Question

QUESTION 6

1. Other things equal, as perceived risk falls for a country,

	a.	the domestic interest rate rises and the domestic currency gets stronger
	b.	the domestic interest rate rises and the domestic currency gets weaker
	c.	the domestic interest rate falls and the domestic currency gets stronger
	d.	the domestic interest rate falls and the domestic currency gets weaker

QUESTION 7

1. Suppose investors and currency speculators expect that a currency will depreciate in about six months. This will cause the currency to begin depreciating now.

True

False

QUESTION 8

1. Which of the following tends to cause markets to expect a currency to have a higher value in the near future?

	a.	the expectation that the country will have lower interest rates in the near future (and with other things equal)
	b.	the expectation that the country will have a stronger economy in the near future (and with other things equal)
	c.	both A and B
	d.	neither A nor B

QUESTION 9

1. Suppose a country maintains a fixed exchange rate below the market exchange rate.

	a.	It would need to supply the domestic currency to foreign exchange markets to prevent a shortage of the domestic currency.
	b.	It would need to demand the domestic currency in foreign exchange markets to prevent a surplus of the domestic currency.
	c.	It would have a narrow balance of payments deficit.
	d.	both A and C
	e.	both B and C

QUESTION 10

1. Suppose a country borrows somewhat more internationally than in the past. Keeping other things equal (like inflation and risk), this country's currency tends to weaken.

True

False

Answer 1

Part 1) Other things equal, as perceived risk falls for a country the domestic interest rate falls and the domestic currency gets stronger. This is because, with the decline in the risk investors invest in the country. As a result, the price of financial assets increases while the yield (interest rate) falls. Similarly, as investors enter a country to invest, they need to convert their foreign exchange into domestic currency. This raises the demand for the domestic currency and as a result the domestic currency appreciates or becomes stronger.

Part 2) The statement “If investors and currency speculators expect that a currency will depreciate in about six months. This will cause the currency to begin depreciating now,” is True. This is because if the investors and currency speculators wait for six months then they will suffer capital loss. This is because if the currency depreciates then the value of their investment will fall. For example, if a Japanese investor has invested 1000 yen in the US when the exchange rate was $50 for yen, then it means he has purchased financial assets worth $50,000. However, if the exchange rate depreciates to $60 per yen then while going out the Japanese investor will have 50,000/60 = 833.33 yen. So, he will face a capital loss. In order to avoid this, investors will start taking out their money from the country whose currency they expect to depreciate. This will eventually cause the currency to depreciate as demand for foreign exchange will increase while the supply of currency that is expected to depreciate increases.

Part 3) The expectation that the country will have a stronger economy in the near future (and with other things equal) will cause markets to expect a currency to have a higher value in the near future. This is because, in such a situation, investors will invest in the economy, and to make the investment they would need the domestic currency. As a result, demand for the domestic currency will increase.

Part 4) If a country maintains a fixed exchange rate below the market exchange rate then it would need to supply the domestic currency to foreign exchange markets to prevent a shortage of the domestic currency.

Part 5) The statement that “If a country borrows somewhat more internationally than in the past. Keeping other things equal (like inflation and risk), this country's currency tends to weaken,” is True. For example, if a country must pay $10 million each month in interest payments on its outstanding debts. But if that same $10 million of notional payments becomes less valuable, it will be easier to cover that interest. For instance, if the domestic currency is devalued to half of its initial value, the $10 million debt payment will only be worth $5 million now.