question 5

Assuming no inflation and no interest rate changes abroad,which of the following would leave the spot market exchange rate essentially unchanged?

A) an increase in nominal interest rates from 4% to 5% when inflation is expected to rise from 0% to 1%
B) an increase in nominal interest rates from 6% to 8% when the consumer price index is expected to rise from 206 to 208
C) a reduction in nominal interest rates from 7% to 4% when the inflation rate is expected to be 3%
D) a decrease in bond prices by 1% when deflation of 1% is expected
E) a reduction of interest rates from 5% to 3% when the consumer price index is expected to rise from 103 to 105

Question 6

Suppose North American and European interest rates have been the same. A sharp,permanent increase in US interest rates to levels above those of America's trade partners can be expected to cause

A) the long term nominal value of the dollar to be lower than it otherwise would be
B) an immediate decline in the spot market value of the dollar
C) gradual appreciation of the dollar over many years, until it reaches its new long run value
D) an immediate jump in the dollar's spot market value, followed by subsequent depreciation
E) no change in the real, long term exchange rates

Question 7

There is strong empirical support for

A) purchasing power parity as a guide to one-year forward exchange rates for low-inflation countries
B) covered interest parity when interest rates are risk-free
C) uncovered interest parity, augmented by risk premiums, as a guide to spot market exchange rates
D) using purchasing power parity together with uncovered interest parity to predict currency appreciations and depreciations
E) none of the above

Question 8

The next questions refer to the following.
The one-year interest rate in the U.S. is 3%, and the one-year rate in Japan is 5%. Investors expect the spot market exchange rate one year from now to be ¥100 = $1.
An American investor requires a 2% risk premium on Japanese investments. Under these conditions,the American investor will acquire Japanese assets if,on the current spot market,$1 can be exchanged for

A) more than ¥100
B) between ¥98.10 and ¥100
C) ¥98.10
D) between ¥96.26 and ¥100
E) less than ¥96.26

Question 9

The next questions refer to the following.
Suppose prices in the US are twice as high as those in England, but the US interest rate is 4% while the interest rate in England is 8%. No inflation is expected in either country.
Under these assumptions,the market would be expecting

A) the dollar to depreciate by 4%
B) the dollar to appreciate by 4%
C) the dollar to double in value over the long run
D) the dollar to depreciate by 50%
E) the dollar to appreciate by 32%

Question 10

The next questions refer to the following.
Suppose one-year interest rates in Great Britain are 10%, and one-year interest rates in the US are 6%. During the course of the year, the pound depreciates 10% against the dollar.
Compared to buying US bonds,American speculators who purchased British bonds at the start of the year received rates of return about

A) 26 percentage points lower
B) 13 percentage points higher
C) the same
D) 2 percentage points higher
E) 7 percentage points lower

Question 11

The next questions refer to the following.
Suppose prices in the US are twice as high as those in England, but the US interest rate is 4% while the interest rate in England is 8%. No inflation is expected in either country.
On the spot market,UIP predicts that the exchange rate should be

A) £1.08 = $1.04
B) £2.16 = $0.96
C) £2.04 = $1.00
D) £1.50 = $2.00
E) £1 = $2.08

Question 12

If there is a 4% one-year forward premium on the US dollar relative to the Canadian dollar,this implies

A) Canadian interest rates on one year accounts are approximately 4 percentage points above US rates
B) The US dollar is expected to be worth C$1.04 in one year from now
C) Short term interest rates are about 4% lower in the US than one-year rates
D) US bonds are roughly 4% riskier than Canadian bonds
E) The US dollar is expected to depreciate by 4% over the next 12 months

Question 13

The next questions refer to the following.
The one-year interest rate in the U.S. is 3%, and the one-year rate in Japan is 5%. Investors expect the spot market exchange rate one year from now to be ¥100 = $1.
A Japanese investor requires a 2% risk premium on US investments. She will acquire US assets if,on the current spot market,$1 can be exchanged for

A) more than ¥103.88
B) between ¥100 and ¥103.88
C) ¥100
D) between ¥96.19 and ¥100
E) less than ¥96.19

Question 14

The next questions refer to the following.
Suppose currency traders expect that one year from now, £1 will be worth $1.50, and the one-year risk-free interest rate in the UK is 7% while the one-year risk-free rate in the US is 3%.
Then according to uncovered interest parity,today's spot rate should price £1 at

A) $1.35
B) $1.40
C) $1.44
D) $1.56
E) $1.65

Question 15

On a typical day,the most heavily traded currency combination is the

A) Canadian dollar/US dollar
B) US dollar/euro
C) euro/yen
D) yen/pound sterling
E) pound sterling/rupee

Question 16

Consider the simple case of covered interest parity. If the spot market exchange rate is £1 = $2.50,the one-year UK interest rate is 6% and the one-year US interest rate is 4%,then the one-year forward rate must price the pound sterling at

A) $2.75
B) $2.55
C) $2.45
D) $2.25
E) $2.15

Question 17

The next questions refer to the following.
Suppose currency traders expect that one year from now, £1 will be worth $1.50, and the one-year risk-free interest rate in the UK is 7% while the one-year risk-free rate in the US is 3%.
Suppose American prices are twice as high as British prices,but there is no inflation occurring or expected in either country. In the short run,the US interest rate is 10% and the British interest rate is 5%. Then on the spot market,according to UIP,

A) £1 = $0.60 and the pound will depreciate to $0.50
B) £1 = $2.10 and the pound will depreciate to $2.00
C) £1 = $1.91 and the pound will appreciate to $2.00
D) £1 = $2.05 and the pound will depreciate to $2.00
E) £1 = $0.45 and the pound will appreciate to $0.50

Question 18

The geographic center of international currency exchange is

A) New York City
B) London
C) Tokyo
D) Bonn
E) Paris

Question 19

The next questions refer to the following.
Suppose one-year interest rates in Great Britain are 10%, and one-year interest rates in the US are 6%. During the course of the year, the pound depreciates 10% against the dollar.
Compared to buying British bonds,British speculators who purchased US bonds at the start of the year received rates of return about

A) 26 percentage points lower
B) 14 percentage points lower
C) the same
D) 2 percentage points higher
E) 8 percentage points higher

Question 20

Suppose the spot market exchange rate is currently ¥180 = £1,the one-year risk-free interest rate in Japan is 2% and the one year risk-free interest rate in Great Britain is 5%. Japanese who buy British bonds without covering their transactions with a forward contract must believe

A) that the yen will appreciate more than 3% against the pound sterling
B) that in one year, ¥183.6 will be worth less than £1.05 on the spot market
C) that interest rates will rise in Japan and fall in Great Britain
D) that one-year forward exchange rate is £1 = ¥171
E) that the spot market has undervalued the yen relative to the pound sterling

Question 21

Carry Trades involve

A) Buying low interest rate currencies and selling high interest rate ones
B) Holding a currency trade for a very long time
C) Buying high interest rate currencies and selling low interest rate ones
D) Trading on bandwagon effects
E) arbitrage

Question 22

Order flows and exchange rates

A) are correlated in the long run but not in the short run
B) are correlated because foreign exchange markets have essentially perfect information and assimilate it quickly
C) are correlated because traders interpret others' purchase orders as a signal to buy
D) are both determined in the short run by macroeconomic forces
E) are uncorrelated

Question 23

The difference between the number of market participants seeking to buy a currency and the number seeking to sell it is called

A) a currency crisis
B) the market shortage
C) order flow
D) uncovered interest parity
E) the forward premium

Question 24

Which of the following has been least important in enhancing the globalization of capital markets over the past twenty years?

A) development of the internet
B) bank deregulation
C) capital account liberalization
D) creation of fiscal surpluses
E) advances in telecommunication