Question 1

Use the Portfolio-Balance Approach to answer this question.Other things remaining constant,if the supply of foreign bonds increases,what would happen to the domestic currency?
A) The domestic currency would appreciate.
B) The domestic currency would depreciate.
C) The domestic currency would not change.
D) The domestic currency would sharply depreciate and then appreciate later.

Accepted Answer

The increase in the supply of foreign bonds makes them more attractive to domestic investors, leading to an increase in demand for foreign bonds and a decrease in demand for domestic currency. This causes the domestic currency to depreciate.

Question 2

With imperfect substitutability,investors will hold more foreign assets only if they are compensated for risks.

Accepted Answer

With imperfect substitutability, investors cannot simply switch between domestic and foreign assets, which means they will hold more foreign assets only if they are compensated for the additional risks (such as currency fluctuations, political instability, etc.) that come with investing in foreign markets.

Question 3

Use the Portfolio-Balance Approach to answer this question.Other things remaining constant,if the supply of domestic bonds increases,what would happen to the domestic currency?
A) The domestic currency would appreciate.
B) The domestic currency would depreciate.
C) The domestic currency would not change.
D) The domestic currency would sharply depreciate and then appreciate later.

Accepted Answer

According to the Portfolio Balance Approach, an increase in the supply of domestic bonds will lead to a decrease in their price, making them less attractive to investors. As a result, investors will shift their investment to foreign bonds, increasing the demand for foreign currency and decreasing the demand for the domestic currency. This will lead to a depreciation of the domestic currency.

Question 4

Which of the following statements describes the Currency Substitution Approach?
A) As expectations of a trade deficit change, the exchange rate today will change due to the expected change in asset holdings.
B) Exchange rate adjusts to compensate for changes in international currency portfolios.
C) Slowly adjusting goods prices may cause the exchange rate to over-react in the short run.
D) All of the above are correct.

Accepted Answer

The Currency Substitution Approach states that exchange rates adjust to compensate for changes in international currency portfolios. While A and C are related to exchange rates, they do not specifically describe the Currency Substitution Approach.

Question 5

The Theory of Exchange Rate Overshooting explains high exchange rate volatility by assuming that CIRP does not hold in the short run,but PPP does.

Accepted Answer

The Theory of Exchange Rate Overshooting, proposed by Rudi Dornbusch, explains high exchange rate volatility by assuming that PPP does not hold in the short run due to price stickiness, but the Covered Interest Rate Parity (CIRP) does hold, allowing for immediate adjustments in financial markets.

Question 6

The Portfolio-Balance Approach assumes:
A) imperfect capital mobility
B) perfectly elastic demand for foreign bonds
C) interest rate equalization across countries
D) imperfect substitution between domestic and foreign bonds

Accepted Answer

The answer of The Portfolio-Balance Approach assumes:
A) imperfect capital mobility
B)...

Question 7

The Theory of Exchange Rate Overshooting explains high exchange rate volatility by assuming that ________ does not hold in the ________,but ________ does.
A) PPP, short run, CIRP
B) CIRP, short run, PPP
C) PPP, long run, CIRP
D) CIRP, long run, PPP

Accepted Answer

The Theory of Exchange Rate Overshooting explains high exchange rate volatility by assuming that Purchasing Power Parity (PPP) does not hold in the short run, but the Covered Interest Rate Parity (CIRP) does.

Question 8

Assume that two Caribbean countries announce that they will be coordinating monetary policy.This is because their currencies are considered:
A) Substitutes
B) Compliments
C) Inferior
D) Vulnerable

Accepted Answer

When two countries announce that they will be coordinating monetary policy, it indicates that their currencies are substitutes for each other. This means that the two currencies can be used interchangeably and their exchange rates are likely to be closely related.

Question 9

When citizens anticipate a country to experience trade deficits in the near future,the domestic currency would:
A) Appreciate immediately
B) Appreciate only in the future
C) Depreciate immediately
D) Depreciate only in the future

Accepted Answer

When citizens anticipate a country to experience trade deficits in the near future, they may become hesitant to hold onto the domestic currency, as they believe that the increased imports and decreased exports will lead to a decrease in demand for the currency. This can lead to a higher supply of the domestic currency on the foreign exchange market, resulting in a decrease in its value, or depreciation. Therefore, the domestic currency would depreciate immediately.

Question 10

Which of the following is NOT a factor that causes substantial exchange rate volatility?
A) Unexpected news
B) Changes in expectations about future trade flows
C) Instantaneous adjustments by goods and services prices to shocks.
D) Instantaneous reactions by financial assets markets to shocks

Accepted Answer

Instantaneous adjustments by goods and services prices to shocks are not a factor that causes substantial exchange rate volatility. While changes in goods and services prices can affect exchange rates, they do not typically cause sudden and large fluctuations in currency values. The other factors listed (unexpected news, changes in expectations about future trade flows, and instantaneous reactions by financial assets markets to shocks) can all contribute to substantial exchange rate volatility.

Question 11

Which of the following options correctly reflect the assumptions in the Overshooting Approach?
A) both PPP and CIRP hold in the short run.
B) PPP holds in the short run, but CIRP does not.
C) CIRP holds in the short run, but PPP does not.
D) Neither PPP nor CIRP holds in the short run.

Accepted Answer

The Overshooting Approach assumes that CIRP (Capital International Relative Pricing) holds in the short run, but PPP (Purchasing Power Parity) does not.

Question 12

In general,the basic Monetary Approach to Exchange Rate MAER does not capture the short run volatility of prices.

Accepted Answer

The answer of In general,the basic Monetary Approach to Exchange...

Question 13

People in the Bahamas use both Bahamian dollars and U.S.dollars to pay for goods and services.Suppose that the Fed increases money supply,causing higher inflation rate in the U.S.If the exchange rate were allowed to float,the U.S.dollar will ________ against the Bahamian dollar and Bahamians will substitute toward more __________ holding.
A) appreciate; Bahamian dollars
B) appreciate; U.S. dollars
C) depreciate; Bahamian dollars
D) depreciate; U.S. dollars

Accepted Answer

If the Fed increases money supply and causes higher inflation rate in the U.S., the U.S. dollar will depreciate against the Bahamian dollar. In this case, Bahamians will likely substitute toward holding more Bahamian dollars, as the U.S. dollar will be worth less relative to the Bahamian dollar. Therefore, the correct choice is (C) depreciate; Bahamian dollars.

Question 14

When a high degree of currency substitution exists,to prevent currencies from becoming too variable,countries need international coordination of monetary policy.

Accepted Answer

When a high degree of currency substitution exists, the exchange rate of a country's currency becomes highly dependent on the monetary policy of other countries. Therefore, to prevent currencies from becoming too variable and destabilizing the economy, there needs to be international coordination of monetary policy. This coordination could ensure that countries with highly substitutable currencies have similar monetary policies to avoid significant fluctuations in exchange rates.

Question 15

Which of the following best describe the process of "overshooting" when money supply increases?
A) Exchange rates depreciate more than necessary due to overreaction in financial markets, but are restored as prices fall in response to the greater money supply.
B) Exchange rates depreciate more than necessary due to overreaction in financial markets, but are restored as prices rise in response to the greater money supply.
C) Exchange rates appreciate more than necessary due to overreaction in financial markets, but are restored as prices rise in response to the greater money supply.
D) Exchange rates appreciate more than necessary due to overreaction in financial markets, but are restored as prices fall in response to the greater money supply.

Accepted Answer

When there is an increase in money supply, people tend to spend more, creating an increase in demand for goods and services. This, in turn, causes prices to rise. Initially, financial markets may overreact, causing exchange rates to depreciate more than necessary. However, as prices rise in response to the increased money supply, exchange rates are restored. Therefore, option B best describes the process of "overshooting" when money supply increases.

Question 16

Since news is unexpected and catches people off-guard,
A) it is easy to forecast the future exchange rate.
B) it causes exchange rates to fluctuate substantially.
C) it causes prices of goods and services to vary more than exchange rates.
D) it has no effect on exchange rates.

Accepted Answer

News can have a significant impact on exchange rates as it can alter investor expectations and cause uncertainty. This can lead to fluctuations in exchange rates as investors adjust their trading decisions in response to the news.

Question 17

Exchange rates appear to be more volatile than the monetary approach would predict,because:
A) the monetary approach holds better in the short run than in the long run.
B) prices of goods and services adjust instantaneously, while prices of assets are sluggish.
C) prices of goods and services are sluggish to adjust, while prices of assets adjust instantaneously.
D) the monetary approach is based on many unrealistic assumptions so that it fails to predict exchange rates in both short run and long run.

Accepted Answer

The monetary approach to exchange rates suggests that exchange rates are determined by the relative supply and demand for different currencies, which in turn are influenced by factors like inflation and interest rates. However, in reality, the prices of goods and services are often slow to adjust due to factors like contracts, menu costs, and market frictions. On the other hand, asset prices, including currencies, can adjust very quickly to new information due to the more fluid nature of financial markets. This discrepancy can lead to more volatility in exchange rates than the monetary approach would predict, as it assumes a more immediate adjustment in the prices of goods and services.

Question 18

Assume that in a free country,people in the country can choose to hold assets in any currency.As the domestic inflation rise,the opportunity cost of holding the domestic currency _________ and people will switch to hold assets in _________ currency.
A) increases; foreign
B) increases; domestic
C) decreases; foreign
D) decreases; domestic

Accepted Answer

When domestic inflation rises, the purchasing power of the domestic currency decreases, resulting in a higher opportunity cost for holding it. Therefore, people will switch to holding assets in foreign currency, which is expected to have a lower inflation rate and a relatively stable purchasing power. This will increase the demand for foreign currency and decrease the demand for domestic currency, leading to a depreciation of the domestic currency exchange rate.

Question 19

The exchange rate can "overshoot" its long-run value because the ________ are sluggish in the short run,whereas the __________ adjust instantaneously to a shock.
A) prices in goods and services markets; prices in assets markets
B) foreign exchange markets; prices in assets markets
C) prices in assets markets; prices in goods and services markets
D) prices in bond markets; money balance markets

Accepted Answer

Prices in goods and services markets are typically slower to adjust to shocks than prices in assets markets, such as foreign exchange markets. This can cause the exchange rate to temporarily move beyond its long-run equilibrium value before eventually settling back to that value.

Question 20

In the equilibrium approach,changes in exchange rates occur because of changes in tastes or technology and are part of the adjustment to a shock to the world economy.

Accepted Answer

In the equilibrium approach to exchange rates, changes in exchange rates are indeed seen as responses to changes in fundamental economic factors such as tastes, technology, or productivity. These changes are part of the economy's adjustment process to new conditions or shocks, aiming to reach a new equilibrium.

Quiz 15: Extensions to the Monetary Approach of Exchange Rate Determination

Use the Portfolio-Balance Approach to answer this question.Other things remaining constant,if the supply of foreign bonds increases,what would happen to the domestic currency?

With imperfect substitutability,investors will hold more foreign assets only if they are compensated for risks.

Use the Portfolio-Balance Approach to answer this question.Other things remaining constant,if the supply of domestic bonds increases,what would happen to the domestic currency?

Which of the following statements describes the Currency Substitution Approach?

The Theory of Exchange Rate Overshooting explains high exchange rate volatility by assuming that CIRP does not hold in the short run,but PPP does.

The Portfolio-Balance Approach assumes:

The Theory of Exchange Rate Overshooting explains high exchange rate volatility by assuming that does not hold in the ,but does.

Assume that two Caribbean countries announce that they will be coordinating monetary policy.This is because their currencies are considered:

When citizens anticipate a country to experience trade deficits in the near future,the domestic currency would:

Which of the following is NOT a factor that causes substantial exchange rate volatility?

Which of the following options correctly reflect the assumptions in the Overshooting Approach?

In general,the basic Monetary Approach to Exchange Rate MAER does not capture the short run volatility of prices.

When a high degree of currency substitution exists,to prevent currencies from becoming too variable,countries need international coordination of monetary policy.

Which of the following best describe the process of "overshooting" when money supply increases?

Since news is unexpected and catches people off-guard,

Exchange rates appear to be more volatile than the monetary approach would predict,because:

Assume that in a free country,people in the country can choose to hold assets in any currency.As the domestic inflation rise,the opportunity cost of holding the domestic currency _ and people will switch to hold assets in _ currency.

The exchange rate can "overshoot" its long-run value because the are sluggish in the short run,whereas the __ adjust instantaneously to a shock.

In the equilibrium approach,changes in exchange rates occur because of changes in tastes or technology and are part of the adjustment to a shock to the world economy.