Practice Foreign Exchange FRQ Questions. The answer with explanation is on the slide after the question

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1 Practice Foreign Exchange FRQ Questions The answer with explanation is on the slide after the question

2 2009 FRQ Assume that as a result of increased political instability, investors move their funds out of the country of Tara. (a) How will this decision by investors affect the international value of Tara s currency on the foreign exchange market? Explain.

3 Answer to 2009 FRQ (a) 2 points: One point is earned for stating that Tara s currency will depreciate. One point is earned for explaining that capital flight increases the supply of and/or decreases the demand for Tara s currency in the foreign exchange market, thereby lowering the market equilibrium exchange rate.

4 2006 FRQ Assume the US trade with Japan, Draw a correctly labeled graph of the foreign exchange market for the US dollar. A. There is a Price Level increase for goods in the US show and explain how the supply of the US dollar will be affected in the foreign exchange market. B. Given your answer in part (d), indicated what will happen to the US dollar relative to the Japanese yen

5 Answer 2006 FRQ d. One point is earned for a correctly labeled graph One point is earned for explaining that the fall in real income will cause the demand for imports to decrease One point is earned for showing that the supply curve for dollars will shift to the left e. One point is earned for stating the US dollar will appreciate.

6 2006 B FRQ Assume that South Korea and Canada are trading partners. The equilibrium exchange rate between the Canadian dollar and the SK currency, the won, is shown on the graph of the foreign exchange market. a. Explain how each of the following will affect the demand for the Canadian dollar i. The inflation rate in Canada is higher than the inflation rate in SK ii. Real interest rates in Canada fall relative to real interest rates in SK b. Given your answer to part (a)(ii), indicate how the value of the Canadian dollar is affected. c. As a result of the currency change in part (b), what will happen to Canadian exports to SK? Explain.

7 2006 B FRQ a. 4 points One point is earned for stating that the demand for Canadian dollars will decrease. One point is earned for explaining that Korean demand for Canadian goods will decrease One point is earned for stating that demand for Canadian dollars will fall One point is earned for explaining that Korean demand for Canadian financial assets will decrease. b. 1 point One point is earned for concluding that Canadian dollars will depreciate c. 2 points One point is earned for stating that Canadian exports to Korea will increase One point is earned for explaining that Koreans will find Canadian goods relatively cheaper

8 2000 FRQ Assume that there is an increase in the US demand for French Goods. Explain how the change in demand will affect each of the following. The supply of dollars The international value of the dollar Assume that there is an increase in real interest rates in the US, but not in France. Explain how this increase in interest rates will affect each of the following. The international value of the dollar in the foreign exchange market The quantity of dollars supplied in the foreign exchange market

9 2000 FRQ Answer - supply of dollars increases to buy French goods/ or French Francs (money) - Depreciation of the dollar - Demand for US dollar increases and dollar appreciates - Quantity supplied of dollars increases

10 2002 FRQ Country X has a flexible exchange rate and international capital mobility. Political turmoil outside of country X generates capital flow into Country X Using a correctly labeled foreign-exchange market graph, explain the impact of the capital inflow on the international value of the currency of Country X For Country X, explain the effect of the change in the international value of its currency on each of the following: Exports Imports

11 2002 B FRQ Answer 1 point: correct foreign exchange market graph 1 point: outward shift in the demand for Country X s currency or inward shift in the supply of Country X s currency 1 point: Country X s currency will appreciate because of the increased demand for (or decreased supply of) its currency (b) 1 for the direction of imports and exports, and 1 for an explanation that recognizes relative price differences) 1 point: Country X s imports will increase 1 point: Country X s exports will decrease 1 point: explanation of why imports or exports change that refers to relative price differences. Note: one explanation is sufficient for full credit.

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