Question 1

In the event a nation adopts a currency board system to peg its exchange rate:

Accepted Answer

A)   sterilization occurs more often.
B)   sterilization is impossible.
C)   sterilization means all traders have access to currency reserves.
D)   the nation will have to abandon the system whenever the central bank wants to take a holiday. B

Question 2

(Figure: Central Bank Balance Sheet) When an economy with a pegged exchange rate operates with the money supply backed 100% by reserves, it is at point __________ on the diagram, and the situation is known as __________.

Accepted Answer

A)   Z; complete sterilization
B)   B; modified fixed/float
C)   M; freely floating system
D)   X; currency board system D

Question 3

With a credible peg, whenever there is a rise in the foreign interest rate:

Accepted Answer

A)   there is a drop in the domestic interest rate.
B)   the exchange rate changes.
C)   there is an equal rise in the domestic interest rate.
D)   there will be no change in the domestic interest rate. C

Question 4

An economy is better able to withstand a shock to the money demand if:

Accepted Answer

A)   the backing ratio is lower.
B)   the country holds more domestic assets.
C)   the backing ratio is higher.
D)   the country holds fewer reserves.

Question 5

(Table: Central Bank Balance Sheet) In the balance sheet provided, if the central bank did not issue debt (domestic and foreign), then:

Accepted Answer

A)   it would have to reduce currency reserves by 375.
B)   it would increase currency reserves by 450.
C)   it would increase domestic assets by 450.
D)   it would have to reduce currency reserves by 450.

Question 6

Part of the default risk in developing nations is investor fear of all of the following, EXCEPT:

Accepted Answer

A)   bank failures.
B)   election fraud.
C)   surprise taxation.
D)   capital controls.

Question 7

(Table: Mexico's Central Bank Balance Sheet) Suppose output in Mexico rises, causing money demand to change by 75 million pesos. What will happen to reserves, domestic credit, and the backing ratio? Explain how these changes take place.

Accepted Answer

The answer of (Table: Mexico's Central Bank Balance Sheet) Suppose...

Question 8

Investors in emerging markets often require ______ added to their return because they are concerned about defaults and exchange rate volatility.

Accepted Answer

A)   collateral deposits
B)   credit swap default insurance
C)   a risk premium
D)   compensation for their executives

Question 9

Because of speculative attacks due to the belief a fixed rate will fail, pegged exchange rates:

Accepted Answer

A)   usually exhibit a long, lingering decline and eventual failure.
B)   often collapse suddenly.
C)   will be revived as the central bank has a wake-up call from the financial sector.
D)   are usually not a good idea in the first place.

Question 10

Consider an economy with a fixed exchange rate and money supply equal to 2 billion pesos. The country has 1 billion in reserves and 1 billion in domestic credit. If the output in the country were to increase by 5%, then:

Accepted Answer

A)   the money demand would increase by 10%.
B)   the central bank would have to increase reserves by 5%.
C)   the central bank would have to decrease reserves by 5%.
D)   the central bank would have to decrease domestic credit.

Question 11

When other emerging market nations experience an exchange rate crisis, it affects healthy emerging market economies (raises risk premiums) because of investor worry. This phenomenon is known as:

Accepted Answer

A)   emerging market dysfunction.
B)   the law of like outcomes.
C)   experiential judgment.
D)   contagion.

Question 12

An expansion of the domestic money supply can be offset by the sale of foreign reserves. This technique is called:

Accepted Answer

A)   repatriation.
B)   revaluation.
C)   sterilization.
D)   reversion.

Question 13

If domestic credit is constant, then any change in the demand for money will result in:

Accepted Answer

A)   a change in foreign credit.
B)   a change in the rate of interest.
C)   an inverse change in the price level.
D)   an equal change in foreign currency reserves.

Question 14

(Table: Mexico's Central Bank Balance Sheet) If the country sells 325 million pesos of foreign assets and reduces domestic credit by 425 million pesos, then:

Accepted Answer

A)   the reserves will be 450 million pesos.
B)   the domestic assets will be 1,125 million pesos.
C)   the domestic assets will be 1,075 million pesos.
D)   the reserves will be 1,075 million pesos.

Question 15

In the home economy, when "money" is a liability of the government, the supply of money is equal to:

Accepted Answer

A)   gold reserves on a one-to-one basis.
B)   the physical quantity of currency and coins in circulation.
C)   the assets in a nation's account at the IMF.
D)   the total of bonds (domestic credit)  plus foreign currency and gold reserves held by the central bank.

Question 16

Paul Krugman has analyzed fixed currency pegs and the likely cause for them to break. His model is one in which the central bank is under political control, which results in:

Accepted Answer

A)   fiscal dominance by the elected government whereby the central bank must print money to fund government deficits.
B)   authority of the central bank to set rules for proper monetary management.
C)   the establishment of a currency board to manage the pegged exchange rate.
D)   the ability to control the money supply and interest rates to maintain the peg.

Question 17

A phenomenon that has perplexed many is that emerging market economies have sought to ____ their foreign currency reserves, thus _____ the backing ratio to _____.

Accepted Answer

A)   decrease; raising; more than 50%
B)   increase; lowering; less than $15 billion
C)   get rid of; lowering; less than $30 billion
D)   increase; raising; more than 100%

Question 18

What is the likely cause of an interest rate spread for similar assets denominated in the same currency?

Accepted Answer

A)   There is doubt that the currency's value will hold.
B)   It is due to the country risk where the assets are originated.
C)   It depends on the geographic difference between borrowers and lenders.
D)   It is because in some markets, the middlemen "take" more of a cut.

Question 19

To have adequate protection to cover a depreciation, the central bank must keep its foreign currency reserves at the level at which:

Accepted Answer

A)   they are growing at the same rate as GDP.
B)   they are equal to the demand for money minus the amount of domestic credit (held by the central bank) .
C)   they are greater than zero.
D)   they are worth three months of import protection.

Question 20

When the central bank engages in sterilization of reserves, it is:

Accepted Answer

A)   buying reserves to offset the purchase of government bonds.
B)   selling reserves to offset the sale of government bonds.
C)   selling reserves to offset the purchase of government bonds.
D)   printing more money.

Exam 20: Exchange Rate Crises: How Pegs Work and How They Break