Test Bank FMT-142-156

50.
Assuming initially that the required reserve ratio = 10%, the currency-deposit ratio = 75%, and the excess
reserve ratio = 156%, an increase in the currency-deposit ratio to 150% causes theM1 money multiplier to
________, everything else held constant.
a. increase from 0.73 to 0.78
b. decrease from 0.73 to 0.61
c. increase from 1.54 to 1.67
d. decrease from 1.67 to 1.54
51. The excess reserves ratio is ________ related to expected deposit outflows, and is ________ related to the
market interest rate.
a. negatively; negatively
b. negatively; positively
c. positively; negatively
d. positively; positively
52. The money supply is ________ related to expected deposit outflows, and is ________ related to the market
interest rate.
a. negatively; negatively
b. negatively; positively
c. positively; negatively
d. positively; positively
53. The money multiplier is
a. negatively related to high-powered money.
b. positively related to the excess reserves ratio.
c. negatively related to the required reserve ratio.
d. positively related to holdings of excess reserves.
54. From the start of the global financial crisis in 2007 to date, the currency ratio
a. increased sharply.
b. decreased sharply.
c. increased slightly.
d. decreased slightly.
55. From the start of the global financial crisis in 2007 to date, the excess reserve ratio
a. increased sharply.
b. decreased sharply.
c. increased slightly.
d. decreased slightly.
56. Explain the complete formula for the M1 money supply, and explain how changes in required reserves,
excess reserves, the currency ratio, the nonborrowed base, and borrowed reserves affect the money supply.
1+𝑐
Answer: The formula is 𝑀 = 𝑟𝑟 + 𝑐 + 𝑒
× (𝑀𝐵𝑛 + 𝐵𝑅). The formula indicates that the money supply is
the product of the multiplier times the base. Increases in any of the multiplier components, required reserves,
r; excess reserves, e; or the currency ratio, c; reduce the multiplier and the money supply. Increases in the
nonborrowed base and borrowed reserves both increase the base and the money supply.
Chapter 18: The Foreign Exchange Market

A. Foreign Exchange Market
1. The exchange rate is
a. the price of one currency relative to gold.
b. the value of a currency relative to inflation.
c. the change in the value of money over time.
d. the price of one currency relative to another.
2. Exchange rates are determined in
a. the money market.
b. the foreign exchange market.
c. the stock market.
d. the capital market.
3. Although foreign exchange market trades are said to involve the buying and selling of currencies, most
trades involve the buying and selling of
a. bank deposits denominated in different currencies.
b. SDRs.
c. gold.
d. ECUs.
4. The immediate (two-day) exchange of one currency for another is a
a. forward transaction.
b. spot transaction.
c. money transaction.
d. exchange transaction.
5. An agreement to exchange dollar bank deposits for euro bank deposits in one month is a
a. spot transaction.
b. future transaction.
c. forward transaction.
d. deposit transaction.
6. If 1 euro can be purchased for $1.10 today on the market, this exchange rate is called the
a. spot exchange rate.
b. forward exchange rate.
c. fixed exchange rate.
d. financial exchange rate.
7. In an agreement to exchange dollars for euros in three months at a price of $0.90 per euro, the price is the
a. spot exchange rate.
b. money exchange rate.
c. forward exchange rate.
d. fixed exchange rate.
8. When the value of the British pound changes from $1.25 to $1.50, the pound has ________ and the U.S.
dollar has ________.
a. appreciated; appreciated
b. depreciated; appreciated
c. appreciated; depreciated
d. depreciated; depreciated
9. When the value of the British pound changes from $1.50 to $1.25, then the pound has ________ and the U.S.
10. When the value of the dollar changes from £0.5 to £0.75, then the British pound has ________ and the U.S.
11. When the value of the dollar changes from £0.75 to £0.5, then the British pound has ________ and the U.S.
12. When the exchange rate for the Mexican peso changes from 9 pesos to the U.S. dollar to 10 pesos to the U.S.
dollar, then the Mexican peso has ________ and the U.S. dollar has ________.
13. When the exchange rate for the Mexican peso changes from 10 pesos to the U.S dollar to 9 pesos to the U.S.
dollar, then the Mexican peso has ________ and the U.S. dollar has ________.
14. If one U.S. dollar is traded on the foreign exchange market for about 0.89 euros, then one euro can purchase
about ________ U.S. dollars.
a. 0.75
b. 0.89
c. 1.12
d. 1.75
15. If one U.S. dollar is traded on the foreign exchange market for about 49.0 Indian rupees, then one Indian
rupee can purchase about ________ U.S. dollars.
a. 0.02
b. 1.20
c. 7.00
d. 49.0
16. If one U.S. dollar is traded on the foreign exchange market for about 1.15 Swiss francs, then one Swiss franc
can purchase about ________ U.S. dollars.
a. 0.30
b. 0.87
c. 1.15
d. 3.10
17. If the U.S. dollar appreciates from 1.25 Swiss franc per U.S. dollar to 1.5 francs per dollar, then the franc
depreciates from ________ U.S. dollars per franc to ________ U.S. dollars per franc.
a. 0.80; 0.67
b. 0.67; 0.80
c. 0.50; 0.33
d. 0.33; 0.50
18. If the British pound appreciates from $0.50 per pound to $0.75 per pound, the U.S. dollar depreciates from
________ per dollar to ________ per dollar.
a. £2; £2.5
b. £2; £1.33
c. £2; £1.5
d. £2; £1.25
19. If the Japanese yen appreciates from $0.01 per yen to $0.02 per yen, the U.S. dollar depreciates from
________ per dollar to ________ per dollar.
a. ¥100; ¥50
b. ¥10; ¥5
c. ¥5; ¥10
d. ¥50; ¥100
20. If the dollar appreciates from 1.5 Brazilian reals per dollar to 2.0 reals per dollar, the real depreciates from
________ per real to ________ per real.
a. $0.67; $0.50
b. $0.33; $0.50
c. $0.75; $0.50
d. $0.50; $0.67
e. $0.50; $0.75
21. When the exchange rate for the British pound changes from $1.80 per pound to $1.60 per pound, then,
holding everything else constant, the pound has ________ and ________ expensive.
a. appreciated; British cars sold in the United States become more
b. appreciated; British cars sold in the United States become less
c. depreciated; American wheat sold in Britain becomes more
d. depreciated; American wheat sold in Britain becomes less
22. If the dollar depreciates relative to the Swiss franc
a. Swiss chocolate will become cheaper in the United States.
b. American computers will become more expensive in Switzerland.
c. Swiss chocolate will become more expensive in the United States.
d. Swiss computers will become cheaper in the United States.
23. Everything else held constant, when a country's currency appreciates, the country's goods abroad become
________ expensive and foreign goods in that country become ________ expensive.
a. more; less
b. more; more
c. less; less
d. less; more
24. Everything else held constant, when a country's currency depreciates, its goods abroad become ________
expensive while foreign goods in that country become ________ expensive.
a. more; less
b. more; more
c. less; less
d. less; more
B. Exchange Rates in the Long Run
1. According to the Purchasing Power Parity, if one country's price level rises relative to another's by a certain
percentage, then the other country's currency
a. maintains its value.
b. depreciates by the same percentage.
c. appreciates by the same percentage.
d. lose its value.
2. The real exchange rate between U.S. dollars and the Japanese yen is the price of U.S. goods relative to the
price of Japanese goods denominated in the U.S. dollar. If this real exchange rate is below one, the same
basket of goods is ________ in the United States than in Japan, and the purchasing power of the U.S. dollars
is ________ than the Japanese yen.
a. more expensive; higher
b. cheaper; lower
c. more expensive; lower
d. cheaper; higher
3. The real exchange rate between U.S. dollars and the Japanese yen is the price of U.S. goods relative to the
price of Japanese goods denominated in the U.S. dollar. If it is below one, the same basket of goods is
________ in the United States than in Japan, and the purchasing power of the U.S. dollars is ________ than
the Japanese yen.
a. more expensive; higher
b. cheaper; lower
c. more expensive; lower
d. cheaper; higher
4. The ________ states that exchange rates between any two currencies will adjust to reflect changes in the
price levels of the two countries.
a. theory of purchasing power parity
b. law of one price
c. theory of money neutrality
d. quantity theory of money
5. The theory of PPP suggests that if one country's price level rises relative to another's, its currency should
a. depreciate.
b. appreciate.
c. float.
d. do none of the above.
6. The theory of PPP suggests that if one country's price level falls relative to another's, its currency should
a. depreciate.
b. appreciate.
c. float.
d. do none of the above.
7. The theory of PPP suggests that if one country's price level falls relative to another's, its currency should
a. depreciate in the long run.
b. appreciate in the long run.
c. appreciate in the short run.
d. depreciate in the short run.
8. The theory of purchasing power parity cannot fully explain exchange rate movements in the short run
because
a. all goods are identical even if produced in different countries.
b. monetary policy differs across countries.
c. some goods are not traded between countries.
d. fiscal policy differs across countries
9. The theory of purchasing power parity states that exchange rates between any two currencies will adjust to
reflect changes in
a. the trade balances of the two countries.
b. the current account balances of the two countries.
c. fiscal policies of the two countries.
d. the price levels of the two countries.
10. If the real exchange rate between the United States and Japan is ________, then it is cheaper to buy goods in
Japan than in the United States.
a. greater than 1.0
b. greater than 0.5
c. less than 0.5
d. less than 1.0
11. According to PPP, when the Big Mac has a high price in terms of local currency, then the exchange rate
quoted in U.S. dollars per unit of local currency should be ________.
a. low
b. high
c. uncertain
d. one
12. When a country's goods and services are expensive relative to other countries', we say that its currency is
________ in terms of purchasing power parity.
a. overvalued
b. undervalued
c. rational
d. irrational
13. According to PPP, the real exchange rate between two countries will always equal
a. 0.0
b. 0.5
c. 1.0
d. 1.5
14. The theory of PPP suggests that if one country's price level rises relative to another's, its currency should
a. depreciate in the long run.
b. appreciate in the long run.
c. depreciate in the short run.
d. appreciate in the short run.
15. In the long run, a rise in a country's price level (relative to the foreign price level) causes its currency to
________, while a fall in the country's relative price level causes its currency to ________.
a. appreciate; appreciate
b. appreciate; depreciate
c. depreciate; appreciate
d. depreciate; depreciate
16. If the 2005 inflation rate in Canada is 4 percent, and the inflation rate in Mexico is 2 percent, then the theory
of purchasing power parity predicts that, during 2005, the value of the Canadian dollar in terms of Mexican
pesos will
a. rise by 6 percent.
b. rise by 2 percent.
c. fall by 6 percent.
d. fall by 2 percent
17. Assume that the following are the predicted inflation rates in these countries for the year: 2%for the United
States, 3% for Canada; 4% for Mexico, and 5% for Brazil. According to the purchasing power parity and
everything else held constant, which of the following would we expect to happen?
a. The Brazilian real will depreciate against the U.S. dollar.
b. The Mexican peso will depreciate against the Brazilian real.
c. The Canadian dollar will depreciate against the Mexican peso.
d. The U.S. dollar will depreciate against the Canadian dollar.
18. According to the purchasing power parity theory, a rise in the United States price level of 5 percent, and a
rise in the Mexican price level of 6 percent cause
a. the dollar to appreciate 1 percent relative to the peso.
b. the dollar to depreciate 1 percent relative to the peso.
c. the dollar to depreciate 5 percent relative to the peso.
d. the dollar to appreciate 5 percent relative to the peso.
19. Higher tariffs and quotas cause a country's currency to ________ in the ________ run, everything else held
constant.
a. depreciate; short
b. appreciate; short
c. depreciate; long
d. appreciate; long
20. Lower tariffs and quotas cause a country's currency to ________ in the ________ run, everything else held
constant.
a. depreciate; short
b. appreciate; short
c. depreciate; long
d. appreciate; long
21. Anything that increases the demand for foreign goods relative to domestic goods tends to ________ the
domestic currency because domestic goods will only continue to sell well if the value of the domestic
currency is ________, everything else held constant.
a. depreciate; lower
b. depreciate; higher
c. appreciate; lower
d. appreciate; higher
22. Everything else held constant, increased demand for a country's ________ causes its currency to appreciate
in the long run, while increased demand for ________ causes its currency to depreciate.
a. imports; imports
b. imports; exports
c. exports; imports
d. exports; exports
23. Everything else held constant, increased demand for a country's exports causes its currency to ________ in
the long run, while increased demand for imports causes its currency to ________.
a. appreciate; appreciate
b. appreciate; depreciate
c. depreciate; appreciate
d. depreciate; depreciate
24. Everything else held constant, if a factor increases the demand for ________ goods relative to ________
goods, the domestic currency will appreciate.
a. foreign; domestic
b. foreign; foreign
c. domestic; domestic
d. domestic; foreign
25. Everything else held constant, if a factor decreases the demand for ________ goods relative to ________
goods, the domestic currency will depreciate.
a. foreign; domestic
b. foreign; foreign
c. domestic; domestic
d. domestic; foreign
26. An increase in productivity in a country will cause its currency to ________ because it can produce goods at
a ________ price, everything else held constant.
a. depreciate; lower
b. appreciate; lower
c. depreciate; higher
d. appreciate; higher
27. If, in retaliation for "unfair" trade practices, Congress imposes a 30 percent tariff on JapaneseDVD recorders,
but at the same time, U.S. demand for Japanese goods increases, then, in the long run, ________, everything
else held constant.
a. the Japanese yen should appreciate relative to the U.S. dollar
b. the Japanese yen should depreciate relative to the U.S. dollar
c. there is no effect on the Japanese yen relative to the U.S. dollar
d. the Japanese yen could appreciate, depreciate or remain constant relative to the U.S. dollar
28. If the U.S. Congress imposes a quota on imports of Japanese cars due to claims of "unfair" trade practices,
and Japanese demand for American exports increases at the same time, then, in the long run ________,
everything else held constant.
a. the Japanese yen will appreciate relative to the U.S. dollar
b. the Japanese yen will depreciate relative to the U.S. dollar
c. the Japanese yen will either appreciate, depreciate or remain constant against the U.S. dollar
d. there will be no effect on the Japanese yen relative to the U.S. dollar
29. If the inflation rate in the United States is higher than that in Mexico and productivity is growing at a slower
rate in the United States than in Mexico, then, in the long run, ________, everything else held constant.
a. the Mexican peso will appreciate relative to the U.S. dollar
b. the Mexican peso will depreciate relative to the U.S. dollar
c. the Mexican peso will either appreciate, depreciate, or remain constant relative to the U.S. dollar
d. there will be no effect on the Mexican peso relative to the U.S. dollar
30. If the Brazilian demand for American exports rises at the same time that U.S. productivity rises relative to
Brazilian productivity, then, in the long run, ________, everything else held constant.
a. the Brazilian real will appreciate relative to the U.S. dollar
b. the Brazilian real will depreciate relative to the U.S. dollar
c. the Brazilian real will either appreciate, depreciate, or remain constant relative to the U.S. dollar
d. there is no effect on the Brazilian real relative to the U.S. dollar
31. Which of the followings cause a depreciation of domestic currency in the long run?
I. An increase in domestic price level.
II. An increase in tariff.
III. An increase in imports demand.
IV. An increase in export demand.
V. An increase in productivity.
a. All five.
b. I, II, and III.
c. I and III.
d. IV and V.
32. Explain the law of one price and the theory of purchasing power parity. Why doesn't purchasing power parity
explain all exchange rate movements in the short run? What factors determine long-run exchange rates?
33. Answer: With no trade barriers and low transport costs, the law of one price states that the price of traded
goods should be the same in all countries. The purchasing power parity theory extends the law of one price
to total economies. PPP states that exchange rates should adjust to reflect changes in the price levels between
two countries. PPP may fail to fully explain exchange rates because goods are not identical, and price levels
include traded and nontraded goods and services. Long-run exchange rates are determined by domestic price
levels relative to foreign price levels, trade barriers, import and export demand, and productivity.
C. Exchange Rates in the Short Run: A Supply and Demand Analysis
1. The theory of portfolio choice suggests that the most important factor affecting the demand for domestic and
foreign assets is
a. the level of trade and capital flows.
b. the expected return on these assets relative to one another.
c. the liquidity of these assets relative to one another.
d. the riskiness of these assets relative to one another.
2. The ________ suggests that the most important factor affecting the demand for domestic and foreign assets
is the expected return on domestic assets relative to foreign assets.
a. theory of portfolio choice
b. law of one price
c. interest parity condition
d. theory of foreign capital mobility
3. The theory of portfolio choice suggests that the most important factor affecting the demand for domestic and
foreign assets is the ________ on these assets relative to one another.
a. interest rate
b. risk
c. expected return
d. liquidity
4. As the relative expected return on dollar assets increases, foreigners will want to hold more ________ assets
and less ________ assets, everything else held constant.
a. foreign; foreign
b. foreign; dollar
c. dollar; foreign
d. dollar; dollar
5. When Americans or foreigners expect the return on ________ assets to be high relative to the return on
________ assets, there is a higher demand for dollar assets and a correspondingly lower demand for foreign
assets.
a. dollar; dollar
b. dollar; foreign
c. foreign; dollar
d. foreign; foreign
6. When Americans or foreigners expect the return on ________ assets to be high relative to the return on
________ assets, there is a ________ demand for dollar assets, everything else held constant.
a. dollar; foreign; constant
b. dollar; foreign; higher
c. foreign; dollar; higher
d. foreign; dollar; constant
7. When Americans or foreigners expect the return on dollar assets to be high relative to the return on foreign
assets, there is a ________ demand for dollar assets and a correspondingly ________ demand for foreign
assets.
a. higher; higher
b. higher; lower
c. lower; higher
d. lower; lower
8. Everything else held constant, when the current value of the domestic currency increases, the ________
domestic assets ________.
a. demand for; increases
b. quantity demanded of; increases
c. demand for; decreases
d. quantity demanded of; decreases
9. Everything else held constant, when the current value of the domestic exchange rate increases,the ________
of domestic assets ________.
a. quantity supplied; does not change
b. supply; decreases
c. quantity supplied; increases
d. supply; increases
D. Explaining Changes in Exchange Rates
1. An increase in the domestic interest rate causes the demand for domestic assets to ________ and the
domestic currency to ________, everything else held constant.
a. increase; appreciate
b. increase; depreciate
c. decrease; appreciate
d. decrease; depreciate
2. An increase in the domestic interest rate causes the demand for domestic assets to shift to the ________ and
the domestic currency to ________, everything else held constant.
a. right; appreciate
b. right; depreciate
c. left; appreciate
d. left; depreciate
3. A decrease in the domestic interest rate causes the demand for domestic assets to ________ and the domestic
currency to ________, everything else held constant.
4. A decrease in the domestic interest rate causes the demand for domestic assets to shift to the ________ and
c. left; appreciate
d. left; depreciate
5. ________ in the domestic interest rate causes the demand for domestic assets to increase and the domestic
a. An increase; appreciate
b. An increase; depreciate
c. A decrease; appreciate
d. A decrease; depreciate
6. ________ in the domestic interest rate causes the demand for domestic assets to shift to the right and the
7. ________ in the domestic interest rate causes the demand for domestic assets to decrease and the domestic
8. ________ in the domestic interest rate causes the demand for domestic assets to shift to the left and the
9. ________ in the domestic interest rate causes the demand for domestic assets to ________ and the domestic
currency to appreciate, everything else held constant.
a. An increase; increase
b. An increase; decrease
c. A decrease; increase
d. A decrease; decrease
10. ________ in the domestic interest rate causes the demand for domestic assets to shift to the ________ and
the domestic currency to appreciate, everything else held constant.
a. An increase; right
b. An increase; left
c. A decrease; right
d. A decrease; left
11. _______ in the domestic interest rate causes the demand for domestic assets to ________ and the domestic
currency to depreciate, everything else held constant.
12. ________ in the domestic interest rate causes the demand for domestic assets to shift to the ________ and
the domestic currency to depreciate, everything else held constant.
d. A decrease; left
13. Suppose that the Federal Reserve enacts expansionary policy. Everything else held constant, this will cause
the demand for U.S. assets to ________ and the U.S. dollar to ________.
b. decrease; appreciate
c. increase; depreciate
14. Suppose that the Federal Reserve conducts an open market sale. Everything else held constant, this will
cause the demand for U.S. assets to ________ and the U.S. dollar will ________.
15. An increase in the foreign interest rate causes the demand for domestic assets to ________ and the domestic
16. An increase in the foreign interest rate causes the demand for domestic assets to shift to the ________ and
c. left; appreciate
d. left; depreciate
17. A decrease in the foreign interest rate causes the demand for domestic assets to ________ and the domestic
18. A decrease in the foreign interest rate causes the demand for domestic assets to shift to the ________ and the
c. left; appreciate
d. left; depreciate
19. _______ in the foreign interest rate causes the demand for domestic assets to increase and the domestic
20. ________ in the foreign interest rate causes the demand for domestic assets to shift to the right and the
21. ________ in the foreign interest rate causes the demand for domestic assets to decrease and the domestic
22. ________ in the foreign interest rate causes the demand for domestic assets to shift to the left and the
23. ________ in the foreign interest rate causes the demand for domestic assets to ________ and the domestic
currency to appreciate, everything else held constant.
24. ________ in the foreign interest rate causes the demand for domestic assets to shift to the ________ and the
domestic currency to appreciate, everything else held constant.
d. A decrease; left
25. ________ in the foreign interest rate causes the demand for domestic assets to ________ and the domestic
currency to depreciate, everything else held constant.
26. ________ in the foreign interest rate causes the demand for domestic assets to shift to the ________ and the
domestic currency to depreciate, everything else held constant.
d. A decrease; left
27. Suppose that the European Central Bank enacts expansionary policy. Everything else held constant, this will
cause the demand for U.S. assets to ________ and the U.S. dollar to ________.
28. Suppose that the European Central Bank conducts a main refinancing sale. Everything else held constant,
this would cause the demand for U.S. assets to ________ and the U.S. dollar will ________.
29. An increase in the expected future domestic exchange rate causes the demand for domestic assets to
________ and the domestic currency to ________, everything else held constant.
30. An increase in the expected future domestic exchange rate causes the demand for domestic assets to shift to
the ________ and the domestic currency to ________, everything else held constant.
c. left; appreciate
d. left; depreciate
31. A decrease in the expected future domestic exchange rate causes the demand for domestic assets to
________ and the domestic currency to ________, everything else held constant.
32. A decrease in the expected future domestic exchange rate causes the demand for domestic assets to shift to
the ________ and the domestic currency to ________, everything else held constant.
c. left; appreciate
d. left; depreciate
33. ________ in the expected future domestic exchange rate causes the demand for domestic assets to increase
and the domestic currency to ________, everything else held constant.
34. ________ in the expected future domestic exchange rate causes the demand for domestic assets to shift to the
right and the domestic currency to ________, everything else held constant.
35. ________ in the expected future domestic exchange rate causes the demand for domestic assets to decrease
and the domestic currency to ________, everything else held constant.
left and the domestic currency to ________, everything else held constant.
37. ________ in the expected future domestic exchange rate causes the demand for domestic assets to ________
and the domestic currency to appreciate, everything else held constant.
________ and the domestic currency to appreciate, everything else held constant.
d. A decrease; left
39. _______ in the expected future domestic exchange rate causes the demand for domestic assets to ________
and the domestic currency to depreciate, everything else held constant.
________ and the domestic currency to depreciate, everything else held constant.
d. A decrease; left
41. Suppose the Federal Reserve releases a policy statement today which leads people to believe that the Fed
will be enacting expansionary monetary policy in the near future. Everything else held constant, the release
of this statement would immediately cause the demand for U.S. assets to ________ and the U.S. dollar to
________.
42. Suppose a report was released today that showed the Euro-Zone inflation rate is running above the European
Central Bank's inflation rate target. This leads people to expect that the European Central Bank will enact
contractionary policy in the near future. Everything else held constant, the release of this report would
immediately cause the demand for U.S. assets to ________ and the U.S. dollar will ________.
43. Suppose that the latest Consumer Price Index (CPI) release shows a higher inflation rate in the U.S. than was
expected. Everything else held constant, the release of the CPI report would immediately cause the demand
for U.S. assets to ________ and the U.S. dollar would ________.
44. When domestic real interest rates rise, the domestic currency ________.
a. appreciates
b. depreciates
c. appreciates or depreciates depending on the change in nominal interest rates
d. does not change
45. During the beginning on the global financial crisis in the United States when the effects of the crisis were
mostly confined within the United States, the U. S. dollar ________ because demand for U.S. assets
________.
a. appreciated; increased
b. depreciated; increased
c. appreciated; decreased
d. depreciated; decreased
46. When the effects of the global financial crisis started to spread more quickly throughout the rest of the world,
the U.S. dollar ________ because demand for U.S. assets ________.
a. appreciated; increased
b. depreciated; increased
c. appreciated; decreased
d. depreciated; decreased
47. The Brexit vote in June 2016 resulted in higher expected trade barriers . Therefore, the expected value of the
pound would be ________ in the future. The result was the sharp ________ in the equilibrium exchange rate
for the British pound.
a. lower; fall
b. higher; fall
c. lower; rise
d. higher; rise
48. The Brexit vote in June 2016 resulted in higher expected trade barriers. The relative expectedreturn on
British (pound) assets therefore ________ and so the quantity demanded of pound assets ________ at any
given exchange rate, shifting the demand curve for pound assets to the ________.
a. fell; declined; left
b. fell; increased; right
c. fell; declined; right
d. rose; declined; left
e. rose; increased; left
49. Which of the followings cause the public to expect a depreciation of domestic currency?
I. An increase in domestic price level.
II. An increase in tariff.
III. An increase in imports demand.
IV. An increase in export demand.
V. An increase in productivity.
a. All five.
b. I, II, and III.
c. I and III.
d. IV and V.
50. Explain and show graphically the effect of an increase in the expected future exchange rate on the
equilibrium exchange rate, everything else held constant.
Answer: See figure below.
When the expected future exchange rate increases, the relative expected return on the domestic assets
increases. This will cause the demand for domestic assets to increase and the current value of the exchange
rate will appreciate.
51. Explain and show graphically the effect of an increase in the expected inflation rate on the equilibrium
exchange rate, everything else held constant.
Answer: See figure below.
When the expected inflation rate increases, the relative expected return on domestic assets is affected two
ways. First, through the Fisher effect, the domestic nominal interest rate will increase the expected return on
domestic assets. Second, through purchasing power parity, the future value of the domestic exchange rate
will decline which will decrease the expected return on domestic assets. Since it is generally believed that the
effect of the change in the expected future value of the domestic exchange rate is larger than the Fisher
effect, the net effect is a lower expected return on domestic assets. This will decrease the demand for
domestic assets, which will cause the current value of the domestic exchange rate to depreciate.

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50.

Chapter 18: The Foreign Exchange Market

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