Chap 5-6 Review

Assume a two-country world: Country A and Country B. Which of the following is correct about purchasing power parity (PPP) as related to these two countries?

• If Country A's inflation rate exceeds Country B's inflation rate, Country A's currency will weaken.

• If Country A's interest rate exceeds Country B's inflation rate, Country A's currency will weaken.

• If Country A's interest rate exceeds Country B's inflation rate, Country A's currency will strengthen.

• If Country B's inflation rate exceeds Country A's inflation rate, Country A's currency will weaken.

Given a home country and a foreign country, purchasing power parity (PPP) suggests that:

• a home currency will depreciate if the current home inflation rate exceeds the current foreign interest rate.

• a home currency will appreciate if the current home interest rate exceeds the current foreign interest rate.

• a home currency will appreciate if the current home inflation rate exceeds the current foreign inflation rate.

• a home currency will depreciate if the current home inflation rate exceeds the current foreign inflation rate.

The international Fisher effect (IFE) suggests that:

• a home currency will appreciate if the current home inflation rate exceeds the current foreign inflation rate.

• a home currency will depreciate if the current home interest rate exceeds the current foreign interest rate.

• a home currency will appreciate if the current home interest rate exceeds the current foreign interest rate.

• a home currency will depreciate if the current home inflation rate exceeds the current foreign inflation rate.

Because there are sometimes no substitutes for traded goods, this will:

• reduce the probability that PPP shall hold.

• increase the probability that PPP shall hold.

• increase the probability the IFE will hold.

• B and C

Because there are a variety of factors in addition to inflation that affect exchange rates, this will:

• reduce the probability that PPP shall hold.

• increase the probability that PPP shall hold.

• increase the probability the IFE will hold.

• B and C

According to the IFE, if British interest rates exceed U.S. interest rates:

• the British pound's value will remain constant.

• the British pound will depreciate against the dollar.

• the British inflation rate will decrease.

• the forward rate of the British pound will contain a premium.

Given a home country and a foreign country, the international Fisher effect (IFE) suggests that:

• the nominal interest rates of both countries are the same.

• the inflation rates of both countries are the same.

• the exchange rates of both countries will move in a similar direction against other currencies.

• none of the above

Given a home country and a foreign country, purchasing power parity suggests that:

• the inflation rates of both countries will be the same.

• the nominal interest rates of both countries will be the same.

• A and B

• none of the above

If interest rates on the euro are consistently below U.S. interest rates, then for the international Fisher effect (IFE) to hold:

• the value of the euro would often appreciate against the dollar.

• the value of the euro would often depreciate against the dollar.

• the value of the euro would remain constant most of the time.

• the value of the euro would appreciate in some periods and depreciate in other periods, but on average have a zero rate of appreciation.

If the international Fisher effect (IFE) did not hold based on historical data, then this suggests that:

• some corporations with excess cash can lock in a guaranteed higher return on future foreign short-term investments.

• some corporations with excess cash could have generated profits on average from covered interest arbitrage.

• some corporations with excess cash could have generated higher profits on average from foreign short-term investments than from domestic short-term investments.

• most corporations that consistently invest in foreign short-term investments would have generated the same profits (on average) as from domestic short-term investments.