Chapter 4—Exchange Rate Determination

1. The value of the Australian dollar (A$) today is $0.73. Yesterday, the value of the Australian
dollar was $0.69. The Australian dollar ____ by ____%.
a. depreciated; 5.80
b. depreciated; 4.00
c. appreciated; 5.80
d. appreciated; 4.00

2. If a currency's spot rate market is ____, its exchange rate is likely to be ____ to a single large
purchase or sale transaction.
a. liquid; highly sensitive
b. illiquid; insensitive
c. illiquid; highly sensitive
d. none of the above.

3. ____ is not a factor that causes currency supply and demand schedules to change.
a. Relative inflation rates
b. Relative interest rates
c. Relative income levels
d. Expectations
e. All of the above are factors that cause currency supply and demand schedules to change.

4. A large increase in the income level in Mexico along with no growth in the U.S. income level is
normally expected to cause (assuming no change in interest rates or other factors) a(n) ____ in
Mexican demand for U.S. goods, and the Mexican peso should ____.
a. increase; appreciate
b. increase; depreciate
c. decrease; depreciate
d. decrease; appreciate

5. An increase in U.S. interest rates relative to German interest rates would likely ____ the U.S.
demand for euros and ____ the supply of euros for sale.
a. reduce; increase
b. increase; reduce
c. reduce; reduce
d. increase; increase

6. Investors from Germany, the United States, and the U.K. frequently invest in each other based on
prevailing interest rates. If British interest rates increase, German investors are likely to buy ____
dollar-denominated securities, and the euro is likely to ____ relative to the dollar.
a. fewer; depreciate
b. fewer; appreciate
c. more; depreciate
d. more; appreciate

7. When the "real" interest rate is relatively low in a given country, then the currency of that country
is typically expected to be:
a. weak, since the country's quoted interest rate would be high relative to the inflation rate.
b. strong, since the country's quoted interest rate would be low relative to the inflation rate.
c. strong, since the country's quoted interest rate would be high relative to the inflation rate.
d. weak, since the country's quoted interest rate would be low relative to the inflation rate.
 8. Assume that the inflation rate becomes much higher in the U.K. relative to the U.S. This will place
____ pressure on the value of the British pound. Also, assume that interest rates in the U.K. begin
to rise relative to interest rates in the U.S. The change in interest rates will place ____ pressure on
the value of the British pound.
a. upward; downward
b. upward; upward
c. downward; upward
d. downward; downward

9. In general, when speculating on exchange rate movements, the speculator will borrow the currency
that is expected to appreciate and invest in the country whose currency is expected to depreciate.
a. True
b. False

10. Baylor Bank believes the New Zealand dollar will appreciate over the next five days from $.48 to
$.50. The following annual interest rates apply:

Currency Lending Rate Borrowing Rate

Dollars 7.10% 7.50%
New Zealand dollar (NZ$) 6.80% 7.25%

Baylor Bank has the capacity to borrow either NZ$10 million or $5 million. If Baylor Bank's
forecast is correct, what will its dollar profit be from speculation over the five-day period
(assuming it does not use any of its existing consumer deposits to capitalize on its expectations)?
a. $521,325.
b. $500,520.
c. $104,262.
d. $413,419.
e. $208,044.

11. Assume the following information regarding U.S. and European annualized interest rates:

Currency Lending Rate Borrowing Rate

U.S. Dollar ($) 6.73% 7.20%
Euro (€) 6.80% 7.28%

Trensor Bank can borrow either $20 million or €20 million. The current spot rate of the euro is
$1.13. Furthermore, Trensor Bank expects the spot rate of the euro to be $1.10 in 90 days. What is
Trensor Bank's dollar profit from speculating if the spot rate of the euro is indeed $1.10 in 90
days?
a. $579,845.
b. $583,800.
c. $588,200.
d. $584,245.
e. $980,245.

12. The equilibrium exchange rate of pounds is $1.70. At an exchange rate of $1.72 per pound:
a. U.S. demand for pounds would exceed the supply of pounds for sale and there would be a
shortage of pounds in the foreign exchange market.
b. U.S. demand for pounds would be less than the supply of pounds for sale and there would
be a shortage of pounds in the foreign exchange market.
 c. U.S. demand for pounds would exceed the supply of pounds for sale and there would be a
surplus of pounds in the foreign exchange market.
d. U.S. demand for pounds would be less than the supply of pounds for sale and there would
be a surplus of pounds in the foreign exchange market.
e. U.S. demand for pounds would be equal to the supply of pounds for sale and there would
be a shortage of pounds in the foreign exchange market.
13. Assume that Swiss investors have francs available to invest in securities, and they initially view
U.S. and British interest rates as equally attractive. Now assume that U.S. interest rates increase
while British interest rates stay the same. This would likely cause:
a. the Swiss demand for dollars to decrease and the dollar will depreciate against the pound.
b. the Swiss demand for dollars to increase and the dollar will depreciate against the Swiss
franc.
c. the Swiss demand for dollars to increase and the dollar will appreciate against the Swiss
franc.
d. the Swiss demand for dollars to decrease and the dollar will appreciate against the pound.
14. The real interest rate adjusts the nominal interest rate for:
a. exchange rate movements.
b. income growth.
c. inflation.
d. government controls.
e. none of the above
15. If U.S. inflation suddenly increased while European inflation stayed the same, there would be:
a. an increased U.S. demand for euros and an increased supply of euros for sale.
b. a decreased U.S. demand for euros and an increased supply of euros for sale.
c. a decreased U.S. demand for euros and a decreased supply of euros for sale.
d. an increased U.S. demand for euros and a decreased supply of euros for sale.

16. If inflation in New Zealand suddenly increased while U.S. inflation stayed the same, there would
be:
a. an inward shift in the demand schedule for NZ$ and an outward shift in the supply
schedule for NZ$.
b. an outward shift in the demand schedule for NZ$ and an inward shift in the supply
schedule for NZ$.
c. an outward shift in the demand schedule for NZ$ and an outward shift in the supply
schedule for NZ$.
d. an inward shift in the demand schedule for NZ$ and an inward shift in the supply schedule
for NZ$.

17. If the U.S. and Japan engage in substantial financial flows but little trade, ____ directly influences
their exchange rate the most. If the U.S. and Switzerland engage in much trade but little financial
flows, ____ directly influences their exchange rate the most.
a. interest rate differentials; interest rate differentials
b. inflation and interest rate differentials; interest rate differentials
c. income and interest rate differentials; inflation differentials
d. interest rate differentials; inflation and income differentials
e. inflation and income differentials; interest rate differentials

18. If inflation increases substantially in Australia while U.S. inflation remains unchanged, this is
expected to place ____ pressure on the value of the Australian dollar with respect to the U.S.
dollar.
a. upward
 b. downward
c. either upward or downward (depending on the degree of the increase in Australian
inflation)
d. none of the above; there will be no impact

19. Assume that British corporations begin to purchase more supplies from the U.S. as a result of
several labor strikes by British suppliers. This action reflects:
a. an increased demand for British pounds.
b. a decrease in the demand for British pounds.
c. an increase in the supply of British pounds for sale.
d. a decrease in the supply of British pounds for sale.

20. The exchange rates of smaller countries are very stable because the market for their currency is
very liquid.
a. True
b. False

21. The phrase "the dollar was mixed in trading" means that:
a. the dollar was strong in some periods and weak in other periods over the last month.
b. the volume of trading was very high in some periods and low in other periods.
c. the dollar was involved in some currency transactions, but not others.
d. the dollar strengthened against some currencies and weakened against others.

22. Assume that the U.S. places a strict quota on goods imported from Chile and that Chile does not
retaliate. Holding other factors constant, this event should immediately cause the U.S. demand for
Chilean pesos to ____ and the value of the peso to ____.
a. increase; increase
b. increase; decline
c. decline; decline
d. decline; increase
23. Any event that increases the U.S. demand for euros should result in a(n) ____ in the value of the
euro with respect to ____, other things being equal.
a. increase; U.S. dollar
b. increase; nondollar currencies
c. decrease; nondollar currencies
d. decrease; U.S. dollar

24. Any event that reduces the U.S. demand for Japanese yen should result in a(n) ____ in the value of
the Japanese yen with respect to ____, other things being equal.
a. increase; U.S. dollar
b. increase; nondollar currencies
c. decrease; nondollar currencies
d. decrease; U.S. dollar

25. Any event that increases the supply of British pounds to be exchanged for U.S. dollars should
result in a(n) ____ in the value of the British pound with respect to ____, other things being equal.
a. increase; U.S. dollar
b. increase; nondollar currencies
c. decrease; nondollar currencies
d. decrease; U.S. dollar
26. Any event that reduces the supply of Swiss francs to be exchanged for U.S. dollars should result in
a(n) ____ in the value of the Swiss franc with respect to ____, other things being equal.
a. increase; U.S. dollar
b. increase; nondollar currencies
c. decrease; nondollar currencies
d. decrease; U.S. dollar

27. Assume that the U.S. experiences a significant decline in income, while Japan's income remains
steady. This event should place ____ pressure on the value of the Japanese yen, other things being
equal. (Assume that interest rates and other factors are not affected.)
a. upward
b. downward
c. no
d. upward and downward (offsetting)

28. News of a potential surge in U.S. inflation and zero Chilean inflation places ____ pressure on the
value of the Chilean peso. The pressure will occur ____.
a. upward; only after the U.S. inflation surges
b. downward; only after the U.S. inflation surges
c. upward; immediately
d. downward; immediately

29. Assume that Canada places a strict quota on goods imported from the U.S. and that the U.S. does
not retaliate. Holding other factors constant, this event should immediately cause the supply of
Canadian dollars to be exchanged for U.S. dollars to ____ and the value of the Canadian dollar to
____.
a. increase; increase
b. increase; decline
c. decline; decline
d. decline; increase

30. Assume that Japan places a strict quota on goods imported from the U.S. and the U.S. places a
strict quota on goods imported from Japan. This event should immediately cause the U.S. demand
for Japanese yen to ____, and the supply of Japanese yen to be exchanged for U.S. dollars to ____.
a. increase; increase
b. increase; decline
c. decline; decline
d. decline; increase

31. Which of the following is not mentioned in the text as a factor affecting exchange rates?
a. relative interest rates.
b. relative inflation rates.
c. government controls.
d. expectations.
e. all of the above are mentioned in the text as factors affecting exchange rates.

32. If a country experiences high inflation relative to the U.S., its exports to the U.S. should ____, its
imports should ____, and there is ____ pressure on its currency's equilibrium value.
a. decrease; increase; upward
b. decrease; decrease; upward
c. increase; decrease; downward
d. decrease; increase; downward
e. increase; decrease; upward
33. If a country experiences an increase in interest rates relative to U.S. interest rates, the inflow of
U.S. funds to purchase its securities should ____, the outflow of its funds to purchase U.S.
securities should ____, and there is ____ pressure on its currency's equilibrium value.
a. increase; decrease; downward
b. decrease; increase; upward
c. increase; decrease; upward
d. decrease; increase; downward
e. increase; increase; upward

34. An increase in U.S. inflation relative to Singapore inflation places upward pressure on the
Singapore dollar.
a. True
b. False

35. When expecting a foreign currency to depreciate, a possible way to speculate on this movement is
to borrow dollars, convert the proceeds to the foreign currency, lend in the foreign country, and
use the proceeds from this investment to repay the dollar loan.
a. True
b. False

36. Since supply and demand for a currency are constant (primarily due to government intervention),
currency values seldom fluctuate.
a. True
b. False
37. Relatively high Japanese inflation may result in an increase in the supply of yen for sale and a
reduction in the demand for yen.
a. True
b. False

38. The main effect of interest rate movements on exchange rates is through their effect on
international trade.
a. True
b. False

39. Country X frequently engages in trade flows with the U.S. (such as imports and exports). Country
Y frequently engages in capital flows with the U.S. (such as financial investments). Everything
else held constant, an increase in U.S. interest rates would affect the exchange rate of Country X's
currency more than the exchange rate of Country Y's currency.
a. True
b. False
40. Increases in relative income in one country vs. another result in an increase in the first country's
currency value.
a. True
b. False
41. Trade-related foreign exchange transactions are more responsive to news than financial flow
transactions.
a. True
b. False
42. Signals regarding future actions of market participants in the foreign exchange market sometimes
result in overreactions.
a. True
b. False
43. The markets that have a smaller amount of foreign exchange trading for speculatory purposes than
for trade purposes will likely experience more volatility than those where trade flows play a larger
role.
a. True
b. False
44. Liquidity of a currency can affect the extent to which speculation can impact the currency's value.
a. True
b. False
45. Forecasting a currency's future value is difficult, because it is difficult to identify how the factors
affecting the currency value will change, and how they will interact to impact the currency's value.
a. True
b. False

46. The standard deviation should be applied to values rather than percentage movements when
comparing volatility among currencies.
a. True
b. False

47. Movements of foreign currencies tend to be more volatile for shorter time horizons.
a. True
b. False

48. If a currency's spot market is ____, its exchange rate is likely to be ____ to a single large purchase
or sale transaction.
a. liquid; highly sensitive
b. illiquid; insensitive
c. liquid; insensitive
d. none of the above

49. The value of euro was $1.30 last week. During last week the euro depreciated by 5%. What is the
value of euro today?
a. $1.365
b. $1.235
c. $1.330
d. $1.30

50. Government controls can only affect the supply of a given currency for sale and not the demand.
a. True
b. False

51. If one foreign currency will appreciate against the dollar, then all foreign currencies will appreciate
against the dollar but by different degrees.
a. True
b. False

52. Assume that the income levels in U.K. start to rise, while U.S. income levels remain unchanged.
This will place ____ pressure on the value of British pound. Also, assume that U.S. interest rates
rise, while the British pound remains unchanged. This will place ____ pressure on the value of
British pound.
a. downward; downward
b. upward; downward
c. upward; upward
d. downward; upward
53. If the Fed announces that it will decrease the U.S. interest rates, and European Central Bank takes
no action, then the value of euro will ____ against the value of U.S. dollar. The Fed's action is
called ____ intervention.
a. appreciate; direct
b. depreciate; direct
c. appreciate; indirect
d. depreciate; indirect

54. Assume that the total value of investment transactions between U.S. and Mexico is minimal. Also
assume that total dollar value of trade transactions between these two countries is very large. Now
assume that Mexico's inflation has suddenly increased, and Mexican interest rates have suddenly
increased. Overall, this would put ____ pressure on the value of Mexican peso. The inflation effect
should be ____ pronounced than the interest rate effect.
a. downward; more
b. upward; more
c. downward; less
d. upward; less

55. If U.S. experiences a sudden surge in inflation and surge in interest rates while Japanese inflation
and interest rates remain unchanged, the value of Japanese yen will ____ against the U.S. dollar.
a. appreciate
b. depreciate
c. remain unchanged
d. cannot be determined from the information provided.

56. If the Japanese yen is expected to appreciate against the U.S. dollar and interest rates in the U.S.
and Japan are similar, banks may try speculating on this anticipated exchange rate movement by
borrowing ____ and investing in ____.
a. yen; dollars
b. yen; yen
c. dollars; yen
d. dollars; dollars

57. British investors frequently invest in the U.S. or Italy, depending on the prevailing interest rates. If
Italian interest rates suddenly rise high above U.S. rates, the investors will ____ the supply of
pounds to be exchanged for dollars and thus put ____ pressure on the value of the pound against
the U.S. dollar.
a. increase; downward
b. decrease; upward
c. increase; upward
d. decrease; downward

58. The equilibrium exchange rate of the Swiss franc is $0.90. At an exchange rate $.83:
a. U.S. demand for Swiss francs would exceed the supply of francs for sale and there would
be a shortage of francs in the foreign exchange market.
b. U.S. demand for Swiss francs would be less than the supply of francs for sale and there
would be a shortage of francs in the foreign exchange market.
c. U.S. demand for Swiss francs would exceed the supply of francs for sale and there would
be a surplus of francs in the foreign exchange market.
d. U.S. demand for Swiss francs would be less than the supply of francs for sale and there
would be a surplus of Swiss francs in the foreign exchange market.
59. Financial flow foreign exchange transactions are more responsive to news than trade-related
transactions.
a. True
b. False

60. Assume that the British government eliminates all controls on imports by British companies. Other
things being equal, the U.S. demand for pounds would ____, the supply of pounds for sale would
____, and the equilibrium value of the pound would ____.
a. increase; increase; increase
b. decrease; increase; decrease
c. remain unchanged; increase; decrease
d. remain unchanged; increase; increase

61. Country X frequently engages in trade flows with the U.S. (such as imports and exports). Country
Y frequently engages in capital flows with the U.S. (such as financial investments). Everything
else held constant, an increase in U.S. inflation would affect the exchange rate of Country Y's
currency more than the exchange rate of Country X's currency.
a. True
b. False

62. Assume that U.S. inflation is expected to surge in the near future. The expectation of surge in
inflation will most likely place ____ pressure on U.S. dollar immediately.
a. upward
b. downward
c. no
d. cannot be determined

63. When the Japanese yen appreciates against the U.S. dollar, this means that the U.S. dollar is
strengthening relative to the yen.
a. True
b. False

64. Illiquid currencies tend to exhibit less volatile exchange rate movements than liquid currencies.
a. True
b. False

65. The supply curve for a currency is downward sloping since U.S. corporations would be
encouraged to purchase more foreign goods when the foreign currency is worth less.
a. True
b. False

66. Relatively high Japanese inflation may result in an increase in the supply of yen for sale and a
reduction in the demand for yen, other things being equal.
a. True
b. False

67. If the British government desires an appreciation in its currency with respect to the U.S. dollar, it
would consider intervening in the foreign exchange market by buying dollars with pounds.
a. True
b. False
68. Country X frequently engages in trade flows with the U.S. (such as imports and exports). Country
Y frequently engages in financial flows with the U.S. (such as financial investments). Everything
else held constant, an increase in U.S. interest rates would affect the exchange rate of Country X's
currency more than the exchange rate of Country Y's currency.
a. True
b. False

69. Illiquid currencies tend to exhibit ____ volatile exchange rate movements, as the equilibrium
prices of their currencies adjust to ____ changes in supply and demand conditions.
a. less; even minor
b. less; only large
c. more; even minor
d. more; only large
e. none of the above

70. Which of the following is not mentioned in the text as a factor affecting exchange rates?
a. Relative interest rates
b. Relative inflation rates
c. Government controls
d. Expectations
e. All of the above are mentioned in the text as factors affecting exchange rates.

71. Which of the following events would most likely result in an appreciation of the U.S. dollar?
a. U.S. inflation is very high.
b. The Fed indicates that it will raise U.S. interest rates.
c. Future U.S. interest rates are expected to decline.
d. Japan is expected to increase interest rates in the near future.

72. Which of the following interactions will likely have the least effect on the dollar's value? Assume
everything else is held constant.
a. A reduction in U.S. inflation accompanied by an increase in real U.S. interest rates
b. A reduction in U.S. inflation accompanied by an increase in nominal U.S. interest rates
c. An increase in U.S. inflation accompanied by an increase in nominal, but not real, U.S.
interest rates
d. An increase in Singapore's inflation accompanied by an increase in real U.S. interest rates
e. An increase in Singapore's interest rates accompanied by an increase in U.S. inflation.

73. If a country experiences high inflation relative to the U.S., its exports to the U.S. should ____, its
imports should ____, and there is ____ pressure on its currency's equilibrium value.
a. decrease; increase; upward
b. decrease; decrease; upward
c. increase; decrease; downward
d. decrease; increase; downward
e. increase; decrease; upward

74. If a country experiences an increase in interest rates relative to U.S. interest rates, the inflow of
U.S. funds to purchase its securities should ____, the outflow of its funds to purchase U.S.
securities should ____, and there is ____ pressure on its currency's equilibrium value.
a. increase; decrease; downward
b. decrease; increase; upward
c. increase; decrease; upward
d. decrease; increase; downward
e. increase; increase; upward