IBUS 401 Exam 2 COMPLETE
QUESTIONS & SOLUTIONS
fixed exchange rate system - ANSWER exchange rates are either held constant or
allowed to fluctuate only within very narrow boundaries, central bank can reset a fixed
exchange rate by devaluing or reducing the value of the currency adjacent other
currencies, central bank can also revalue or increase the value of its currency against
other currencies
advantages of fixed exchange rates - ANSWER insulate country from risk of currency
appreciation, allows firms to engage in direct foreign investment without currency risk
disadvantages of fixed exchange rates - ANSWER risk that government will alter value
of currency, country and MNC may be more vulnerable to economic conditions in other
countries
freely floating exchange rate system - ANSWER exchange rates are determined by
markets forces without government intervention
advantages of a freely floating system - ANSWER country is more insulated from
inflation of other countries, from unemployment of other countries, does not require
central bank to maintain exchange rates within specified boundaries
disadvantages of a freely floating exchange rate system - ANSWER can adversely
affect a country that has high unemployment and high inflation
managed float exchange rate system - ANSWER governments sometimes intervene to
prevent they currencies from moving too far in a certain direction
pegged exchange rate system - ANSWER home currency value is pegged to one
foreign currency or to an index of currencies
what are some limitations of a pegged exchange rate? - ANSWER may attract foreign
investment because exchange rate is expected to remain stable, weak or economic or
political conditions can cause firms and investors to question whether the peg will be
broken
currency boards used to peg currency values - ANSWER a system for pegging the
value of the local currency to some other specified currency, the board must maintain
currency reserves for all the currency that it has printed
interest rates of pegged currencies - ANSWER interest rate will move in tandem with
the interest rate of the currency to which it is tied
, direct intervention - ANSWER to force the dollar to depreciate the Fed can intervene
directly by exchanging dollars that it holds as reserves for other foreign currencies in the
foreign exchange market, creates downward pressure on the dollar
relative form of PPP - ANSWER due to market imperfections prices of the same basket
of products in different counters will not necessarily be the same but the rate of change
in prices should be similar when measured in common currency
rational behind relative PPP theory - ANSWER exchange rate adjustment is necessary
for the relative purchasing power to be the same whether buying products locally or
from another country
derivation of PPP - ANSWER relationship between relative inflation rates and the
exchange rate
____ is the mechanism by which the inflation differential affects the exchange rate
according to this theory - ANSWER international trade
fisher effect - ANSWER suggest that the nominal interest rate contain two components:
expected inflation rate and real interest rate
_____ represents the return on the investment to savers after accounting for expected
inflation - ANSWER real rate of interest
The IFE theory suggest that currencies with ____ will have high expected inflation and
the relatively high inflation will cause currencies to ____ - ANSWER high interest rates,
depreciate
international fisher effect - ANSWER relationship between the interest rate differential
between two countries and expected exchange rate
The IFE theory relies on the ____ and ____ - ANSWER fisher effect and PPP
limitation of the fisher effect - ANSWER the difference between the nominal interest rate
and actual inflation rate is not consistent. Thus, while the fisher effect can effectively
use nominal interest rates to estimate the markets expected inflation over a particular
period the market may be wrong
limitation of PPP - ANSWER Other country characteristics besides inflation (income
levels, government controls) can affect exchange rate movements. Even if the expected
inflation derived from the Fisher effect properly reflects the actual inflation rate over the
period, relying solely on inflation to forecast the future exchange rate is subject to error
____ focuses on why the forward rate differs from the spot rate and on the degree of
difference that should exist. it relates to a specific point in time - ANSWER IRP
QUESTIONS & SOLUTIONS
fixed exchange rate system - ANSWER exchange rates are either held constant or
allowed to fluctuate only within very narrow boundaries, central bank can reset a fixed
exchange rate by devaluing or reducing the value of the currency adjacent other
currencies, central bank can also revalue or increase the value of its currency against
other currencies
advantages of fixed exchange rates - ANSWER insulate country from risk of currency
appreciation, allows firms to engage in direct foreign investment without currency risk
disadvantages of fixed exchange rates - ANSWER risk that government will alter value
of currency, country and MNC may be more vulnerable to economic conditions in other
countries
freely floating exchange rate system - ANSWER exchange rates are determined by
markets forces without government intervention
advantages of a freely floating system - ANSWER country is more insulated from
inflation of other countries, from unemployment of other countries, does not require
central bank to maintain exchange rates within specified boundaries
disadvantages of a freely floating exchange rate system - ANSWER can adversely
affect a country that has high unemployment and high inflation
managed float exchange rate system - ANSWER governments sometimes intervene to
prevent they currencies from moving too far in a certain direction
pegged exchange rate system - ANSWER home currency value is pegged to one
foreign currency or to an index of currencies
what are some limitations of a pegged exchange rate? - ANSWER may attract foreign
investment because exchange rate is expected to remain stable, weak or economic or
political conditions can cause firms and investors to question whether the peg will be
broken
currency boards used to peg currency values - ANSWER a system for pegging the
value of the local currency to some other specified currency, the board must maintain
currency reserves for all the currency that it has printed
interest rates of pegged currencies - ANSWER interest rate will move in tandem with
the interest rate of the currency to which it is tied
, direct intervention - ANSWER to force the dollar to depreciate the Fed can intervene
directly by exchanging dollars that it holds as reserves for other foreign currencies in the
foreign exchange market, creates downward pressure on the dollar
relative form of PPP - ANSWER due to market imperfections prices of the same basket
of products in different counters will not necessarily be the same but the rate of change
in prices should be similar when measured in common currency
rational behind relative PPP theory - ANSWER exchange rate adjustment is necessary
for the relative purchasing power to be the same whether buying products locally or
from another country
derivation of PPP - ANSWER relationship between relative inflation rates and the
exchange rate
____ is the mechanism by which the inflation differential affects the exchange rate
according to this theory - ANSWER international trade
fisher effect - ANSWER suggest that the nominal interest rate contain two components:
expected inflation rate and real interest rate
_____ represents the return on the investment to savers after accounting for expected
inflation - ANSWER real rate of interest
The IFE theory suggest that currencies with ____ will have high expected inflation and
the relatively high inflation will cause currencies to ____ - ANSWER high interest rates,
depreciate
international fisher effect - ANSWER relationship between the interest rate differential
between two countries and expected exchange rate
The IFE theory relies on the ____ and ____ - ANSWER fisher effect and PPP
limitation of the fisher effect - ANSWER the difference between the nominal interest rate
and actual inflation rate is not consistent. Thus, while the fisher effect can effectively
use nominal interest rates to estimate the markets expected inflation over a particular
period the market may be wrong
limitation of PPP - ANSWER Other country characteristics besides inflation (income
levels, government controls) can affect exchange rate movements. Even if the expected
inflation derived from the Fisher effect properly reflects the actual inflation rate over the
period, relying solely on inflation to forecast the future exchange rate is subject to error
____ focuses on why the forward rate differs from the spot rate and on the degree of
difference that should exist. it relates to a specific point in time - ANSWER IRP
