Part A. Multiple Choice Questions: Choose only one, most satisfactory answer for
ID: 1151191 • Letter: P
Question
Part A. Multiple Choice Questions: Choose only one, most satisfactory answer for each question (5 points each).
1. When the US dollar depreciates relative to the yen, all prices of domestically produced goods remaining the same in domestic currency, then compared to the Japanese products,
US products become relatively less expensive for the Japanese, but relatively more expensive for the Americans and Europeans.
US products become relatively more expensive for the Americans.
US products become relatively more expensive for the Europeans.
US products become relatively more expensive for the Japanese.
none of the above.
2. GLS Inc. manufactures grain handling equipment in Central Illinois and exports some of its products to other countries. In the Canadian market, it competes with local firms and has to match their prices in Canadian dollars (C$). Suppose those prices remain constant this year, but the US dollar (US$) appreciates vis-à-vis the C$ by 5%. If GLS wants to remain as competitive in that market this year as it has been in the past, it must
lower the US$ price of its exports to Canada by more than 5%.
keep the US$ price of its exports to Canada constant.
lower the US$ price of its exports to Canada by 5%.
lower the C$ price of its exports to Canada by 5%.
raise the C$ price of its exports to Canada by 5%.
3. Treat the US dollar as the home currency. If the rates of interest on dollar and euro deposits are equal to each other, i$ = i€, and the spot exchange rate is greater than the expected future exchange rates, e > ee, then in the spot market for foreign exchange,
covered interest parity will hold.
uncovered interest parity will hold.
supply and demand will be balanced.
there will be excess demand for the euro.
there will be excess demand for the dollar.
4. Assume that the interest parity condition holds and risk-free, one-year rates of interest in the US and Euro area are 1% and 0%, respectively. If the European Central Bank raises the rate of interest in the Euro area to 0.5%, the expected appreciation of the dollar vis-à-vis the euro during the next 12 months
will rise.
will decline.
may rise, may decline.
will remain unchanged.
5. Assume that the covered and uncovered interest parities both hold at all times and that ef = x and ee= y represent today’s one-year forward and expected exchange rates of the dollar vis-à-vis the yen. If tomorrow everyone comes to expect the dollar to have a higher value relative to the yen than y, then
ef will decline by the same amount that ee rises.
ef will rise by more than the increase in ee.
ef will rise by less than the increase in ee.
ef will rise by the same amount as ee.
ef will remain unchanged.
6. This question is based on the article, “Carry on trading,” published by The Economist on August 10, 2013. (Copied below.) According to the article, “carry trade” consists of
buying goods in a country with low prices and exporting and selling them to a country with higher prices.
buying bonds in a country with low interest rates and taking and selling those bonds in a country with higher rates.
borrowing in a country with low interest rates and investing the proceeds of the loan in a country with higher rates.
buying stocks in a country with low interest rates and taking and selling those stocks in a country with higher rates.
buying the currency of a country with a low exchange rate and selling that currency in a country with a higher exchange rates.
7. According to the article, “Carry on trading,” the covered interest parity condition
is totally rejected by empirical evidence.
is supported by empirical evidence quite well.
is not supported by empirical evidence very well.
does not always hold and the market’s deviations from it can be exploited to make a small risk-free profit.
is supported by empirical evidence only when inflation rates in the two trading countries are low, but not otherwise.
8. According to the article, “Carry on trading,” mentioned above, the data on the volume of goods and currency trades indicate that foreign exchange transactions are mostly used for
buying foreign currencies and holding them as reserves.
buying and selling financial assets across countries.
buying and selling services across countries.
buying and selling goods across countries.
9. The empirical evidence on trade in major currency discussed in the article, “Carry on trading,” mentioned above, shows that with high probability,
the forward exchange rates have tended to overestimate the actual currency depreciation in countries with higher interest rates.
the expected exchange rate implied by the interest parity condition has not been equal to the forward rate.
the uncovered interest parity condition has been rejected.
the covered interest parity condition has been rejected.
10. The article, “Carry on trading,” mentioned above, points to a number of possible explanations for the profitability of carry trade. Which of the following is among those explanations?
Currencies always move in line with relative inflation rates, enabling carry traders to use their superior knowledge of inflation and predict depreciation and appreciation better than other currency market participants.
Carry traders take advantage of real interest rate differentials, while other currency market participants focus on nominal interest rate differences.
Profits of carry trade could be risk premia for holding assets denominated in the currencies of countries with persistent current-account deficits.
Carry traders have longer views of the currency markets than the other participants in those markets.
Explanation / Answer
1. Whn dollar depreciates it implies people of Japan will be able to buy more of US goods from one dollar than earlier as now more of US dollar are exchanged against one yen. Thus the US goods have become cheaper for Japanese and Japanese goods have become costlier for American. Hnec option 'US products become relatively less expensive for the Japanese, but relatively more expensive for the Americans and Europeans.' is correct.
2. When US dollar appreciates against canadian dollar by 5% it implies 5% of more canadian dollar will be required to pay in exchange of US dollar. Thus US dollar has become expensive against Can dollar. It implies the American good also becomes expensier because of US dollar being expensive. Thus in order to be competitive the company needs to reduce the price expressed in US dollar by 5%. Thus option 'lower the US$ price of its exports to Canada by 5%.' is correct.
3. Covered parity will exist as the retun of euro is inequilibrium with return in dollar.
4.If the interst rate is increased to 0.5% then there will be more demand of euro for investment declining dollar. Hence option 'will decline' is correct.