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1 Chapter 11 The International Monetary System True / False Questions 1. The international monetary system refers to the institutional arrangements that govern exchange rates. True False 2. A pegged exchange rate means the value of a currency is fixed relative to a reference currency. True False 3. A dirty float occurs when a country uses pegged exchange rates to value its currency. True False 4. The gold standard called for fixed exchange rates against the U.S. dollar. True False

2 5. The amount of a currency needed to purchase one ounce of gold was referred to as the gold par value under the gold standard. True False 6. A country is said to be in balance-of-trade equilibrium when it produces all the goods needed for domestic consumption. True False 7. The agreement reached at Bretton Woods established the International Monetary Fund (IMF) and the World Bank. True False 8. Implementing a fixed exchange rate regime increases the price inflation in countries. True False 9. World Bank offers low-interest loans to risky customers whose credit rating is often poor. True False

3 10. IDA loans receive direct funding from the World Bank. True False 11. The fixed exchange rate system established at Bretton Woods failed due to speculative pressures on the U.S. dollar. True False 12. Gold was declared as the formal reserve asset in the Jamaica agreement of True False 13. IMF members were permitted to sell their own gold reserves at the market price in the Jamaica agreement. True False 14. The value of U.S dollar increased between 1980 and 1985 despite running a growing trade deficit. True False

4 15. The rise in the value of the dollar gave U.S goods a competitive advantage over others between 1985 and True False 16. Market forces have produced a stable dollar exchange rate under a floating exchange rate regime. True False 17. Advocates of a floating exchange rate regime argue that removal of the obligation to maintain exchange rate parity would restore monetary control to a government. True False 18. The monetary autonomy argument is supported by the advocates of fixed exchange rates. True False 19. Fixed exchange rates lead to speculation and uncertainty in the value of currencies. True False

5 20. Supporters of floating exchange rates claim that trade deficits are determined by the balance between savings and investment in a country. True False 21. Exchange rates are determined by the government under a pure "free float" system. True False 22. A country valuates its currency without attaching it to a reference currency under the pegged exchange rate regime. True False 23. The great virtue claimed for a pegged exchange rate is that it imposes monetary discipline on a country and leads to low inflation. True False 24. Adopting a pegged exchange rate regime increases the inflationary pressures in a country. True False

6 25. A country that introduces a currency board commits itself to converting its domestic currency on demand into another currency at a fixed exchange rate. True False 26. A currency board system limits the ability of the government to print money and, thereby, create inflationary pressures. True False 27. Interest rates adjust automatically under a strict currency board system. True False 28. Currencies of countries with currency boards will become uncompetitive and overvalued if local inflation rates are lower than the inflation rate in the country to which the currency is pegged. True False 29. The IMF's original function was to provide a pool of money from which members could borrow in the short term. True False

7 30. A currency crisis occurs when investors lose confidence in a country's banking system. True False 31. A foreign debt crisis is a situation in which a country cannot service its foreign debt obligations. True False 32. The IMF made pegging Mexican peso to the dollar, a condition for lending money to the Mexican government in the 1980s. True False 33. Government projects were a factor behind the investment boom in most Southeast Asian economies. True False 34. The quality of investments declined significantly in the Asian countries during the 1990s. True False

8 35. In the 1990s, most of the borrowing by the companies who invested in Asian countries had been in local currencies. True False 36. Most of the loans issued by the IMF are unconditional loans. True False 37. Moral hazard arises when people behave recklessly because they know they will be saved if things go wrong. True False 38. The Asian economic crisis was caused by high inflation rates. True False 39. The current system of foreign exchange is a mixed system of government intervention and speculative activity. True False 40. Firms should not utilize the forward exchange market when they are faced with uncertainty about the future value of currencies. True False

9 Multiple Choice Questions 41. The international monetary system refers to the institutional arrangements that govern. A. microeconomic parameters B. exchange rates C. gross domestic produce D. foreign direct investment 42. When the foreign exchange market determines the relative value of a currency, we say that the country is adhering to a regime. A. currency board exchange B. pegged exchange rate C. fixed exchange rate D. floating exchange rate

10 43. A pegged exchange rate means that the value of a currency is. A. fixed against other currencies based on an agreement B. not determined by free market forces C. fixed relative to a reference currency D. independent of the valuations of other currencies 44. A dirty float refers to a situation in which. A. a set of currencies are fixed against each other at some mutually agreed on exchange rate B. many countries join hands to form a monetary system and an exchange rate C. more than one foreign currency is used as the formal reference for a country's currency D. a country tries to hold its currency against an important reference currency without a formal pegged rate

11 45. After World War II, world's major industrial nations arranged their currencies against each other at a mutually agreed on exchange rate. This is an example of a system. A. fixed exchange rate B. dirty float exchange C. pegged exchange rate D. floating exchange rate 46. Which of the following statements is true of the Gold standard? A. Gold standard was adopted only by the smaller nations of the world. B. Currencies were pegged to gold under the gold standard. C. Convertibility to gold was not guaranteed under the gold standard. D. Gold standard was not helpful in maintaining balance-of-trade equilibrium. 47. Gold par value refers to the. A. ratio of price of gold in a currency to price of gold in U.S. dollars B. amount of a currency needed to purchase one ounce of gold C. ratio of price of gold in a currency to price of gold in euros D. amount of gold required to equal the reference currency that a nation is using

12 48. A country is said to be in balance-of-trade equilibrium when. A. it has the potential to produce all goods that its residents want without engaging in foreign trade B. the income its residents earn from exports is equal to the money its residents pay for imports C. the country import all goods that its residents want by engaging in foreign trade D. it has the potential to balance the production and procurement of the basic amenities that it needs 49. A country's trade balance is in surplus when A. its exports are more than its imports B. it experiences negative inflation C. its exports equal the imports D. the prices of commodities are low in the country

13 50. Which of the following is an advantage of using the gold standard? A. The standard makes sure that goods are not priced out from markets due to inflation. B. The standard does not require a commitment from nations to maintain its currency's value. C. The standard effectively prevents the devaluation of currencies across the world. D. It contains a powerful mechanism for achieving balance-of-trade equilibrium by all countries. 51. The agreement reached at Bretton Woods established. A. International Monetary Fund B. World Economic Forum C. United Nations D. International Atomic Energy Agency

14 52. Which of the following observations is true of the Bretton Woods agreement? A. All countries agreed to fix the value of their currency in terms of gold under the agreement. B. The system accepted Pound as the official reference currency against gold. C. The agreement established a floating system of monetary exchange. D. Two multinational institutions, World Economic Forum and WTO, were formed under the agreement. 53. The World Bank was established at the at Bretton Woods conference to. A. establish an international monetary system B. promote general economic development C. establish gold standard across the world D. fund the initiatives of the United Nations 54. Identify the currency that was convertible to gold under the Bretton Woods system. A. Pound B. Yen C. Euro D. Dollar

15 55. What will happen if a country increases its money supply rapidly under fixed exchange rate regime? A. Imports will become less attractive in that country. B. The country will face negative inflation. C. Trade deficit would widen in that country. D. The country's products will become more attractive in world markets. 56. Which of the following is a disadvantage of using a rigid policy of fixed exchange rates? A. It is likely to create high unemployment in some cases. B. It will lead to inflationary economies across the world. C. It is likely to bring about trade wars between nations. D. It will instigate competitive devaluations and intense competition. 57. Which of the following is a function of World Bank? A. Implementing a rigid fixed exchange rate regime B. Promoting gold standard across the world C. Lending money to governments for development D. Implementing a flexible fixed exchange rate regime

16 58. Which of the following is a factor that initiated the collapse of the fixed exchange rate system? A. Worsening of Great Britain's balance of trade B. Recession in third world countries C. Price inflation in Europe D. Worsening of U.S. foreign trade position 59. Which of the following changes were made to IMF's Articles of Agreement in the Jamaica agreement? A. IMF members were permitted to use Dollar as the convertible currency. B. Gold was declared as a formal reserve asset for IMF members. C. IMF members were permitted to sell their gold reserves at the market price. D. IMF members were restricted from entering the foreign exchange market. 60. exchange rates were declared as acceptable in the Jamaica agreement of IMF. A. Pegged B. Fixed C. Floating D. Gold standard

17 61. United States had large and growing trade deficit between 1980 and Despite this, the value of U.S. dollar rose during this period. Which of the following is a factor that caused this occurrence? A. United States attracted heavy inflows of capital from foreign investors during this period. B. Banks in the United States offered low interest rates to investors during this period. C. Markets across the world witnessed strong economies during this period. D. Developed countries in Europe maintained trade equilibrium and supplied goods to underdeveloped countries. 62. Which of the following is the reason why the current foreign-exchange system is sometimes thought of as a managed-float system? A. The exchange rates of a currency are determined by market forces. B. Governments intervene frequently in the foreign exchange market. C. Major currencies are allowed to freely float against each other. D. Countries use a reference currency to estimate the value of their currencies.

18 63. Which of the following arguments is in favor of floating exchange rates? A. A country's ability to expand or contract its money supply should be limited by the need to maintain exchange rate parity. B. Maintaining balance of trade equilibrium is not in the best interest of a country. C. Countries can isolate themselves from uncertainties when they trade using a mutually agreed on exchange rate. D. Governments can restore monetary control by removing the obligation to maintain exchange rate parity. 64. The monetary autonomy argument holds that. A. each country should be allowed to choose its own inflation rate B. inflation is beneficial to a country's economy and growth C. inflation is detrimental to a country's economy and growth D. countries should restrict inflation based on the global standards 65. Which of the following arguments is against the use of fixed exchange rates? A. Monetary discipline is the most important determinant of a strong economy. B. Each country has the freedom to choose its own inflation rate. C. Market speculation can cause fluctuations in exchange rates. D. Governments are likely to expand the monetary supply far too rapidly due to political pressures.

19 66. Which of the following arguments strengthen the idea of floating exchange rates? A. External agencies should not interfere in the monetary policies of a country. B. Trade deficits can be corrected through changes in exchange rates. C. Changes in exchange rates will not impact the trade balance in a country. D. Governments should act in ways to minimize the uncertainty in monetary markets. 67. Those in favor of floating exchange rate claim that. A. uncertainty in monetary markets dampens the growth of international trade B. inflation is beneficial to a country if it is controlled closely C. trade imbalances can be adjusted by using floating exchange rates D. governments can have rigid control over monetary markets by using floating rates 68. Which of the following is an exchange rate policy where the exchange rate is determined completely by market forces? A. Managed float B. Fixed peg C. Free float D. Currency board

20 69. Which of the following is the exchange rate policy where the government intervenes in the exchange rate system only in a limited way? A. Managed float B. Fixed peg C. Free float D. Currency board 70. Under a exchange rate regime, a country will attach the value of its currency to that of a major currency. A. managed float B. pegged C. free float D. currency board

21 71. Which of the following statements is true of pegged exchange rates? A. A pegged exchange rate allows a country's currency to be determined by market forces. B. A pegged exchange rate weakens the monetary discipline of a country. C. Pegged exchange rates are popular among many of the world's smaller nations. D. Adopting a pegged exchange rate regime increases inflationary pressures in a country. 72. A country that introduces a currency board commits itself to converting its domestic currency on demand into. A. another currency at a fixed exchange rate B. gold or silver at a fixed exchange rate C. gold or silver at a floating exchange rate D. another currency at a floating exchange rate 73. Under a currency board system,. A. inflation rates are maintained at high level B. countries issue domestic notes at will C. interest rates remain constant D. government lacks the ability to set interest rates

22 74. A currency crisis occurs due to. A. the loss of confidence in a country's banking system B. heavy foreign debt obligations C. high levels of trade deficit D. a speculative attack on the exchange value 75. Moral hazard arises when people behave recklessly because. A. of the restrictions that exist in a country's monetary policy B. of the restrictions that IMF has imposed on them C. they know they will be saved if things go wrong D. they face financial difficulties arising out of external factors 76. Which of the following is a common criticism against IMF? A. IMF lacks any real mechanism for accountability. B. It is hesitant to help banks when they are in crisis. C. IMF has not intervened to resolve the Asian crisis. D. It did not try to resolve the Mexican currency crisis.

23 77. Which of the following observations is true of the current system of foreign exchange market? A. Most of the currencies can be converted to gold in the current system of foreign exchange. B. The current system is driven by fixed exchange rates. C. Currencies float freely against others in the current system. D. The current system is a combination of government intervention and speculative activity. 78. Which of the following will help a company hedge against currency fluctuations? A. Finding a large supplier to supply all the raw materials B. In-house manufacturing of raw materials C. Basing business in a single country D. Dispersing production to different geographic locations 79. Contracting out manufacturing allows companies to reduce economic exposure because. A. having multiple suppliers attracts subsidies from government B. it reduces the pressure on them to maintain a trade surplus C. it allows companies to shift suppliers from country to country D. quality issues are insignificant when manufacturing is contracted to others

24 80. Increasingly the has been acting as macroeconomic police of the world economy, insisting that countries seeking significant borrowings adopt certain macroeconomic policies. A. ECOSOC B. IMF C. UN D. World Bank Essay Questions 81. What is international monetary system? What are the major trading currencies?

25 82. Explain the floating exchange rate regime. Give examples. 83. Compare and contrast a pegged exchange system with a dirty float system of exchange rates. 84. How does a fixed exchange rate system work?

26 85. What is gold standard? What was the major advantage of the system? 86. With the help of an example, explain how balance-of-trade equilibrium is maintained under the gold standard.

27 87. What is the Bretton Woods agreement? How was it different from the gold standard? 88. Identify the multinational institutions that were established at the Bretton Woods agreement. What were their roles in the international monetary system?

28 89. Explain the events that led to the failure of the Bretton Woods system. 90. Discuss the significance of the Jamaica Agreement. 91. Discuss the arguments that favor a floating exchange rate system against a fixed exchange rate system.

29 92. Present the common arguments that favor fixed exchange rates. 93. Describe the different exchange rate policies that are in practice today. 94. Discuss the pegged exchange rate regime.

30 95. What is a currency board? Why do countries choose this type of system? What are the disadvantages of this type of arrangement? 96. Compare currency crisis, banking crisis, and foreign debt crisis. 97. Recent policies of the IMF have drawn a lot of criticism. Discuss these criticisms.

31 98. Discuss the criticism that IMF is exacerbating a problem called moral hazard. 99. How can international companies reduce their economic exposure in a world of constantly fluctuating exchange rates?

32 100. Do you think businesses can influence government policies? Explain your answer.

33 Chapter 11 The International Monetary System Answer Key True / False Questions 1. The international monetary system refers to the institutional arrangements that govern exchange rates. TRUE The international monetary system refers to the institutional arrangements that govern exchange rates. Learning Objective: Describe the historical development of the modern global monetary system. Topic: Introduction

34 2. A pegged exchange rate means the value of a currency is fixed relative to a reference currency. TRUE A pegged exchange rate means the value of the currency is fixed relative to a reference currency, such as the U.S. dollar, and then the exchange rate between that currency and other currencies is determined by the reference currency exchange rate. Learning Objective: Describe the historical development of the modern global monetary system. Topic: Introduction 3. A dirty float occurs when a country uses pegged exchange rates to value its currency. FALSE Countries, while not adopting a formal pegged rate, try to hold the value of their currency within some range against an important reference currency such as the U.S. dollar, or a "basket" of currencies. This is often referred to as a dirty float. Learning Objective: Describe the historical development of the modern global monetary system.

35 Topic: Introduction 4. The gold standard called for fixed exchange rates against the U.S. dollar. FALSE Pegging currencies to gold and guaranteeing convertibility is known as the gold standard. By 1880, most of the world's major trading nations, including Great Britain, Germany, Japan, and the United States, had adopted the gold standard. Learning Objective: Describe the historical development of the modern global monetary system. Topic: The Gold Standard 5. The amount of a currency needed to purchase one ounce of gold was referred to as the gold par value under the gold standard. TRUE Under the gold standard, the amount of a currency needed to purchase one ounce of gold was referred to as the gold par value. Learning Objective: Describe the historical development of the modern global monetary system. Topic: The Gold Standard

36 6. A country is said to be in balance-of-trade equilibrium when it produces all the goods needed for domestic consumption. FALSE A country is said to be in balance-of-trade equilibrium when the income its residents earn from exports is equal to the money its residents pay to other countries for imports (the current account of its balance of payments is in balance). Learning Objective: Describe the historical development of the modern global monetary system. Topic: The Gold Standard 7. The agreement reached at Bretton Woods established the International Monetary Fund (IMF) and the World Bank. TRUE The agreement reached at Bretton Woods established two multinational institutions the International Monetary Fund (IMF) and the World Bank. Learning Objective: Explain the role played by the World Bank and the IMF in the international monetary system. Topic: The Bretton Woods System

37 8. Implementing a fixed exchange rate regime increases the price inflation in countries. FALSE A fixed exchange rate regime imposes monetary discipline on countries, thereby curtailing price inflation. Learning Objective: Explain the role played by the World Bank and the IMF in the international monetary system. Topic: The Bretton Woods System 9. World Bank offers low-interest loans to risky customers whose credit rating is often poor. TRUE World Bank offers low-interest loans to risky customers whose credit rating is often poor, such as the governments of underdeveloped nations. Learning Objective: Explain the role played by the World Bank and the IMF in the international monetary system. Topic: The Bretton Woods System

38 10. IDA loans receive direct funding from the World Bank. FALSE One of the funding schemes of the World Bank is overseen by the International Development Association (IDA), an arm of the bank created in Resources to fund IDA loans are raised through subscriptions from wealthy members such as the United States, Japan, and Germany. Learning Objective: Explain the role played by the World Bank and the IMF in the international monetary system. Topic: The Bretton Woods System 11. The fixed exchange rate system established at Bretton Woods failed due to speculative pressures on the U.S. dollar. TRUE U.S. dollar was the only currency that could be converted into gold in the fixed exchange rate system established at Bretton Woods. As the currency that served as the reference point for all others, the dollar occupied a central place in the system. The system failed when its key currency U.S. dollar faced speculative pressure. Blooms: Understand Difficulty: 2 Medium Learning Objective: Describe the historical development of the modern global monetary system.

39 Topic: The Collapse of the Fixed Exchange Rate System 12. Gold was declared as the formal reserve asset in the Jamaica agreement of FALSE In the Jamaica agreement, gold was abandoned as a reserve asset. The IMF returned its gold reserves to members at the current market price, placing the proceeds in a trust fund to help poor nations. Learning Objective: Describe the historical development of the modern global monetary system. Topic: The Floating Exchange Rate Regime 13. IMF members were permitted to sell their own gold reserves at the market price in the Jamaica agreement. TRUE In the Jamaica agreement, gold was abandoned as a reserve asset. IMF also permitted its members to sell their own gold reserves at the market price. Learning Objective: Describe the historical development of the modern global monetary system. Topic: The Floating Exchange Rate Regime

40 14. The value of U.S dollar increased between 1980 and 1985 despite running a growing trade deficit. TRUE The rise in the value of the dollar between 1980 and 1985 occurred when the United States was running a large and growing trade deficit, importing substantially more than it exported. A number of favorable factors overcame the unfavorable effect of a trade deficit. Learning Objective: Describe the historical development of the modern global monetary system. Topic: The Floating Exchange Rate Regime 15. The rise in the value of the dollar gave U.S goods a competitive advantage over others between 1985 and FALSE Rise in dollar will make U.S. goods less competitive. The rise in the dollar priced U.S. goods out of foreign markets and made imports relatively cheap. Learning Objective: Describe the historical development of the modern global monetary system. Topic: The Floating Exchange Rate Regime

41 16. Market forces have produced a stable dollar exchange rate under a floating exchange rate regime. FALSE Under a floating exchange rate regime, market forces have produced a volatile dollar exchange rate. Governments have sometimes responded by intervening in the market buying and selling dollars in an attempt to limit the market's volatility and to correct what they see as overvaluation or potential undervaluation of the dollar. Learning Objective: Describe the historical development of the modern global monetary system. Topic: The Floating Exchange Rate Regime 17. Advocates of a floating exchange rate regime argue that removal of the obligation to maintain exchange rate parity would restore monetary control to a government. TRUE Advocates of a floating exchange rate regime argue that removal of the obligation to maintain exchange rate parity would restore monetary control to a government. Blooms: Understand

42 Difficulty: 2 Medium Learning Objective: Compare and contrast the differences between a fixed and a floating exchange rate system. Topic: Fixed versus Floating Exchange Rates 18. The monetary autonomy argument is supported by the advocates of fixed exchange rates. FALSE Advocates of floating rates argue that each country should be allowed to choose its own inflation rate. This is called the monetary autonomy argument. Advocates of fixed rates argue against this. Learning Objective: Compare and contrast the differences between a fixed and a floating exchange rate system. Topic: Fixed versus Floating Exchange Rates 19. Fixed exchange rates lead to speculation and uncertainty in the value of currencies. FALSE Speculation can make exchange rates volatile in the floating exchange rate system. Speculation also adds to the uncertainty surrounding future currency movements that characterizes floating exchange rate regimes. A fixed exchange rate eliminates such uncertainty.

43 Blooms: Understand Difficulty: 2 Medium Learning Objective: Compare and contrast the differences between a fixed and a floating exchange rate system. Topic: Fixed versus Floating Exchange Rates 20. Supporters of floating exchange rates claim that trade deficits are determined by the balance between savings and investment in a country. FALSE Those in favor of floating exchange rates argue that floating rates help adjust trade imbalances. Critics of floating rates claim that trade deficits are determined by the balance between savings and investment in a country, not by the external value of its currency. Blooms: Understand Difficulty: 2 Medium Learning Objective: Compare and contrast the differences between a fixed and a floating exchange rate system. Topic: Fixed versus Floating Exchange Rates 21. Exchange rates are determined by the government under a pure "free float" system. FALSE Under a pure "free float" system, exchange rates are determined by market forces.

44 Learning Objective: Identify exchange rate regimes that are used in the world today and why countries adopt different exchange rate regimes. Topic: Exchange Rate Regimes in Practice 22. A country valuates its currency without attaching it to a reference currency under the pegged exchange rate regime. FALSE Under a pegged exchange rate regime, a country will peg the value of its currency to that of a major currency so that, for example, as the U.S. dollar rises in value, its own currency rises too. Learning Objective: Identify exchange rate regimes that are used in the world today and why countries adopt different exchange rate regimes. Topic: Exchange Rate Regimes in Practice 23. The great virtue claimed for a pegged exchange rate is that it imposes monetary discipline on a country and leads to low inflation. TRUE As with a full fixed exchange rate regime, the great virtue claimed for a pegged exchange rate is that it imposes monetary discipline on a country and leads to low inflation.

45 Blooms: Understand Difficulty: 2 Medium Learning Objective: Identify exchange rate regimes that are used in the world today and why countries adopt different exchange rate regimes. Topic: Exchange Rate Regimes in Practice 24. Adopting a pegged exchange rate regime increases the inflationary pressures in a country. FALSE Evidence shows that adopting a pegged exchange rate regime moderates inflationary pressures in a country. Blooms: Understand Difficulty: 2 Medium Learning Objective: Identify exchange rate regimes that are used in the world today and why countries adopt different exchange rate regimes. Topic: Exchange Rate Regimes in Practice

46 25. A country that introduces a currency board commits itself to converting its domestic currency on demand into another currency at a fixed exchange rate. TRUE A country that introduces a currency board commits itself to converting its domestic currency on demand into another currency at a fixed exchange rate. To make this commitment credible, the currency board holds reserves of foreign currency equal at the fixed exchange rate to at least 100 percent of the domestic currency issued. Learning Objective: Identify exchange rate regimes that are used in the world today and why countries adopt different exchange rate regimes. Topic: Exchange Rate Regimes in Practice 26. A currency board system limits the ability of the government to print money and, thereby, create inflationary pressures. TRUE The currency board can issue additional domestic notes and coins only when there are foreign exchange reserves to back it. This limits the ability of the government to print money and, thereby, create inflationary pressures. Blooms: Understand Difficulty: 2 Medium

47 Learning Objective: Identify exchange rate regimes that are used in the world today and why countries adopt different exchange rate regimes. Topic: Exchange Rate Regimes in Practice 27. Interest rates adjust automatically under a strict currency board system. TRUE Under a strict currency board system, interest rates adjust automatically. If investors want to switch out of domestic currency into, for example, U.S. dollars, the supply of domestic currency will shrink. This will cause interest rates to rise until it eventually becomes attractive for investors to hold the local currency again. Blooms: Understand Difficulty: 2 Medium Learning Objective: Identify exchange rate regimes that are used in the world today and why countries adopt different exchange rate regimes. Topic: Exchange Rate Regimes in Practice

48 28. Currencies of countries with currency boards will become uncompetitive and overvalued if local inflation rates are lower than the inflation rate in the country to which the currency is pegged. FALSE If local inflation rates remain higher than the inflation rate in the country to which the currency is pegged, the currencies of countries with currency boards can become uncompetitive and overvalued. Blooms: Understand Difficulty: 2 Medium Learning Objective: Identify exchange rate regimes that are used in the world today and why countries adopt different exchange rate regimes. Topic: Exchange Rate Regimes in Practice 29. The IMF's original function was to provide a pool of money from which members could borrow in the short term. TRUE The IMF's original function was to provide a pool of money from which members could borrow, short term, to adjust their balance-of-payments position and maintain their exchange rate. Learning Objective: Understand the debate surrounding the role of the IMF in the management of financial crises.

49 Topic: Crisis Management by the IMF 30. A currency crisis occurs when investors lose confidence in a country's banking system. FALSE A currency crisis occurs when a speculative attack on the exchange value of a currency results in a sharp depreciation in the value of the currency or forces authorities to expend large volumes of international currency reserves and sharply increase interest rates to defend the prevailing exchange rate. Blooms: Understand Difficulty: 2 Medium Learning Objective: Understand the debate surrounding the role of the IMF in the management of financial crises. Topic: Crisis Management by the IMF 31. A foreign debt crisis is a situation in which a country cannot service its foreign debt obligations. TRUE A foreign debt crisis is a situation in which a country cannot service its foreign debt obligations, whether private-sector or government debt. Learning Objective: Understand the debate surrounding the role of the IMF in the management of financial crises. Topic: Crisis Management by the IMF

50 32. The IMF made pegging Mexican peso to the dollar, a condition for lending money to the Mexican government in the 1980s. TRUE The Mexican peso had been pegged to the dollar since the early 1980s when the International Monetary Fund made it a condition for lending money to the Mexican government. Learning Objective: Understand the debate surrounding the role of the IMF in the management of financial crises. Topic: Crisis Management by the IMF 33. Government projects were a factor behind the investment boom in most Southeast Asian economies. TRUE An added factor behind the investment boom in most Southeast Asian economies was the government. In many cases, the governments had embarked on huge infrastructure projects. Learning Objective: Understand the debate surrounding the role of the IMF in the management of financial crises. Topic: Crisis Management by the IMF

51 34. The quality of investments declined significantly in the Asian countries during the 1990s. TRUE Volume of investments increased in the Asian countries during the 1990s. As the volume of investments ballooned, often at the bequest of national governments, the quality of many of these investments declined significantly. Learning Objective: Understand the debate surrounding the role of the IMF in the management of financial crises. Topic: Crisis Management by the IMF 35. In the 1990s, most of the borrowing by the companies who invested in Asian countries had been in local currencies. FALSE The companies that had made the investments in Asia, in 1990s, were under huge debt burdens and they were finding it difficult to service. Much of the borrowing had been in U.S. dollars, as opposed to local currencies. Learning Objective: Understand the debate surrounding the role of the IMF in the management of financial crises. Topic: Crisis Management by the IMF

52 36. Most of the loans issued by the IMF are unconditional loans. FALSE All IMF loan packages come with conditions attached. Until very recently, the IMF has insisted on a combination of tight macroeconomic policies, including cuts in public spending, higher interest rates, and tight monetary policy. Learning Objective: Understand the debate surrounding the role of the IMF in the management of financial crises. Topic: Crisis Management by the IMF 37. Moral hazard arises when people behave recklessly because they know they will be saved if things go wrong. TRUE Moral hazard arises when people behave recklessly because they know they will be saved if things go wrong. Learning Objective: Understand the debate surrounding the role of the IMF in the management of financial crises. Topic: Crisis Management by the IMF

53 38. The Asian economic crisis was caused by high inflation rates. FALSE The Asian economic crisis and the global financial of crisis were caused not by high inflation rates, but by excessive debt. Learning Objective: Understand the debate surrounding the role of the IMF in the management of financial crises. Topic: Crisis Management by the IMF 39. The current system of foreign exchange is a mixed system of government intervention and speculative activity. TRUE The current system of foreign exchange is a mixed system in which a combination of government intervention and speculative activity can drive the foreign exchange market. Learning Objective: Explain the implications of the global monetary system for currency management and business strategy. Topic: Implications for Managers

54 40. Firms should not utilize the forward exchange market when they are faced with uncertainty about the future value of currencies. FALSE Faced with uncertainty about the future value of currencies, firms can utilize the forward exchange market. Blooms: Understand Difficulty: 2 Medium Learning Objective: Explain the implications of the global monetary system for currency management and business strategy. Topic: Implications for Managers Multiple Choice Questions

55 41. The international monetary system refers to the institutional arrangements that govern. A. microeconomic parameters B. exchange rates C. gross domestic produce D. foreign direct investment The international monetary system refers to the institutional arrangements that govern exchange rates. Learning Objective: Describe the historical development of the modern global monetary system. Topic: Introduction

56 42. When the foreign exchange market determines the relative value of a currency, we say that the country is adhering to a regime. A. currency board exchange B. pegged exchange rate C. fixed exchange rate D. floating exchange rate When the foreign exchange market determines the relative value of a currency, we say that the country is adhering to a floating exchange rate regime. Four of the world's major trading currencies the U.S. dollar, the European Union's euro, the Japanese yen, and the British pound are all free to float against each other. Learning Objective: Describe the historical development of the modern global monetary system. Topic: Introduction

57 43. A pegged exchange rate means that the value of a currency is. A. fixed against other currencies based on an agreement B. not determined by free market forces C. fixed relative to a reference currency D. independent of the valuations of other currencies A pegged exchange rate means the value of the currency is fixed relative to a reference currency, such as the U.S. dollar, and then the exchange rate between that currency and other currencies is determined by the reference currency exchange rate. Learning Objective: Describe the historical development of the modern global monetary system. Topic: Introduction

58 44. A dirty float refers to a situation in which. A. a set of currencies are fixed against each other at some mutually agreed on exchange rate B. many countries join hands to form a monetary system and an exchange rate C. more than one foreign currency is used as the formal reference for a country's currency D. a country tries to hold its currency against an important reference currency without a formal pegged rate Countries, while not adopting a formal pegged rate, try to hold the value of their currency within some range against an important reference currency such as the U.S. dollar, or a "basket" of currencies. This is often referred to as a dirty float. Learning Objective: Describe the historical development of the modern global monetary system. Topic: Introduction

59 45. After World War II, world's major industrial nations arranged their currencies against each other at a mutually agreed on exchange rate. This is an example of a system. A. fixed exchange rate B. dirty float exchange C. pegged exchange rate D. floating exchange rate With a fixed exchange rate system, the values of a set of currencies are fixed against each other at some mutually agreed on exchange rate. Blooms: Apply Difficulty: 3 Hard Learning Objective: Describe the historical development of the modern global monetary system. Topic: Introduction

60 46. Which of the following statements is true of the Gold standard? A. Gold standard was adopted only by the smaller nations of the world. B. Currencies were pegged to gold under the gold standard. C. Convertibility to gold was not guaranteed under the gold standard. D. Gold standard was not helpful in maintaining balance-of-trade equilibrium. Pegging currencies to gold and guaranteeing convertibility is known as the gold standard. By 1880, most of the world's major trading nations, including Great Britain, Germany, Japan, and the United States, had adopted the gold standard. Blooms: Understand Difficulty: 2 Medium Learning Objective: Describe the historical development of the modern global monetary system. Topic: The Gold Standard

61 47. Gold par value refers to the. A. ratio of price of gold in a currency to price of gold in U.S. dollars B. amount of a currency needed to purchase one ounce of gold C. ratio of price of gold in a currency to price of gold in euros D. amount of gold required to equal the reference currency that a nation is using The amount of a currency needed to purchase one ounce of gold is referred to as the gold par value. Learning Objective: Describe the historical development of the modern global monetary system. Topic: The Gold Standard

62 48. A country is said to be in balance-of-trade equilibrium when. A. it has the potential to produce all goods that its residents want without engaging in foreign trade B. the income its residents earn from exports is equal to the money its residents pay for imports C. the country import all goods that its residents want by engaging in foreign trade D. it has the potential to balance the production and procurement of the basic amenities that it needs A country is said to be in balance-of-trade equilibrium when the income its residents earn from exports is equal to the money its residents pay to other countries for imports (the current account of its balance of payments is in balance). Learning Objective: Describe the historical development of the modern global monetary system. Topic: The Gold Standard

63 49. A country's trade balance is in surplus when A. its exports are more than its imports B. it experiences negative inflation C. its exports equal the imports D. the prices of commodities are low in the country A country's trade balance is in surplus when it exports more than what it imports. Learning Objective: Describe the historical development of the modern global monetary system. Topic: The Gold Standard

64 50. Which of the following is an advantage of using the gold standard? A. The standard makes sure that goods are not priced out from markets due to inflation. B. The standard does not require a commitment from nations to maintain its currency's value. C. The standard effectively prevents the devaluation of currencies across the world. D. It contains a powerful mechanism for achieving balance-of-trade equilibrium by all countries. The great strength claimed for the gold standard was that it contained a powerful mechanism for achieving balance-of-trade equilibrium by all countries. Blooms: Understand Difficulty: 2 Medium Learning Objective: Describe the historical development of the modern global monetary system. Topic: The Gold Standard

65 51. The agreement reached at Bretton Woods established. A. International Monetary Fund B. World Economic Forum C. United Nations D. International Atomic Energy Agency The agreement reached at Bretton Woods established two multinational institutions the International Monetary Fund (IMF) and the World Bank. Learning Objective: Explain the role played by the World Bank and the IMF in the international monetary system. Topic: The Bretton Woods System

66 52. Which of the following observations is true of the Bretton Woods agreement? A. All countries agreed to fix the value of their currency in terms of gold under the agreement. B. The system accepted Pound as the official reference currency against gold. C. The agreement established a floating system of monetary exchange. D. Two multinational institutions, World Economic Forum and WTO, were formed under the agreement. The Bretton Woods agreement called for a system of fixed exchange rates that would be policed by the IMF. Under the agreement, all countries were to fix the value of their currency in terms of gold but were not required to exchange their currencies for gold. Learning Objective: Explain the role played by the World Bank and the IMF in the international monetary system. Topic: The Bretton Woods System

67 53. The World Bank was established at the at Bretton Woods conference to. A. establish an international monetary system B. promote general economic development C. establish gold standard across the world D. fund the initiatives of the United Nations The agreement reached at Bretton Woods established the World Bank. The task of the World Bank was to promote general economic development. Learning Objective: Explain the role played by the World Bank and the IMF in the international monetary system. Topic: The Bretton Woods System

68 54. Identify the currency that was convertible to gold under the Bretton Woods system. A. Pound B. Yen C. Euro D. Dollar Under the Bretton Woods agreement, all countries were to fix the value of their currency in terms of gold but were not required to exchange their currencies for gold. Only the dollar remained convertible into gold. Learning Objective: Explain the role played by the World Bank and the IMF in the international monetary system. Topic: The Bretton Woods System

69 55. What will happen if a country increases its money supply rapidly under fixed exchange rate regime? A. Imports will become less attractive in that country. B. The country will face negative inflation. C. Trade deficit would widen in that country. D. The country's products will become more attractive in world markets. A fixed exchange rate regime imposes monetary discipline on countries and curtails price inflation. For example, if a country increases its money supply by printing more currency, the increase in money supply would lead to price inflation. Given fixed exchange rates, inflation would make the country's goods uncompetitive in world markets, while the prices of imports would become more attractive in that country. The result would be a widening trade deficit in the country, with the country importing more than it exports. Blooms: Apply Difficulty: 3 Hard Learning Objective: Explain the role played by the World Bank and the IMF in the international monetary system. Topic: The Bretton Woods System

70 56. Which of the following is a disadvantage of using a rigid policy of fixed exchange rates? A. It is likely to create high unemployment in some cases. B. It will lead to inflationary economies across the world. C. It is likely to bring about trade wars between nations. D. It will instigate competitive devaluations and intense competition. A rigid policy of fixed exchange rates would be too inflexible. In some cases, a country's attempts to reduce its money supply growth and correct a persistent balance-of-payments deficit could force the country into recession and create high unemployment. Blooms: Understand Difficulty: 2 Medium Learning Objective: Explain the role played by the World Bank and the IMF in the international monetary system. Topic: The Bretton Woods System

71 57. Which of the following is a function of World Bank? A. Implementing a rigid fixed exchange rate regime B. Promoting gold standard across the world C. Lending money to governments for development D. Implementing a flexible fixed exchange rate regime The World Bank was established to reconstruct world economies. The bank lends money to entities such as governments. Difficulty: 2 Medium Learning Objective: Explain the role played by the World Bank and the IMF in the international monetary system. Topic: The Bretton Woods System

72 58. Which of the following is a factor that initiated the collapse of the fixed exchange rate system? A. Worsening of Great Britain's balance of trade B. Recession in third world countries C. Price inflation in Europe D. Worsening of U.S. foreign trade position U.S. dollar had a special role in the fixed exchange rate system as the only currency that could be converted into gold. This meant that any pressure on the dollar would devalue the system. The increase in inflation and the worsening of the U.S. foreign trade position gave rise to speculation in the foreign exchange market that the dollar would be devalued. This initiated the demise of the fixed exchange rate system. Learning Objective: Describe the historical development of the modern global monetary system. Topic: The Collapse of the Fixed Exchange Rate System

73 59. Which of the following changes were made to IMF's Articles of Agreement in the Jamaica agreement? A. IMF members were permitted to use Dollar as the convertible currency. B. Gold was declared as a formal reserve asset for IMF members. C. IMF members were permitted to sell their gold reserves at the market price. D. IMF members were restricted from entering the foreign exchange market. IMF members met in Jamaica in January 1976 and agreed to the rules for the international monetary system that are in place today. In the meeting, gold was abandoned as a reserve asset. IMF members were permitted to sell their own gold reserves at the market price. Learning Objective: Describe the historical development of the modern global monetary system. Topic: The Floating Exchange Rate Regime

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