Question 1

An increase in real income _____ the demand for real money balances and thereby causes a ____ in the nominal rate of interest.

Accepted Answer

A)   lowers; rise
B)   lowers; fall
C)   raises; rise
D)   raises; fall C

Question 2

(Figure: The Domestic Interest Rate) Using the graph, if i€ falls, the result is:

Accepted Answer

A)   the dollar interest rate line shifts up and the spot rate rises.
B)   the dollar interest rate line shifts down and the spot rate rises.
C)   the foreign return line shifts up and to the right and the spot rate rises.
D)   the foreign return line shifts down and to the left and the spot rate falls. D

Question 3

Explaining exchange rate behavior in the long run assumes that changes in price levels and real interest rates affect nominal exchange rates so that interest parity and PPP hold. Short-run deviations from PPP may be explained by an alternative theory called the:

Accepted Answer

A)   relative PPP approach.
B)   asset approach to exchange rate determination.
C)   long-run equilibrium approach.
D)   law of one price. B

Question 4

Evaluate the following statement: Higher nominal interest rates are associated with an appreciating exchange rate. Do you agree, disagree, or both? Explain.

Accepted Answer

The answer of Evaluate the following statement: Higher nominal interest...

Question 5

If domestic returns are greater than foreign returns, then:

Accepted Answer

A)   the spot rate is too high.
B)   the spot rate is too low.
C)   expectations of future exchange rates will change in the long run.
D)   There is no opportunity for arbitrage.

Question 6

Assuming sticky prices and given expectations of future exchange rates, what is the short-run effect on the exchange rate of the U.S. dollar (purchasing euros) and on domestic and foreign rates of return if there is a temporary increase in the quantity of euros?

Accepted Answer

A)   Rates of return on domestic and foreign assets diverge, as the dollar appreciates.
B)   Domestic and foreign rates of return both fall, as the dollar depreciates.
C)   Domestic and foreign rates of return converge, as depreciation of the euro raises returns for U.S. investors who purchase euro-based assets.
D)   Rates of return on dollar assets fall, causing investors to switch into euro assets and, therefore, the U.S. dollar depreciates against the euro.

Question 7

Assume that the U.S. interest rate is 5%, the European interest rate is 2%, and the future expected exchange rate in one year is $1.224. At approximately what exchange rate will the returns between the United States and Europe be equalized?

Accepted Answer

A)   $1.20
B)   $1.224
C)   $1.188
D)   $1.98

Question 8

Using the UIP equation to determine the spot exchange rate, assume that the expected spot rate (after one year) for euros (in terms of dollars) equals $1.50, the current interest rate on euro deposits is 4.5%, and the current interest rate on dollar deposits is 5.5%. Which of the following current spot rates would satisfy the equation?

Accepted Answer

A)   $1.65
B)   $1.50
C)   $1.485
D)   $1.25

Question 9

The asset approach to short-run exchange rate determination relies on which three variables?

Accepted Answer

A)   prices, interest rates, and inflation
B)   the reserve ratio, aggregate wealth, and interest rates
C)   nominal domestic rates, foreign interest rates, and expectations of exchange rate changes
D)   prices, aggregate wealth, and inflation

Question 10

If Japan seeks to control its exchange rates so that ¥100 = $1, which of the following policies should it NOT maintain?

Accepted Answer

A)   interest rates that provide the same return as alternative international rates
B)   a stable rate of price level changes that will not cause currency depreciation or appreciation
C)   a willingness to raise interest rates when its currency begins to depreciate
D)   a willingness to raise price levels

Question 11

Which of the following is NOT a method of forecasting exchange rates?

Accepted Answer

A)   technical methods
B)   animal methods
C)   economic fundamental methods
D)   All of these are methods.

Question 12

When expected dollar-euro exchange rates rise, the foreign expected dollar return curve shifts:

Accepted Answer

A)   in.
B)   out.
C)   not at all.
D)   Not enough information is provided to answer the question.

Question 13

Comparing the examples of Denmark and the United Kingdom in relationship to the European Monetary Union, the krone is pegged to the euro, whereas the British pound is not. What can be predicted then about their interest rates?

Accepted Answer

A)   The United Kingdom has the ability to set its own interest rates and pursue an independent monetary policy, whereas Denmark's rates are virtually the same as those of the euro.
B)   Denmark gets the benefits of having fixed exchange rates as well as having an independent monetary policy and the ability to set its own rates of interest.
C)   Denmark's price level in the long run will be much higher than the Eurozone because it has to keep exchange rates fixed.
D)   The United Kingdom will discover that it cannot lower its own interest rates after all, or the pound will depreciate so far that no investors will make investments in the United Kingdom.

Question 14

Using the UIP equation to determine the spot exchange rate requires a knowledge of: I. expected future exchange rates.
II) observed rates of interest.
III) expected returns on foreign deposits.

Accepted Answer

A)   I and II only
B)   II and III only
C)   I and III only
D)   I, II, and III

Question 15

The U.S. Federal Reserve has recently been engaged in quantitative easing in which it is essentially expanding the money supply. What are the likely short-run and long-run implications of this?

Accepted Answer

The answer of The U.S. Federal Reserve has recently been...

Question 16

To complete the theory of exchange rates, a model should be created that:

Accepted Answer

A)   accommodates short-run changes in variables.
B)   accommodates long-run changes in variables.
C)   accommodates changes in expectations.
D)   accommodates short-run and long-run changes in variables and changes in expectations.

Question 17

Using the UIP equation, what would happen to the spot rate for euros if the interest rate on euro deposits rises, ceteris paribus?

Accepted Answer

A)   The spot rate to purchase euros would rise (dollar depreciation) .
B)   The spot rate to purchase euros would fall (dollar appreciation) .
C)   The spot rate to purchase euros would be unchanged.
D)   The U.S. Federal Reserve would have to raise U.S. short-term interest rates.

Question 18

If the U.S. interest rate is 5% and the interest rate in Germany is 2%, and the euro is expected to appreciate by 2% over the next year, then investors would:

Accepted Answer

A)   sell dollars in the spot market.
B)   buy euros.
C)   seek to invest in the United States.
D)   seek to invest in Germany.

Question 19

In the short run/long run, a strong currency goes with:

Accepted Answer

A)   a low interest rate/a high interest rate.
B)   a high interest rate/a high interest rate.
C)   a high interest rate/a low interest rate.
D)   a low interest rate/a low interest rate.

Question 20

When traders perceive a permanent money supply adjustment, long-term nominal interest rates ___ affected, the expected exchange rate ____ affected, and the spot exchange rate _____ affected.

Accepted Answer

A)   are not; is; is
B)   are; is; is not
C)   are not; is not; is not
D)   are; is not; is

Exam 15: Exchange Rates II: the Asset Approach in the Short Run

An increase in real income _ the demand for real money balances and thereby causes a in the nominal rate of interest.

(Figure: The Domestic Interest Rate) Using the graph, if i_€ falls, the result is: