Chapter 12 – Exchange Rate Determination
Multiple Choice
1. The trade or elasticities approach is more useful in explaining exchange rates during which time frame?
A)Short run
B)Medium run
C)Long run
D)All of the above
Answer: C Page: 313
2. Which of the following is true about PPP theory?
A)The theory explains that the change in the exchange rate between two currencies is proportional to the change in the ratio in the two countries' general price levels
B)The theory explains that the change in the exchange rate between two currencies is greater than the change in the ratio in the two countries' general price levels
C)The theory explains that the change in the exchange rate between two currencies is less than the change in the ratio in the two countries' general price levels
D)The theory explains that exchange rates and price levels are unrelated
Answer: A Page: 314
3. According to the law of one price, in order for commodity arbitrage to equalize the price of homogeneous traded commodities, it is necessary that which of the following donotexist?
A)Transportation costs
B)Tariffs
C)NTBs
D)All of the above
Answer: D Page: 314
4. Which of the following states that the equilibrium exchange rate is equal to the ratio of price levels in the two nations?
A)The relative theory of exchange rate determination
B)The absolute purchasing-power parity theory
C)The relative purchasing-power parity theory
D)The absolute theory of exchange rate determination
Answer: B Page: 314
5. Which of the following states that the percentage change in the exchange rate is equal to the difference in the percentage change in the price level in the two countries?
A)The relative theory of exchange rate determination
B)The absolute purchasing-power parity theory
C)The relative purchasing-power parity theory
D)The absolute purchasing-power parity theory
Answer: C Page: 315
6. If the price for a Big Mac in the US is $2.00 and the price for a Big Mac in the UK is ₤3, what is the absolute purchasing-power parity equilibrium exchange rate between the dollar and the Euro (using the dollar as the domestic currency)?
A).667
B)1.5
C).333
D)None of the above
Answer: A Page: 314
7. According to the relative purchasing-power parity theory, what is the percentage change in the exchange rate if the price for one unit of corn in the US is $10 in 2003 and $12 in 2004, and in the UK, ₤15 in 2003 and ₤20 in 2004?
A)-14.7%
B)13.3%
C)-13.3%
D)10.5%
Answer: C Page: 315
8. Which approach to exchange rate determination stresses the role of trade in the determination of exchange rates?
A)The asset model of exchange rates
B)The elasticities approach to exchange rates
C)The portfolio model of exchange rates
D)None of the above
Answer: B Page: 313
9. Which of the following approaches to exchange rate determination stresses the role of the flow of goods and services in the determination of exchange rates?
A)The portfolio model of exchange rates
B)The asset model of exchange rates
C)The trade approach to exchange rates
D)All of the above
Answer: C Page: 313
10. Which of the following approaches to exchange rate determination postulates that exchange rates are determined in the process of equilibrating or balancing the demand and supply of financial assets in each country?
A)The asset model of exchange rates
B)The trade approach to exchange rates
C)The elasticities approach to exchange rates
D)None of the above
Answer: A Page: 319
11. Which of the following approaches to exchange rate determination postulates that exchange rates are determined in the process of equilibrating or balancing the demand and supply of financial assets in each country?
A)The trade approach to exchange rates
B)The portfolio model of exchange rates
C)The elasticities approach to exchange rates
D)All of the above
Answer: B Page: 319
12. From which of the following does a nation's demand for foreign exchange arise?
A)From the inflow of foreign investments
B)From the sale of the foreign currency by the speculators when they expect the foreign currency to depreciate
C)From speculators when they expect the foreign currency to appreciate
D)Both a & c
Answer: C Page: 311
13. From which of the following does a nation's supply of foreign exchange arise?
A)From the inflow of foreign investment
B)From the sale of foreign currency by the speculators when the expect the foreign currency to depreciate
C)From the exportation of goods and services to other nations
D)All of the above
Answer: D Page: 311
14. A nation's currency will depreciate if the nation itself experiences which of the following?
A)Economic growth
B)A decrease in its price level
C)An increase in the interest rate
D)None of the above
Answer: A Page: 311
15. Which of the following will cause a nation's currency to depreciate?
A)Economic downturns, especially in times of depression
B)An increase in its price level (inflation)
C)An increase in the interest rate
D)All of the above
Answer: B Page: 311
16. A nation's currency will depreciate if the nation's economy experiences which of the following?
A)An increase in the price level
B)Economic growth
C)Expectations of depreciation
D)All of the above
Answer: D Page: 311
17. Which of the following would occur if the price level in the US increases relative to the UK, and before this increase the dollar was in exchange rate equilibrium with the sterling?
A)The United States will now find imports from the UK cheaper
B)The US will now demand fewer pounds
C)UK citizens will supply more pounds to the US
D)All of the above
Answer: A Page: 312
18. Which of the following would occur if the price level in the US increases relative to the UK, and before this increase the dollar was in an exchange rate equilibrium with the sterling?
A)The United States will import more British goods and services
B)The US will now demand more pounds
C)The UK will supply less pounds to the US
D)All of the above
Answer: D Page: 312
19. Which of the following would occur if labor productivity in the UK increased relative to that in the US, and before this increase the dollar was in an exchange rate equilibrium with the sterling?
A)The United States will now demand fewer imports
B)The United States will now demand more pounds
C)The UK will supply more pounds to the US
D)None of the above
Answer: B Page: 313
20. Which of the following would occur if labor productivity in the UK increased relative to that in the US, and before this increase the dollar was in an exchange rate equilibrium with the sterling?
A)The United States will now demand fewer imports
B)The US will now demand fewer pounds
C)The UK will supply more pounds to the US
D)None of the above
Answer: D Page: 313
21. Which of the following would occur if the interest rate in the United States fell relative to that in the UK, and before this increase the dollar was in an exchange rate equilibrium with the sterling?
A)The United States will now demand fewer imports
B)The United States will now demand fewer pounds
C)The UK will supply fewer pounds to the US
D)None of the above
Answer: C Page: 313
22. Which of the following would occur if the interest rate in the United States fell relative to that in the UK, and before this increase the dollar was in an exchange rate equilibrium with the sterling?
E)The United States will now demand fewer imports
F)The UK will now demand fewer pounds
G)The UK will supply more pounds to the US
H)None of the above
Answer: D Page: 313
23. Under the trade approach to exchange rate determination, what will happen if the value of a nation's imports exceeds the value of the nation's imports?
A)The exchange rate will rise
B)Exports rise
C)Imports fall until trade is balanced
D)All of the above
Answer: D Page: 313
24. How does the employment of resources affect the amount of currency depreciation required to shift domestic resources to the production of more exports and import substitutes?
A)The greater the employment of resources (i.e. a lower unemployment rate) the greater the depreciation of the nation's currency is needed
B)The greater the employment of resources the less depreciation of the nation's currency is needed
C)The size of the employment of resources has relatively little influence on the amount of currency depreciation needed, as there is a loose relation between the two
D)None of the above
Answer: A Page: 314
25. Which of the following is the elasticity approach not able to explain?
A)The large volatility of exchange rates over the past three decades
B)The sharp appreciation of the dollar from 1995 to 2002
C)The failure of the US trade deficits to decline when the dollar depreciated sharply from 1985 to 1988
D)All of the above
Answer: D Page: 314
26. The elasticities approach is more useful in explaining exchange rates during which time frame?
A)Short run
B)Medium run
C)Long run
D)All of the above
Answer: C Page: 314
27. Which of the following approaches to exchange rate determination postulates that the exchange rate is determined in the process of equilibrating the total demand and supply of the national currency in each nation?
A)The purchasing-power parity theory
B)The monetary model of exchange rates
C)The trade approach to exchange rates
D)The elasticities approach to exchange rates
Answer: B Page: 315
28. What determines the supply of money in each nation?
A)The nation's monetary authorities
B)The level of real income in the nation
C)The general price level
D)The interest rate
Answer: A Page: 319
29. What determines the demand for money in each nation?
A)The level of real income in the nation
B)The general price level
C)The interest rate
D)All of the above
Answer: D Page: 319
30. What type of relationship does the demand for money and interest rates exhibit?
A)A constant positive relationship
B)An inverse relationship
C)A stochastic relationship
D)An increasingly positive relationship
Answer: B Page: 319
31. An increase in the nation's money supply leads to which of the following?
A)Proportionate increases in prices
B)Proportionate decreases in prices
C)Depreciation of the nation's currency in the long run
D)Both a & c
Answer: D Page: 319
32. Expectations in which of the following should immediately lead to actual, equal percentage changes in exchange rates, according to the monetary approach to exchange rates?
A)Expectations of changes in growth rates
B)Expectations of changes in inflation rates
C)Expectations of changes in exchange rates
D)All of the above
Answer: D Page: 319
33. If the rate of inflation is suddenly expected to be 8% higher than previously anticipated in the US than in the UK, the dollar should immediately depreciate by what percent with respect to the pound in order to keep prices equal in the US and the UK?
A)8%
B)10%
C)6%
D)9%
Answer: A Page: 319
34. Which of the following countries have experienced a higher rate of inflation than the US from 1973-2003?
A)Switzerland
B)Italy
C)Belgium
D)Austria
Answer: B Page: 318
35. Which of the following countries' currency has experienced a higher rate of depreciation than the US' from 1973-2003?
A)Italy
B)New Zealand
C)U.K.
D)All of the above
Answer: D Page: 318
36. During which time period did the exchange rate between the dollar and German mark become increasingly different?
A)1986-1989
B)1973-1985
C)1990-1995
D)1968-1972
Answer: B Page: 320
37. Monetary and asset or portfolio models have not been very successful in forecasting exchange rates, especially in the short run, due to which of the following reasons?
A)Exchange rates are strongly affected by new information that is characteristically unpredictable
B)Although offering theoretical support for the conclusions drawn by the models, the models are weak econometrically speaking
C)Expectations of exchange market participants often become self-fulfilling
D)Both a & c
Answer: D Page: 324
38. During which time period was the there a sharp overvaluation of the US dollar?
A)1994-1998
B)1991-1993
C)2000-2002
D)2003-present
Answer: C Page: 324
True/False
39. True or False? The trade or elasticities approach stresses the role of trade or the flow of goods and services in the determination of exchange rates.
Answer: True Page: 313
40. True or False? Purchasing-power parity theory postulates that the change in the exchange rate between two currencies is proportional to the change in the ratio in the two countries' general price levels
Answer: True Page: 314
41. True or False? Absolute purchasing-power parity theory postulates that the percentage change in the exchange rate is equal to the difference in the percentage change in the price level in the two countries.
Answer: False Page: 314
42. True or False? Relative purchasing-power parity theory postulates that the equilibrium exchange rate is equal to the ratio of the price levels in the two nations.
Answer: False Page: 315
43. True or False? The monetary model of exchange rates postulates that exchange rates are determined in the process of balancing the stock of money in each nation.
Answer: True Page: 315
44. True or False? The real exchange rate is the observed exchange rate or the domestic currency price of the foreign currency.
Answer: False Page: 319
45. True or False? The nominal exchange rate is the exchange rate or the domestic currency price of the foreign currency.
Answer: True Page: 319
46. True or False? In the real world exchange rate, overshooting is not observed and can be considered theoretical rhetoric.
Answer: False Page: 321
47. True or False? The relative purchasing-power parity theory is potentially more useful than the absolute purchasing-power parity theory because instead of an unrealistic assumption of no transportation costs or trade obstructions, it simply assumes that there are no changes in these factors.
Answer: True Page: 315
48. True or False? If the rate of inflation is suddenly expected to be 7% higher in the US than in the UK, and higher than previously anticipated, the dollar should immediately depreciate by 9 percent with respect to the pound in order to keep prices equal in the US and the UK.
Answer: False Page: 319
49. True or False? According to absolute PPP theory, we expect that the price of any particular product should be the same in different countries, but in reality this is often not the case.
Answer: True Page: 317
Essay
50. Discuss the difference between the absolute purchasing-power parity theory and the relative purchasing-power parity theory.
Answer: The absolute purchasing-parity theory postulates that the equilibrium exchange rate between two currencies is equal to the ratio of the price levels in the two nations. According to the law of one price, a given commodity should have the same price in both countries when expressed in the same currency. So, if the price of a Big Mac is $2.50 in the US and it is $3.00 in the UK, than it would be ina firm’s interest to buy in the US and sell in the UK until the price falls in the UK and increases in the US to the point where they equal. Commodity arbitrage thus equilibrates commodity prices throughout the market. However, this theory does not hold if transportation costs, tariffs or other obstructions to the free flow of trade exist, or if there are structural changes that take place in either of the two nations in question. A potentially more useful exchange rate model is the relative purchasing-power parity theory. It postulates that the change in the exchange rate is equal to the difference in the change in the price level in the two countries. In this case, as long as there are no changes in transportation costs, obstructions to trade, ratio of traded to non traded goods, and in the structure of the economies, the percentage change in the exchange rate should equal the difference in the percentage change in the two countries' general price levels. Since trade and commodity arbitrage respond sluggishly, we expect relative purchasing power-parity to be approximated only in the long run.
