Question

Foreign Exchange Markets

Multiple-Choice:

1. The theory of purchasing-power parity indicates that if the price level in the United States rises by 5% while the price level in Mexico rises by 6%, then

a. the dollar appreciates by 1% relative to the peso.

b. the dollar depreciates by 1% relative to the peso.

c. the exchange rate between the dollar and the peso remains unchanged.

d. the dollar appreciates by 5% relative to the peso.

e. the dollar depreciates by 5% relative to the peso.

2. If, in retaliation for “unfair” trade practices, Congress imposes a quota on Japanese cars, but at the same time Japanese demand for American goods increases, then in the long run

a. the Japanese yen should appreciate relative to the dollar.

b. the Japanese yen should depreciate relative to the dollar.

c. the dollar should depreciate relative to the yen.

d. it is not clear whether the dollar should appreciate or depreciate relative to the yen.

3. A rise in the expected future exchange rate shifts the demand for domestic assets to the ____ and causes the exchange rate to _____.

a. right; appreciate

b. right; depreciate

c. left; appreciate

d. left; depreciate

4. If the foreign interest rate rises and people expect domestic productivity to rise relative to foreign productivity, then (holding everything else constant)

a. the demand for domestic assets shifts left and the domestic currency appreciates.

b. the demand for domestic assets shifts right and the domestic currency appreciates.

c. the effect on the exchange rate is uncertain.

5. If the interest rate on dollar deposits is 10%, and the dollar is expected to appreciate by 7% over the coming year, then the expected return on the dollar deposits in terms of foreign currency is

a. 3%

b. 17%

c. –3%

d. 10%

6. If the interest rate on dollar deposits is 10%, and the dollar is expected to appreciate by 7% over the coming year, then the expected return on the dollar deposits in terms of dollars is

a. 3%

b. 17%

c. –3%

d. 10%

7. Exchange rates are volatile because

a. central banks are constantly manipulating the value of foreign exchange.

b. inflation rates are volatile.

c. expectations about the variables that influence exchange rates change frequently.

d. real interest rates are volatile.

Answer 1

1. The theory of purchasing power parity indicates that if the price level in the United states rises by 5% while the price in Mexico rises by 6% .Then, the dollar appreciates by 1% relative to the peso. Hence,option(A) is correct.

2. If , in retaliation for "unfair "trade practices , Congress imposes a quota on Japanese cars, but at the same time Japanese demand for American goods increases, then in the long run the Japanese Yen should depreciate relative to the U.S dollar. Hence,option(B) is correct.

3. A rise in the expected future exchange rate shifts the demand for domestic assets to the right and causes the exchange rate to appreciate. Hence,option(A) is correct.

4. If the foreign interest rate rises and people expect domestic productivity to rise ,then the demand for domestic assets shifts left and the effect on the exchange rate is uncertain. Hence,option(C) is correct.