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Chapters 8 Through 21
Chapter
8—Relationships among Inflation, Interest Rates, and Exchange Rates
1. Assume
a two-country world: Country A and Country B. Which of the following is correct
about purchasing power parity (PPP) as related to these two countries?
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a.
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If Country A's inflation rate exceeds Country B's
inflation rate, Country A's currency will weaken.
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b.
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If Country A's interest rate exceeds Country B's
inflation rate, Country A's currency will weaken.
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c.
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If Country A's interest rate exceeds Country B's
inflation rate, Country A's currency will strengthen.
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d.
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If Country B's inflation rate exceeds Country A's
inflation rate, Country A's currency will weaken.
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2. Given
a home country and a foreign country, purchasing power parity (PPP) suggests
that:
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a.
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a home currency will depreciate if the current
home inflation rate exceeds the current foreign interest rate.
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b.
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a home currency will appreciate if the current home
interest rate exceeds the current foreign interest rate.
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c.
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a home currency will appreciate if the current
home inflation rate exceeds the current foreign inflation rate.
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d.
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a home currency will depreciate if the current
home inflation rate exceeds the current foreign inflation rate.
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3. The
international Fisher effect (IFE) suggests that:
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a.
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a home currency will depreciate if the current
home interest rate exceeds the current foreign interest rate.
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b.
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a home currency will appreciate if the current
home interest rate exceeds the current foreign interest rate.
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c.
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a home currency will appreciate if the current
home inflation rate exceeds the current foreign inflation rate.
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d.
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a home currency will depreciate if the current
home inflation rate exceeds the current foreign inflation rate.
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4. Because
there are a variety of factors in addition to inflation that affect exchange
rates, this will:
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a.
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reduce the probability that PPP shall hold.
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b.
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increase the probability that PPP shall hold.
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c.
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increase the probability the IFE will hold.
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d.
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B and C
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5. Because
there are sometimes no substitutes for traded goods, this will:
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a.
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reduce the probability that PPP shall hold.
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b.
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increase the probability that PPP shall hold.
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c.
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increase the probability the IFE will hold.
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d.
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B and C
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6. According
to the IFE, if British interest rates exceed U.S. interest rates:
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a.
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the British pound's value will remain constant.
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b.
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the British pound will depreciate against the
dollar.
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c.
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the British inflation rate will decrease.
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d.
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the forward rate of the British pound will contain
a premium.
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e.
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today's forward rate of the British pound will
equal today's spot rate.
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7. Given
a home country and a foreign country, the international Fisher effect (IFE)
suggests that:
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a.
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the nominal interest rates of both countries are
the same.
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b.
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the inflation rates of both countries are the
same.
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c.
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the exchange rates of both countries will move in
a similar direction against other currencies.
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d.
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none of the above
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8. Given
a home country and a foreign country, purchasing power parity suggests that:
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a.
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the inflation rates of both countries will be the
same.
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b.
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the nominal interest rates of both countries will
be the same.
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c.
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A and B
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d.
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none of the above
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9. If
interest rates on the euro are consistently below U.S. interest rates, then for
the international Fisher effect (IFE) to hold:
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a.
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the value of the euro would often appreciate
against the dollar.
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b.
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the value of the euro would often depreciate
against the dollar.
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c.
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the value of the euro would remain constant most
of the time.
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d.
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the value of the euro would appreciate in some
periods and depreciate in other periods, but on average have a zero rate of
appreciation.
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10. If
the international Fisher effect (IFE) did not hold based on historical data,
then this suggests that:
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a.
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some corporations with excess cash can lock in a
guaranteed higher return on future foreign short-term investments.
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b.
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some corporations with excess cash could have
generated profits on average from covered interest arbitrage.
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c.
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some corporations with excess cash could have
generated higher profits on average from foreign short-term investments than
from domestic short-term investments.
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d.
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most corporations that consistently invest in
foreign short-term investments would have generated the same profits (on
average) as from domestic short-term investments.
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11. Under
purchasing power parity, the future spot exchange rate is a function of the
initial spot rate in equilibrium and:
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a.
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the income differential.
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b.
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the forward discount or premium.
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c.
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the inflation differential.
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d.
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none of the above
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12. According
to the international Fisher effect, if U.S. investors expect a 5% rate of
domestic inflation over one year, and a 2% rate of inflation in European
countries that use the euro, and require a 3% real return on investments over
one year, the nominal interest rate on one-year U.S. Treasury securities would
be:
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a.
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2%.
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b.
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3%.
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c.
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−2%.
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d.
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5%.
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e.
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8%.
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13. According
to the international Fisher effect, if investors in all countries require the
same real rate of return, the differential in nominal interest rates between
any two countries:
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a.
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follows their exchange rate movement.
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b.
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is due to their inflation differentials.
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c.
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is zero.
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d.
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is constant over time.
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e.
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C and D
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14. Assume
that U.S. and British investors require a real return of 2%. If the nominal
U.S. interest rate is 15%, and the nominal British rate is 13%, then according
to the IFE, the British inflation rate is expected to be about ____ the U.S.
inflation rate, and the British pound is expected to ____.
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a.
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2 percentage points above; depreciate by about 2%
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b.
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3 percentage points above; depreciate by about 3%
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c.
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3 percentage points below; appreciate by about 3%
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d.
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3 percentage points below; depreciate by about 3%
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e.
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2 percentage points below; appreciate by about 2%
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15. Assume
U.S. and Swiss investors require a real rate of return of 3%. Assume the
nominal U.S. interest rate is 6% and the nominal Swiss rate is 4%. According to
the international Fisher effect, the franc will ____ by about ____.
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a.
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appreciate; 3%
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b.
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appreciate; 1%
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c.
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depreciate; 3%
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d.
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depreciate; 2%
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e.
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appreciate; 2%
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16. Assume
that the U.S. and Chile nominal interest rates are equal. Then, the U.S.
nominal interest rate decreases while the Chilean nominal interest rate remains
stable. According to the international Fisher effect, this implies expectations
of ____ than before, and that the Chilean peso should ____ against the dollar.
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a.
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lower U.S. inflation; depreciate
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b.
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lower U.S. inflation; appreciate
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c.
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higher U.S. inflation; depreciate
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d.
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higher U.S. inflation; appreciate
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17. According
to the international Fisher effect, if Venezuela has a much higher nominal rate
than other countries, its inflation rate will likely be ____ than other
countries, and its currency will ____.
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a.
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lower; strengthen
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b.
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lower; weaken
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c.
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higher; weaken
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d.
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higher; strengthen
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18. If
interest rate parity holds, then the one-year forward rate of a currency will
be ____ the predicted spot rate of the currency in one year according to the
international Fisher effect.
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a.
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greater than
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b.
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less than
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c.
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equal to
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d.
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answer is dependent on whether the forward rate
has a discount or premium
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19. The
Fisher effect is used to determine the:
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a.
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real inflation rate.
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b.
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real interest rate.
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c.
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real spot rate.
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d.
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real forward rate.
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20. Latin
American countries have historically experienced relatively high inflation, and
their currencies have weakened. This information is somewhat consistent with
the concept of:
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a.
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interest rate parity.
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b.
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locational arbitrage.
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c.
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purchasing power parity.
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d.
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the exchange rate mechanism.
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21. Assume
that the inflation rate in Singapore is 3%, while the inflation rate in the
U.S. is 8%. According to PPP, the Singapore dollar should ____ by ____%.
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a.
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appreciate; 4.85
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b.
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depreciate; 3,11
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c.
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appreciate; 3.11
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d.
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depreciate; 4.85
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22. The
inflation rate in the U.S. is 3%, while the inflation rate in Japan is 10%. The
current exchange rate for the Japanese yen (¥) is $0.0075. After supply and
demand for the Japanese yen has adjusted in the manner suggested by purchasing
power parity, the new exchange rate for the yen will be:
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a.
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$0.0076.
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b.
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$0.0073.
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c.
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$0.0070.
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d.
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$0.0066.
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23. Assume
that the U.S. inflation rate is higher than the New Zealand inflation rate.
This will cause U.S. consumers to ____ their imports from New Zealand and New
Zealand consumers to ____ their imports from the U.S. According to purchasing
power parity (PPP), this will result in a(n) ____ of the New Zealand dollar
(NZ$).
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a.
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reduce; increase; appreciation
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b.
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increase; reduce; appreciation
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c.
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reduce; increase; depreciation
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d.
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reduce; increase; appreciation
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24. The
following regression analysis was conducted for the inflation rate information
and exchange rate of the British pound:
Regression
results indicate that a0 = 0 and a1 = 2.
Therefore:
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a.
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purchasing power parity holds.
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b.
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purchasing power parity overestimated the exchange
rate change during the period under examination.
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c.
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purchasing power parity underestimated the
exchange rate change during the period under examination.
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d.
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purchasing power parity will overestimate the
exchange rate change of the British pound in the future.
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25. Which
of the following is indicated by research regarding purchasing power parity
(PPP)?
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a.
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PPP clearly holds in the short run.
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b.
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Deviations from PPP are reduced in the long run.
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c.
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PPP clearly holds in the long run.
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d.
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There is no relationship between inflation
differentials and exchange rate movements in the short run or long run.
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26. The
interest rate in the U.K. is 7%, while the interest rate in the U.S. is 5%. The
spot rate for the British pound is $1.50. According to the international Fisher
effect (IFE), the British pound should adjust to a new level of:
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a.
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$1.47.
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b.
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$1.53.
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c.
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$1.43.
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d.
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$1.57.
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27. If
nominal British interest rates are 3% and nominal U.S. interest rates are 6%,
then the British pound (£) is expected to ____ by about ____%, according to the
international Fisher effect (IFE).
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a.
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depreciate; 2.9
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b.
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appreciate; 2.9
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c.
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depreciate; 1.0
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d.
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appreciate; 1.0
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e.
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none of the above
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28. There
is much evidence to suggest that Japanese investors invest in U.S. Treasury
securities when U.S. interest rates are higher than Japanese interest rates. These
investors most likely believe in the international Fisher effect.
a.
True
b.
False
29. Which
of the following is not true regarding IRP, PPP, and the IFE?
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a.
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IRP suggests that a currency's spot rate will
change according to interest rate differentials.
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b.
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PPP suggests that a currency's spot rate will
change according to inflation differentials.
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c.
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The IFE suggests that a currency's spot rate will
change according to interest rate differentials.
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d.
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All of the above are true.
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30. The
relative form of purchasing power parity (PPP) accounts for the possibility of
market imperfections such as transportation costs, tariffs, and quotas in
establishing a relationship between inflation rates and exchange rate changes.
a.
True
b.
False
31. According
to the international Fisher effect (IFE), the exchange rate percentage change
should be approximately equal to the differential in income levels between two
countries.
a.
True
b.
False
32. Research
indicates that deviations from purchasing power parity (PPP) are reduced over
the long run.
a.
True
b.
False
33. The
IFE theory suggests that foreign currencies with relatively high interest rates
will appreciate because the high nominal interest rates reflect expected
inflation.
a.
True
b.
False
34. If
the IFE theory holds, that means that covered interest arbitrage is not
feasible.
a.
True
b.
False
35. If
interest rate parity holds, and the international Fisher effect (IFE) holds,
foreign currencies with relatively high interest rates should have forward
discounts and those currencies would be expected to depreciate.
a.
True
b.
False
36. Interest
rate parity can only hold if purchasing power parity holds.
a.
True
b.
False
37. If
interest rate parity holds, then the international Fisher effect must hold.
a.
True
b.
False
38. Which
of the following theories suggests that the percentage change in spot exchange
rate of a currency should be equal to the inflation differential between two
countries?
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a.
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purchasing power parity (PPP).
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b.
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triangular arbitrage.
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c.
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international Fisher effect (IFE).
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d.
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interest rate parity (IRP).
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39. Which
of the following theories suggests that the percentage difference between the
forward rate and the spot rate depends on the interest rate differential
between two countries?
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a.
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purchasing power parity (PPP).
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b.
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triangular arbitrage.
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c.
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international Fisher effect (IFE).
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d.
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interest rate parity (IRP).
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40. Which
of the following theories can be assessed using data that exists at one
specific point in time?
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a.
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purchasing power parity (PPP)
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b.
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international Fisher effect (IFE).
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c.
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A and B
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d.
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interest rate parity (IRP).
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41. Which
of the following theories suggests the percentage change in spot exchange rate
of a currency should be equal to the interest rate differential between two
countries?
|
a.
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absolute form of PPP.
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b.
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relative form of PPP.
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c.
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international Fisher effect (IFE).
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d.
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interest rate parity (IRP).
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42. The
following regression analysis was conducted for the inflation rate information
and exchange rate of the British pound:
Regression
results indicate that a0 = 0 and a1 = 1.
Therefore:
|
a.
|
purchasing power parity holds.
|
|
b.
|
purchasing power parity overestimated the exchange
rate change during the period under examination.
|
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c.
|
purchasing power parity underestimated the
exchange rate change during the period under examination.
|
|
d.
|
purchasing power parity will overestimate the
exchange rate change of the British pound in the future.
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43. The
following regression analysis was conducted for the inflation rate information
and exchange rate of the British pound:
Regression
results indicate that a0 = 0 and a1 = 0.4.
Therefore:
|
a.
|
purchasing power parity holds.
|
|
b.
|
purchasing power parity overestimated the exchange
rate change during the period under examination.
|
|
c.
|
purchasing power parity underestimated the
exchange rate change during the period under examination.
|
|
d.
|
purchasing power parity will overestimate the
exchange rate change of the British pound in the future.
|
44. Assume
that the one-year interest rate in the U.S. is 7% and in the U.K. is 5%.
According to the international Fisher effect, British pound's spot exchange
rate should ____ by about ____ over the year.
|
a.
|
depreciate; 1.9%
|
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b.
|
appreciate; 1.9%
|
|
c.
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depreciate; 3.94%
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d.
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appreciate; 3.94%
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45. According
to the international Fisher effect (IFE):
|
a.
|
the nominal rate of return on a foreign investment
should be equal to the nominal rate of return on the domestic investment.
|
|
b.
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the exchange rate adjusted rate of return on a
foreign investment should be equal to the interest rate on a local money
market investment.
|
|
c.
|
the percentage change in the foreign spot exchange
rate will be positive if the foreign interest rate is higher than the local
interest rate.
|
|
d.
|
the percentage change in the foreign spot exchange
rate will be negative if foreign interest rate is lower than the local
interest rate.
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46. Assume
that the U.S. one-year interest rate is 5% and the one-year interest rate on
euros is 8%. You have $100,000 to invest and you believe that the international
Fisher effect (IFE) holds. The euro's spot exchange rate is $1.40. What will be
the yield on your investment if you invest in euros?
|
a.
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8%
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b.
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5%
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c.
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3%
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d.
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2.78%
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47. Assume
that the U.S. one-year interest rate is 3% and the one-year interest rate on
Australian dollars is 6%. The U.S. expected annual inflation is 5%, while the
Australian inflation is expected to be 7%. You have $100,000 to invest for one
year and you believe that PPP holds. The spot exchange rate of an Australian
dollar is $0.689. What will be the yield on your investment if you invest in
the Australian market?
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a.
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6%
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b.
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3%
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c.
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4%
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d.
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2%
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