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The Economics of Money, Banking, and Financial Markets, 9e (Mishkin)

Chapter 17 The Foreign Exchange Market

17.1 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.

Answer: D

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2) Exchange rates are determined in

A) the money market.

B) the foreign exchange market.

C) the stock market.

D) the capital market.

Answer: B

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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.

Answer: A

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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.

Answer: B

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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.

Answer: C

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6) Today 1 euro can be purchased for $1.10. This is the

A) spot exchange rate.

B) forward exchange rate.

C) fixed exchange rate.

D) financial exchange rate.

Answer: A

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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.

Answer: C

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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

Answer: C

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9) When the value of the British pound changes from $1.50 to $1.25, then the pound has ________ and the U.S. dollar has ________.

A) appreciated; appreciated

B) depreciated; appreciated

C) appreciated; depreciated

D) depreciated; depreciated

Answer: B

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10) When the value of the dollar changes from £0.5 to £0.75, then the British pound has ________ and the U.S. dollar has ________.

A) appreciated; appreciated

B) depreciated; appreciated

C) appreciated; depreciated

D) depreciated; depreciated

Answer: B

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11) When the value of the dollar changes from £0.75 to £0.5, then the British pound has ________ and the U.S. dollar has ________.

A) appreciated; appreciated

B) depreciated; appreciated

C) appreciated; depreciated

D) depreciated; depreciated

Answer: C

Ques Status: Previous Edition

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 ________.

A) appreciated; appreciated

B) depreciated; appreciated

C) appreciated; depreciated

D) depreciated; depreciated

Answer: B

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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 ________.

A) appreciated; appreciated

B) depreciated; appreciated

C) appreciated; depreciated

D) depreciated; depreciated

Answer: C

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14) On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 0.75 euros. Therefore, one euro would have purchased about ________ U.S. dollars.

A) 0.75

B) 1.00

C) 1.33

D) 1.75

Answer: C

Ques Status: Revised

15) On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 49.0 Indian rupees. Thus, one Indian rupee would have purchased about ________ U.S. dollars.

A) 0.02

B) 1.20

C) 7.00

D) 49.0

Answer: A

Ques Status: Revised

16) On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 1.15 Swiss francs. Therefore, one Swiss franc would have purchased about ________ U.S. dollars.

A) 0.30

B) 0.87

C) 1.15

D) 3.10

Answer: B

Ques Status: Revised

17) On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 3.33 Romanian new lei. Therefore, one Romanian new lei would have purchased about ________ U.S. dollars.

A) 0.30

B) 1.86

C) 2.86

D) 3.33

Answer: A

Ques Status: Revised

18) 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

Answer: A

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19) 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

Answer: B

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20) 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¥

Answer: A

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21) 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

Answer: A

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22) 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

Answer: C

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23) 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.

Answer: C

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24) 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

Answer: A

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25) 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

Answer: D

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17.2 Exchange Rates in the Long Run

1) According to the law of one price, if the price of Colombian coffee is 100 Colombian pesos per pound and the price of Brazilian coffee is 4 Brazilian reals per pound, then the exchange rate between the Colombian peso and the Brazilian real is:

A) 40 pesos per real.

B) 100 pesos per real.

C) 25 pesos per real.

D) 0.4 pesos per real.

Answer: C

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2) The starting point for understanding how exchange rates are determined is a simple idea called ________, which states: if two countries produce an identical good, the price of the good should be the same throughout the world no matter which country produces it.

A) Gresham's law

B) the law of one price

C) purchasing power parity

D) arbitrage

Answer: B

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3) 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

Answer: A

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4) 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.

Answer: A

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5) 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.

Answer: B

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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.

Answer: B

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7) The theory of purchasing power parity cannot fully explain exchange rate movements 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.

Answer: C

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8) 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.

Answer: D

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9) 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

Answer: A

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10) 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

Answer: C

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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.

Answer: A

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12) 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

Answer: C

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13) 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.

Answer: D

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14) 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.

Answer: A

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15) 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.

Answer: A

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16) 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

Answer: D

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17) 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

Answer: C

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18) 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

Answer: A

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19) 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

Answer: C

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20) 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

Answer: B

Ques Status: Revised

21) 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

Answer: D

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22) 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

Answer: D

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23) 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

Answer: B

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24) If, in retaliation for "unfair" trade practices, Congress imposes a 30 percent tariff on Japanese DVD 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 Answer: D

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25) 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

Answer: B

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26) 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

Answer: A

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27) 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

Answer: B

Ques Status: Previous Edition

28) Explain the law of one price and the theory of purchasing power parity. Why doesn't purchasing power parity explain all exchange rate movements? What factors determine long-run exchange rates?

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.

Ques Status: Previous Edition

17.3 Exchange Rates in the Short Run: A Supply and Demand Analysis

1) The theory of asset demand 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.

Answer: B

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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 asset demand

B) law of one price

C) interest parity condition

D) theory of foreign capital mobility

Answer: A

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3) The theory of asset demand 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

Answer: C

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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

Answer: C

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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

Answer: B

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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

Answer: B

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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

Answer: B

Ques Status: Revised

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

Answer: D

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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

Answer: A

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17.4 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

Answer: A

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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

Answer: A

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3) A decrease 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

Answer: D

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4) A decrease 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

Answer: D

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5) ________ in the domestic interest rate causes the demand for domestic assets to increase and the domestic currency to ________, everything else held constant.

A) An increase; appreciate

B) An increase; depreciate

C) A decrease; appreciate

D) A decrease; depreciate

Answer: A

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and the domestic currency to ________, everything else held constant.

A) An increase; appreciate

B) An increase; depreciate

C) A decrease; appreciate

D) A decrease; depreciate

Answer: A

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7) ________ in the domestic interest rate causes the demand for domestic assets to decrease and the domestic currency to ________, everything else held constant.

A) An increase; appreciate

B) An increase; depreciate

C) A decrease; appreciate

D) A decrease; depreciate

Answer: D

Ques Status: Previous Edition

8) ________ in the domestic interest rate causes the demand for domestic assets to shift to the left and the domestic currency to ________, everything else held constant.

A) An increase; appreciate

B) An increase; depreciate

C) A decrease; appreciate

D) A decrease; depreciate

Answer: D

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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

Answer: A

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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

Answer: A

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the domestic currency to depreciate, everything else held constant.

A) An increase; increase

B) An increase; decrease

C) A decrease; increase

D) A decrease; decrease

Answer: D

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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.

A) An increase; right

B) An increase; left

C) A decrease; right

D) A decrease; left

Answer: D

Ques Status: Previous Edition

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 ________.

A) increase; appreciate

B) decrease; appreciate

C) increase; depreciate

D) decrease; depreciate

Answer: D

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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 ________.

A) increase; appreciate

B) increase; depreciate

C) decrease; appreciate

D) decrease; depreciate

Answer: A

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15) An increase in the foreign 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

Answer: D

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________ and the domestic currency to ________, everything else held constant.

A) right; appreciate

B) right; depreciate

C) left; appreciate

D) left; depreciate

Answer: D

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17) A decrease in the foreign 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

Answer: A

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18) A decrease in the foreign 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

Answer: A

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19) ________ in the foreign interest rate causes the demand for domestic assets to increase and the domestic currency to ________, everything else held constant.

A) An increase; appreciate

B) An increase; depreciate

C) A decrease; appreciate

D) A decrease; depreciate

Answer: C

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20) ________ in the foreign interest rate causes the demand for domestic assets to shift to the right and the domestic currency to ________, everything else held constant.

A) An increase; appreciate

B) An increase; depreciate

C) A decrease; appreciate

D) A decrease; depreciate

Answer: C

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domestic currency to ________, everything else held constant.

A) An increase; appreciate

B) An increase; depreciate

C) A decrease; appreciate

D) A decrease; depreciate

Answer: B

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22) ________ in the foreign interest rate causes the demand for domestic assets to shift to the left and the domestic currency to ________, everything else held constant.

A) An increase; appreciate

B) An increase; depreciate

C) A decrease; appreciate

D) A decrease; depreciate

Answer: B

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23) ________ in the foreign 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

Answer: C

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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.

A) An increase; right

B) An increase; left

C) A decrease; right

D) A decrease; left

Answer: C

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25) ________ in the foreign interest rate causes the demand for domestic assets to ________ and the domestic currency to depreciate, everything else held constant.

A) An increase; increase

B) An increase; decrease

C) A decrease; increase

D) A decrease; decrease

Answer: B

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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.

A) An increase; right

B) An increase; left

C) A decrease; right

D) A decrease; left

Answer: B

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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 ________.

A) increase; appreciate

B) decrease; appreciate

C) increase; depreciate

D) decrease; depreciate

Answer: A

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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 ________.

A) increase; appreciate

B) increase; depreciate

C) decrease; appreciate

D) decrease; depreciate

Answer: D

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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.

A) increase; appreciate

B) increase; depreciate

C) decrease; appreciate

D) decrease; depreciate

Answer: A

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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.

A) right; appreciate

B) right; depreciate

C) left; appreciate

D) left; depreciate

Answer: A

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31) A decrease in the expected future domestic exchange rate causes the demand for domestic