3. If the price of a British pound increases from $1.50 per pound to $1.80 per pound, we say that:

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1 HOMEWORK 7 (ON CHAPTERS 14 AND 15) ECO41 FALL 2015 UDAYAN ROY Each correct answer is worth 1 point. The maximum score is 20 points. This homework is due in class on Wednesday, December 2. Please show your answers on the answer sheet (on the last page). CHAPTER 14 Exchange Rates and the Foreign Exchange Market 1. How many dollars would it cost to buy an Edinburgh Woolen Mill sweater costing 50 British pounds if the exchange rate is 1.50 dollars per one British pound? a. 50 dollars b. 75 dollars c. 80 dollars d. 90 dollars 2. How many dollars would it cost to buy an Edinburgh Woolen Mill sweater costing 50 British pounds if the exchange rate is 1.80 dollars per one British pound? a. 50 dollars b. 75 dollars c. 80 dollars d. 90 dollars 3. If the price of a British pound increases from $1.50 per pound to $1.80 per pound, we say that: a. The dollar has appreciated and the pound has depreciated b. the dollar has depreciated and the pound has appreciated c. the dollar has appreciated and the pound has appreciated d. the dollar has depreciated and the pound has depreciated 4. When the price of a British pound increases from $1.50 per pound to $1.80 per pound, a. Americans find that Britain s exports are more expensive, and British residents find that imports from America are more expensive. b. Americans find that Britain s exports are more expensive, and British residents find that imports from America are less expensive. c. Americans find that Britain s exports are cheaper; however, British residents are not affected. d. Americans are not affected, but British residents find that imports from America are more expensive. e. None of the above. 5. The exchange rate between two currencies depends on a. The interest rates that can be earned on bank deposits in those two currencies. b. The expected future value of the exchange rate. c. The Gross National Product of the two countries d. Both (a) and (b) are correct. e. None of the above.

2 6. Suppose you must decide whether to keep your money in an American bank or in a European bank. If the interest rate on bank deposits in dollars is 10% and the interest rate on bank deposits in euros is 6%, then a. All your money should be in dollar bank deposits. b. All your money should be in euro bank deposits. c. You should keep your money in both dollar deposits and euro deposits. d. It is impossible to tell, given the information, what you should do. 7. Even if the interest rate on bank deposits in dollars is 10% and the interest rate on bank deposits in euros is 6%, a rational person may keep her money in euros if a. The euro is expected to appreciate (with respect to the dollar) b. The euro is expected to depreciate c. Inflation is expected to be higher in Europe compared to the US d. Inflation is expected to be lower in Europe compared to the US 8. According to the theory of interest parity, which of the following statements is the most accurate? a. A rise in the interest rate offered for dollar bank deposits (R $ ) causes the dollar to appreciate. b. A rise in the interest rate offered for dollar bank deposits (R $ ) causes the dollar to depreciate. c. A rise in the interest rate offered for dollar bank deposits (R $ ) does not affect the dollar. d. For a fixed euro interest rate (R ) and a fixed expected exchange rate (E e $/ ), a rise in the dollar interest rate (R $ ) causes the dollar to appreciate. e. None of the above. 9. If the interest rate paid by US banks (R $ ) is 6 percent and the interest rate paid by European banks (R ) is 4 percent, the theory of interest parity says that people probably expect a. The dollar to increase in value by 2 percent b. The euro to increase in value by 2 percent c. The dollar to increase in value by 10 percent d. The euro to increase in value by 10 percent 10. Which equation represents the interest parity condition? a. R $ = R + (E e $/ E $/ ) / E $/. b. R = R $ + (E e $/ E $/ ) / E $/. c. R $ = R + (E e /$ E /$ ) / E /$. d. R $ = R - (E e $/ E $/ ) / E $/. 11. If all interest rates stay unchanged, the theory of interest parity says that an increase in the expected future value of the euro (E e $/ ) will a. cause the value of the euro (E $/ ) to increase immediately b. cause the value of the euro (E $/ ) to decrease immediately c. have no effect on the value of the euro (E $/ ) immediately 2

3 d. cause the value of the euro (E $/ ) to increase, but only in the long run 12. When the interest parity equation is satisfied, a. The goods market is in equilibrium b. The money market is in equilibrium c. The foreign exchange market is in equilibrium d. All of the above e. None of the above CHAPTER 15 Money, Interest Rates, and Exchange Rates 13. The aggregate money demand (M d ) is a. The portion of the aggregate wealth of the nation s people that they would like to hold in the form of financial assets such as stocks and bonds b. The portion of the aggregate wealth of the nation s people that they would like to hold in the form of liquid assets such as cash and checking accounts c. The portion of the aggregate wealth of the nation s people that they would like to hold in the form of liquid assets such as stocks and bonds d. The wealth that the nation s people consider adequate for a comfortable life 14. The aggregate money demand depends on a. The interest rate b. The price level c. Real gross national product d. All of the above. e. Only (a) and (c) 15. The aggregate money demand a. Depends directly on the interest rate (R) and price level (P), and inversely on real GNP (Y). b. Depends directly on Y and R, and inversely on P. c. Depends directly on Y and P, and inversely on R. d. Depends directly on R, and inversely on P and Y. 16. The aggregate demand for money can be expressed by: a. M d = P L(R,Y) b. M d = L P(R,Y) c. M d = Y P(R, L) d. M d = R L(P,Y) e. M d = R L(R, P) 17. Let L be the aggregate real demand for money (or, equivalently, the purchasing power of the aggregate amount of money demanded, which is M d /P). An increase in 3

4 a. real GNP (Y) reduces the aggregate real money demand at a given interest rate (R). b. real GNP raises the aggregate real money demand at a given interest rate. c. the interest rate raises the aggregate real money demand at a given real GNP. d. real GNP reduces aggregate nominal money demand for a given interest rate 18. When the curve of the supply of money is graphed with the interest rate (R) on the vertical axis and the supply of money (M s ) on the horizontal axis, the curve is a. horizontal because M s is set by the central bank. b. vertical because M s is set by the central bank. c. vertical because M s is set by the households and firms. d. just a point because M s and R are both set by the central bank. e. vertical because R is set by the central bank. 19. When the supply of money is equal to the demand for money (that is, M s = M d ) we have a. equilibrium in the money market b. equilibrium in the foreign exchange market c. equilibrium in both the money market and the foreign exchange market d. equilibrium un the goods and services market e. none of the above 20. Using the equation for equilibrium in the money market, indicate which one of the following statements is the most accurate? a. At any given price level (P) and output (Y), an increase in the money supply (M s ) raises the interest rate while a decrease in the money supply lowers the interest rate (R). b. At any given price level, an increase in the money supply lowers the interest rate while a decrease in the money supply raises the interest rate. c. At any given output level, an increase in the money supply lowers the interest rate while a decrease in the money supply raises the interest rate. d. At any given price level and output, an increase in the money supply lowers the interest rate while a decrease in the money supply raises the interest rate. e. None of the above is true. 21. Using the equation for equilibrium in the money market, we can predict that an increase in a. nominal output raises the interest rate while a fall in real output lowers the interest rate, given the price level and the money supply. b. real output decreases the interest rate while a fall in real output increases the interest rate, given the price level. c. real output raises the interest rate while a fall in real output lowers the interest rate, given the money supply. d. nominal output raises the interest rate while a fall in real output lowers the interest rate, given the price level. e. real output raises the interest rate while a fall in real output lowers the interest rate, given the price level and the money supply. 4

5 22. Assume that the nominal interest rate (R) stays constant over time. If the central bank increases the nation s money supply at a steady annual rate of 5%, and if the nation s real GNP increases at the steady annual rate of 2%, then the nation s annual rate of inflation will be a. 7% b. 3% c. 2.5% d. 3% e. Some value that cannot be calculated from the information given 5

6 ANSWER SHEET HOMEWORK 7 (CHS. 14 AND 15) ECO41 FALL 2015 UDAYAN ROY NAME: DATE: