Financial Markets Chapter 14

Trades in the foreign exchange market consist of transactions in excess of

$1 million

The foreign exchange market

-is organized as an over-the-counter market in which several hundred dealers stand ready to buy and sell deposits denominated in foreign currencies -is very competitive -functions no differently from a centralized market

The theory of purchasing power parity cannot fully explain exchange rate movements because

-not all goods are identical in different countries -some goods are not traded between countries

In the long run, ________ affect the exchange rate

-relative price levels -tariffs and quotas -productivity

Quotas are NOT

-restrictions placed on the quality of foreign goods that can be imported -fees placed on imported goods -restrictions placed on the quantity of foreign goods that can be exported

If the dollar appreciates from 0.8 euros per dollar to 1.2 euros per dollar, the euro depreciates from ________ dollars to ________ dollars per euro

1.25; 0.83

Foreign exchange transactions in the United States each year are well over ________ times greater than the amount of U.S. exports and imports

25

Which of the following causes a depreciation of the domestic currency?

A decline in the domestic real interest rate

Which of the following causes an appreciation of the domestic currency?

A lower domestic interest rate due to a lower expected inflation rate.

As the relative expected return on dollar deposits increases,

Americans will want to hold more dollar deposits and less foreign deposits

If the dollar appreciates relative to the Swiss franc,

Swiss chocolate will become cheaper in the United States.

When the exchange rate for the euro changes from $1.00 to $1.20, then, holding everything else constant, the euro has

appreciated and German cars sold in the United States become more expensive.

When the exchange rate changes from 1.0 euros to the dollar to 0.8 euros to the dollar, the euro has ________ and the dollar has ________

appreciated; depreciated

From 1973 through 2016, the rise in the British price level relative to the U.S. price level is ________ with a rise in the value of the dollar. Over shorter periods, the PPP relationship ________ appear to hold

associated; does not

If the dollar depreciates relative to the Swiss franc,

both Swiss chocolate will become more expensive in the United States and American computers will become less expensive in Switzerland will happen.

Over short periods, the ________ has a much greater role in exchange rate determination than does ________

decision to hold domestic or foreign assets; the demand for exports and imports

With the start of the subprime financial crisis in August 2007, the dollar ________ in value against the euro as the Fed lowered interest rates. By December of 2008, with the financial crisis spreading throughout Europe, foreign central banks cut their interest rates, leading to a ________ in the value of the dollar relative to the euro

declined; rise

In the long run, a rise in a country's price level (relative to the foreign price level) causes its currency to ________, while a rise in the country's relative productivity causes its currency to ________

depreciate; appreciate

When the exchange rate for the euro changes from $1.20 to $1.00, then, holding everything else constant, the euro has

depreciated and American wheat sold in Germany becomes more expensive.

When the exchange rate changes from 1.0 euros to the dollar to 1.2 euros to the dollar, the euro has ________ and the dollar has ________

depreciated; appreciated

When the value of the British pound changes from $1.50 to $1.25, the pound has ________ and the dollar has ________

depreciated; appreciated

When the value of the dollar changes from £0.50 to £0.75, the pound has ________ and the dollar has ________

depreciated; appreciated

If the dollar ________ from 1.2 euros per dollar to 0.8 euros per dollar, the euro ________ from 0.83 dollars to 1.25 dollars per euro

depreciates; appreciates

The purchasing power parity theory

does not take into account that many goods and services are not traded across borders

As the relative expected return on dollar deposits increases, foreigners will want to hold more ________ deposits and less ________ deposits

dollar; foreign

When Americans and foreigners expect the return on ________ deposits to be high relative to the return on ________ deposits, there is a higher demand for dollar deposits and a correspondingly lower demand for foreign deposits

dollar; foreign

If the demand for ________ goods decreases relative to ________ goods, the domestic currency will depreciate

domestic; foreign

A decrease in the domestic interest rate shifts the expected return schedule for ________ deposits to the ________ and causes the domestic currency to depreciate

domestic; left

An increase in the domestic interest rate shifts the expected return schedule for ________ deposits to the ________ and causes the domestic currency to appreciate

domestic; right

The more modern asset market approach to exchange rate determination

emphasizes stocks of assets

Increased demand for a country's ________ causes its currency to appreciate in the long run, while increased demand for ________ causes its currency to depreciate

exports; imports

If the 2015 inflation rate in Britain is 6 percent, and the inflation rate in the U.S. is 4 percent, then the theory of purchasing power parity predicts that, during 2015, the value of the British pound in terms of U.S. dollars will

fall by 2 percent

In the short run, the quantity of dollars supplied (deposits, bonds, equities) is

fixed with respect to the exchange rate

A decrease in the foreign interest rate shifts the expected return schedule for ________ deposits to the ________ and causes the domestic currency to appreciate

foreign; left

A rise in the expected future exchange rate shifts the expected return schedule for ________ deposits to the ________ and causes the domestic currency to appreciate

foreign; left

A fall in the expected future exchange rate shifts the expected return schedule for ________ deposits to the ________ and causes the domestic currency to depreciate

foreign; right

An increase in the foreign interest rate shifts the expected return schedule for ________ deposits to the ________ and causes the domestic currency to depreciate

foreign; right

When Americans and foreigners expect the return on dollar deposits to be high relative to the return on foreign deposits, there is a ________ demand for dollar deposits and a correspondingly ________ demand for foreign deposits

higher; lower

A spot transaction in the foreign exchange market involves the

immediate (within two days) exchange of bank deposits

An increase in which factor will cause domestic currency depreciation?

import demand

Forward exchange rates

involve the exchange of bank deposits at some specified future date

Evidence from the United States during the period 1973-2016 indicates the correspondence between nominal interest rates and exchange rate movements is

not nearly as close as that between real interest rates and exchange rate movements

If a U.S. traveler needs foreign currency for a trip abroad, she would buy the currency in the ________ market from a dealer such as American Express

retail

The theory of purchasing power parity cannot fully explain exchange rate movements because

some goods are not traded between countries

American firms became less competitive compared to foreign firms during the 1980s because

the U.S. dollar became worth more in terms of foreign currencies.

The theory of asset demand suggests that the most important factor affecting the demand for domestic and foreign deposits is

the expected return on these assets relative to one another

The starting point for understanding how exchange rates are determined is a simple idea called ________, which states that 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

the law of one price

The theory of purchasing power parity is a theory of how exchange rates are determined in

the long run

The theory of purchasing power parity states that exchange rates between any two currencies will adjust to reflect changes in

the price levels of the two countries

The ________ states that exchange rates between any two currencies will adjust to reflect changes in the price levels of the two countries

theory of purchasing power parity