Name: Date: Use the following to answer questions 3-4:

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1 Name: Date: 1. A country becomes less competitive in the international market if A) the nominal exchange rate of its currency appreciates. B) the nominal exchange rate of its currency depreciates. C) the real exchange rate of its currency appreciates. D) the real exchange rate of its currency depreciates. 2. If the interest rate on one-year US bond is 6 percent, the current exchange rate is 1.20 C$/US$, and you expect the exchange rate to be 1.22 C$/US$, then the return from investing in the US bond is approximately A) 8 percent. B) 10 percent. C) 6 percent. D) 4 percent. Use the following to answer questions 3-4: 3. If the exchange rate in Figure 8.2 is $1.35, then to re-establish equilibrium, the Bank of Canada could US dollars, its reserve of foreign exchange. A) sell; increasing B) buy; increasing C) sell; decreasing D) buy; decreasing Page 1

2 4. Figure 8.2 shows the supply and demand curves for foreign exchange (C$ per US$). The Canadian dollar is overvalued when the exchange rate is A) $1.55 B) $1.45 C) $1.35 D) $ The typical reason for the central bank intervention in foreign exchange markets is A) to prevent the erosion of foreign exchange reserves of the country. B) to prevent the depreciation of the domestic currency against foreign currency. C) to prevent illegal use of foreign exchange. D) to prevent excessive volatility in the foreign exchange rate. 6. Suppose that the exchange rate of the Canadian dollar is 1.20 C$/US$, that the yield on a one-year Canadian bond is 6 percent and that the yield on a one-year US bond is 5 percent. According to the covered interest arbitrage, the one-year implicit forward rate is approximately A) Cdn$/US$. B) Cdn$/US$. C) Cdn$/US$. D) Cdn$/US$. 7. Which of the following are not recorded in the capital account of the balance of payments? A) Interest payments on foreign debt. B) Inflows of foreign direct investment. C) Outflows of foreign direct investments. D) Purchase of foreign securities. 8. The Canadian dollar has been undervalued in the recent past. This may have been responsible for A) the decrease in foreign exchange reserves in recent years. B) the excess demand for Canadian dollar in foreign exchange markets. C) the increase in foreign exchange reserves in recent years. D) the increase in the demand for imports from the US. Page 2

3 9. Consider the model of an open mixed economy (i.e., an economy with household, business, government and external sectors). Assume that the savings and gross investment are equal. Which of the following is true if the economy has an external deficit of $500 million. A) the government has a budget surplus larger than $500 million. B) the government has a budget deficit larger than $500 million C) the government has a budget deficit of $500 million. D) the government has no budget deficit or budget surplus. 10. While traveling in the United States, you purchase a watch priced at US$175. If the current exchange rate is $1.20 Canadian/US$, what is the cost to you in Canadian currency? A) $210 B) $146. C) $195. D) $ According to the equation of the real exchange rate, if Canadian prices vis-à-vis US prices, this will cause of the Canadian dollar. A) rise; an appreciation. B) rise; a depreciation. C) fall; an appreciation. D) B) and C). Page 3

4 Use the following to answer question 12: The curves Rus and Rc represent the returns to be earned as functions of the spot exchange rate (the Canadian dollar price of a dollar US). 12. In Figure 8.4 an increase in the Canadian interest rate would A) shift the curve Rc upward and raise the exchange rate. B) shift the curve Rc upward and lower the exchange rate. C) shift the curve Rus upward and raise the exchange rate. D) shift the curve Rus upward and lower the exchange rate. 13. If the interest rate on a one-year U.S. bond is 6 percent, the interest rate on a Canadian bond is 5 percent, and the current exchange rate is 1.20 C$/US$, then, according to the uncovered interest rate parity, the expected future exchange rate one- year ahead is roughly A) C$/US$. B) C$/US$. C) C$/US$. D) C$/US$. Page 4

5 14. The concept of 'twin deficits' is explained by the fact that A) an increase in government sector deficits cause interest rates to fall, the country's currency to depreciate and the trade and current account balances to worsen. B) an increase in government sector deficits cause interest rates to rise, the country's currency to appreciate and the trade and current account balances to worsen. C) an increase in government sector deficits cause interest rates to rise, the country's currency to depreciate and the trade and current account balances to worsen. D) an increase in government sector deficits cause interest rates to fall, the country's currency to appreciate and the trade and current account balances to improve. Use the following to answer question 15: 15. In Figure 8.1, the shifts in the demand and supply curves from D 0 to D 1 and S 0 and S 1, respectively can be explained by A) an appreciation of the Canadian dollar thus making it cheaper to buy US goods. B) a depreciation of the Canadian dollar thus making it cheaper to buy US goods. C) a fall in Canadian interest rates will lead Americans to purchase more Canadian dollars. D) a rise in Canadian interest rates will lead Americans to purchase more Canadian dollars. Page 5

6 Answer Key 1. C 2. A 3. C 4. C 5. D 6. B 7. A 8. C 9. C 10. A 11. D 12. B 13. D 14. B 15. B Page 6