The price of one currency expressed in units of another currency
✓
The interest rate paid on bank deposits held in another country
The ratio of a country's exports to the value of its imports
The tax charged on goods when they cross a national border
Correct Answer
The price of one currency expressed in units of another currency
An exchange rate is a price, such as 1.30 dollars per pound, set by demand and supply in the foreign exchange market. The interest rate paid on bank deposits held in another country is a rate of return, not a currency price. The ratio of a country's exports to the value of its imports describes the trade balance. The tax charged on goods when they cross a national border is a tariff.
Category: Foreign Exchange Basics
Question 2
A U.S. company buys 40 percent of a Brazilian manufacturer and takes seats on its board. What kind of investment is this?
Portfolio investment
Foreign direct investment
✓
Currency hedging
Government borrowing
Correct Answer
Foreign direct investment
Buying at least 10 percent of a foreign firm, usually with a role in its management, counts as foreign direct investment, which tends to be long-term. Portfolio investment is a purely financial holding, such as bonds or a small share of stock, with no management role. Currency hedging protects against exchange rate risk rather than buying a firm. Government borrowing is a public debt transaction, not a private ownership stake.
Category: Foreign Exchange Basics
Question 3
A currency office pays 5.50 lira for each dollar it buys and charges 5.80 lira for each dollar it sells. How many lira does a traveler receive for $100?
580 lira
30 lira
550 lira
✓
5,500 lira
Correct Answer
550 lira
When the traveler sells dollars, the office is buying them at 5.50 lira each, so $100 x 5.50 = 550 lira. 580 lira uses the office's selling rate, which applies when the office sells dollars. 30 lira comes from multiplying the 0.30 gap between the two rates by $100. 5,500 lira comes from misplacing the decimal point.
Category: Currency Calculations
Question 4
When an American tourist in Mexico exchanges dollars for pesos, what is she doing in the foreign exchange market?
Demanding dollars and supplying pesos
Demanding both dollars and pesos
Supplying both dollars and pesos
Supplying dollars and demanding pesos
✓
Correct Answer
Supplying dollars and demanding pesos
Every currency exchange is two-sided: the tourist gives up dollars, which adds to their supply, and receives pesos, which adds to their demand. Demanding dollars and supplying pesos describes a Mexican visitor to the United States. Demanding both dollars and pesos and supplying both dollars and pesos are impossible, because demanding one currency always means supplying the other.
Category: Foreign Exchange Basics
Question 5
If the U.S. dollar rises in value against other currencies, what happens to U.S. exporters?
Their foreign earnings convert into fewer dollars, squeezing profits
✓
Their foreign earnings convert into more dollars, raising profits
Their goods become cheaper for buyers in other countries
Their production costs measured in dollars fall sharply
Correct Answer
Their foreign earnings convert into fewer dollars, squeezing profits
A U.S. exporter pays costs in dollars but earns foreign currency, and when the dollar is stronger each unit of foreign currency buys fewer dollars, so profits fall. Their foreign earnings convert into more dollars, raising profits describes a weaker dollar. Their goods become cheaper for buyers in other countries is backward, since a stronger dollar makes U.S. goods more expensive abroad. Their production costs measured in dollars fall sharply is wrong because costs paid in dollars do not change with the exchange rate.
Category: Appreciation and Depreciation
Question 6
Which group benefits when the U.S. dollar strengthens?
U.S. firms that export to Europe
U.S. tourists traveling abroad
✓
Foreign tourists visiting the United States
U.S. hotels that serve foreign visitors
Correct Answer
U.S. tourists traveling abroad
A stronger dollar buys more foreign currency, so trips abroad become cheaper for American travelers. U.S. firms that export to Europe are hurt because their euro sales convert into fewer dollars. Foreign tourists visiting the United States are hurt because their money buys fewer dollars. U.S. hotels that serve foreign visitors lose business when U.S. trips become more expensive for foreigners.
Category: Appreciation and Depreciation
Question 7
A U.S. truck sells for $26,000. If the exchange rate is $1.30 per British pound, what is its price in pounds?
33,800 pounds
26,000 pounds
20,000 pounds
✓
18,200 pounds
Correct Answer
20,000 pounds
To turn dollars into pounds, divide by the number of dollars per pound: 26,000 / 1.30 = 20,000 pounds. 33,800 pounds comes from multiplying by 1.30 instead of dividing. 26,000 pounds ignores the exchange rate. 18,200 pounds comes from subtracting 30 percent, which is not how a currency conversion works.
Category: Currency Calculations
Question 8
If 20 Mexican pesos trade for 1 U.S. dollar, what is the value of 1 peso in dollars?
$0.20
$20.00
$2.00
$0.05
✓
Correct Answer
$0.05
Exchange rates between two currencies are reciprocals, so 1 peso is worth 1 / 20 = $0.05. $20.00 reports pesos per dollar instead of dollars per peso. $0.20 and $2.00 are not the reciprocal of 20 and do not come from any correct conversion.
Category: Currency Calculations
Question 9
A British book costs 8 pounds. At an exchange rate of $1.25 per pound, what does it cost in dollars?
$10.00
✓
$6.40
$9.25
$8.00
Correct Answer
$10.00
To turn pounds into dollars, multiply by the number of dollars per pound: 8 x 1.25 = $10.00. $6.40 comes from dividing by 1.25 instead of multiplying. $9.25 comes from adding the exchange rate to the price. $8.00 ignores the exchange rate.
Category: Currency Calculations
Question 10
According to the demand and supply model, what happens if U.S. interest rates rise relative to interest rates abroad?
Demand for dollars falls, supply rises, and the dollar depreciates
Demand for dollars rises, supply falls, and the dollar appreciates
✓
Demand for dollars rises, supply rises, and the dollar depreciates
Demand for dollars falls, supply falls, and the dollar appreciates
Correct Answer
Demand for dollars rises, supply falls, and the dollar appreciates
Higher U.S. returns attract foreign financial capital, raising demand for dollars, while U.S. investors keep more funds at home, reducing the supply of dollars, so the dollar appreciates. Demand for dollars falls, supply rises, and the dollar depreciates describes relatively lower U.S. interest rates. Demand for dollars rises, supply rises, and the dollar depreciates gets the supply shift wrong. Demand for dollars falls, supply falls, and the dollar appreciates gets the demand shift wrong.
Category: Shifts in Currency Markets
Question 11
What does the demand and supply model predict for the currency of a country whose inflation is much higher than its trading partners'?
It appreciates as demand for it rises and supply of it falls
It depreciates as demand for it rises and supply of it falls
It depreciates as demand for it falls and supply of it rises
✓
It appreciates as demand for it falls and supply of it rises
Correct Answer
It depreciates as demand for it falls and supply of it rises
High inflation erodes what the currency can buy, so fewer people want to hold it and more want to sell it, and the currency depreciates. It appreciates as demand for it rises and supply of it falls is the opposite of what high inflation does. It depreciates as demand for it rises and supply of it falls is inconsistent, since those shifts push the value up. It appreciates as demand for it falls and supply of it rises is inconsistent, since those shifts push the value down.
Category: Shifts in Currency Markets
Question 12
Investors come to expect the euro to strengthen next year. What does the model predict for the euro today?
Demand falls, supply rises, and the euro depreciates now
Nothing changes until the expected strengthening occurs
Demand and supply both fall, so the rate cannot change
Demand rises, supply falls, and the euro appreciates now
✓
Correct Answer
Demand rises, supply falls, and the euro appreciates now
Buyers want euros before the expected rise and holders are slower to sell, so the expectation itself pushes the euro up today and can be self-fulfilling for a while. Demand falls, supply rises, and the euro depreciates now describes an expected weakening. Nothing changes until the expected strengthening occurs ignores that traders act on expectations. Demand and supply both fall, so the rate cannot change gets both shifts wrong.
Category: Shifts in Currency Markets
Question 13
What does the purchasing power parity exchange rate equalize across countries?
The prices of internationally traded goods
✓
The interest rates on government bonds
The growth rates of real GDP
The wages paid to factory workers
Correct Answer
The prices of internationally traded goods
The purchasing power parity (PPP) exchange rate is the rate at which internationally traded goods such as oil, steel and cars would cost the same in different countries. The interest rates on government bonds are not what PPP compares. The growth rates of real GDP differ across countries regardless of exchange rates. The wages paid to factory workers depend on productivity and labor markets, not on PPP.
Category: Purchasing Power Parity
Question 14
At the PPP exchange rate, 1 U.S. dollar equals 1.20 Canadian dollars. A car sells for 30,000 U.S. dollars in the United States. If PPP holds, what should it cost in Canada?
25,000 Canadian dollars
36,000 Canadian dollars
✓
30,000 Canadian dollars
24,000 Canadian dollars
Correct Answer
36,000 Canadian dollars
Each U.S. dollar equals 1.20 Canadian dollars, so 30,000 x 1.20 = 36,000 Canadian dollars. 25,000 Canadian dollars comes from dividing by 1.20 instead of multiplying. 30,000 Canadian dollars ignores the exchange rate. 24,000 Canadian dollars comes from subtracting 20 percent instead of converting.
Category: Purchasing Power Parity
Question 15
Japan's GDP is 500 trillion yen in two straight years, but the exchange rate moves from 100 to 125 yen per dollar. What happens to Japan's GDP measured in dollars?
It rises from $4 trillion to $5 trillion
It stays at $5 trillion in both years
It falls from $5 trillion to $4 trillion
✓
It falls from $5 trillion to $2.5 trillion
Correct Answer
It falls from $5 trillion to $4 trillion
Dividing by yen per dollar gives 500 / 100 = $5 trillion and then 500 / 125 = $4 trillion, an apparent drop caused only by the exchange rate. It rises from $4 trillion to $5 trillion reverses the years. It stays at $5 trillion in both years ignores the change in the exchange rate. It falls from $5 trillion to $2.5 trillion is an arithmetic error. This is why PPP rates are preferred for comparing economies.
Category: Purchasing Power Parity
Question 16
A bank in Thailand borrows in U.S. dollars and lends in baht. What happens to the bank if the baht unexpectedly depreciates?
It needs fewer baht to repay its dollar loans, which brings a windfall
Its dollar debts are automatically converted into baht at the old rate
Its borrowers are required to repay their loans in dollars instead
It needs more baht to repay its dollar loans, which can make it insolvent
✓
Correct Answer
It needs more baht to repay its dollar loans, which can make it insolvent
The bank's borrowers still repay in baht, but a weaker baht buys fewer dollars, so the bank cannot cover its dollar debts and may fail, as many banks did in the East Asian crisis of 1997-1998. It needs fewer baht to repay its dollar loans, which brings a windfall describes an unexpected appreciation of the baht. Its dollar debts are automatically converted into baht at the old rate is false; dollar debts stay in dollars. Its borrowers are required to repay their loans in dollars instead is false, since those loans were made in baht.
Category: Macroeconomic Effects
Question 17
Why might a central bank worry about large, sudden swings in its currency's exchange rate?
They make profits of exporters and importers hard to predict
✓
They automatically raise the country's reserve requirements
They prevent the government from collecting income taxes
They make the country's GDP impossible to measure
Correct Answer
They make profits of exporters and importers hard to predict
Firms that export, use imported inputs or compete with imports can see profits swing sharply when exchange rates jump, so a stable rate gives a steadier business climate. They automatically raise the country's reserve requirements is false; exchange rates do not set reserve rules. They prevent the government from collecting income taxes has no basis. They make the country's GDP impossible to measure is false; GDP is measured in the home currency.
Category: Macroeconomic Effects
Question 18
Which exchange rate policy lets the market usually set the rate but has the central bank step in when the rate moves sharply?
Hard peg
Soft peg
✓
Floating exchange rate
Merged currency
Correct Answer
Soft peg
Under a soft peg the market normally sets the exchange rate, but the central bank intervenes to prevent rapid moves in one direction. A hard peg fixes the rate at all times. A floating exchange rate leaves the rate entirely to the market. A merged currency is shared with other nations, so there is no exchange rate among members to manage.
Category: Exchange Rate Policies
Question 19
Which exchange rate policy requires a central bank to hold the largest foreign exchange reserves?
A floating exchange rate
A soft peg
A hard peg
✓
A merged currency
Correct Answer
A hard peg
Keeping a fixed, unchanging rate means the central bank must be ready at any moment to buy its own currency with foreign currency, which takes large reserves. A floating exchange rate needs no reserves because the market sets the rate. A soft peg needs moderate reserves that rise and fall over time. A merged currency needs none because members share one currency.
Category: Exchange Rate Policies
Question 20
What does a country give up when it adopts a currency it shares with other nations?
Its ability to collect taxes
Its right to trade with other countries
Its power to set a government budget
Its own independent monetary policy
✓
Correct Answer
Its own independent monetary policy
A shared currency has one central bank, such as the European Central Bank for the euro, so a member can no longer set interest rates for its own conditions. Its ability to collect taxes stays with each national government. Its right to trade with other countries is unaffected, and trade among members becomes easier. Its power to set a government budget also remains, since fiscal policy stays national.
Category: Exchange Rate Policies