ECON3372 International Finance - In open economies

Question # 00642163
Course Code : ECON3372
Subject: Economics
Due on: 11/29/2022
Posted On: 11/29/2022 01:55 AM
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ECON 3372 Boston College International Finance 20 Multiple Choice Questions

1) In open economies

A) saving and investment are necessarily equal.

B) as in a closed economy, saving and investment are not necessarily equal.

C) saving and investment are not necessarily equal as they are in a closed economy.

D) saving and investment are necessarily equal contrary to the case of a closed economy.

E) investment always refers to the domestic stock market.

2) If the dollar interest rate is 4 percent, the euro interest rate is 6 percent, then

A) an investor should invest only in dollars if the expected dollar depreciation against the euro is 2 percent.

B) an investor should invest only in euros if the expected dollar appreciation against the euro is less than 2 percent.

C) an investor should be indifferent between dollars and euros if the expected dollar depreciation against the euro is 4 percent.

D) an investor should invest only in dollars.

 E) an investor should invest only in euros.

3) Which one of the following statements is the MOST accurate?

A) A rise in the interest rate offered by dollar deposits causes the dollar to appreciate.

B) A rise in the interest rate offered by dollar deposits causes the dollar to depreciate.

C) A rise in the interest rate offered by dollar deposits does not affect the U.S. dollar.

D) For a given euro interest rate and constant expected exchange rate, a rise in the interest rate offered by dollar deposits causes the dollar to appreciate.

 E) A rise in the interest rate offered by the dollar causes the euro to appreciate.

 4) A reduction in a country's money supply, holding prices and output constant, causes

A) its currency to depreciate in the foreign exchange market.

B) its currency to appreciate in the foreign exchange market.

 C) does not affect its currency in the foreign market.

D) does affect its currency in the foreign market in an ambiguous manor.

E) affects other countries currency in the foreign market.

5) Which of the following statements is the MOST accurate?

A) Relative PPP may be valid even when absolute PPP is not, provided the factors causing deviations from absolute PPP are more or less stable over different commodities.

B) Absolute PPP may be valid even when relative PPP is not, provided the factors causing deviations from relative PPP are more or less stable over time.

C) Relative PPP may be valid even when absolute PPP is not, provided the factors causing deviations from absolute PPP are more or less stable over time.

D) Relative PPP is not valid when absolute PPP is not.

E) Relative PPP is only valid when absolute PPP is valid, providing the factors causing deviations from relative PPP are more or less stable over time.

6) The real exchange rate, q, is defined as

A) the price of the foreign aggregate basket of goods in terms of the domestic one.

B) the price of the domestic aggregate basket of goods in terms of the foreign one.

C) the price of the foreign aggregate basket of goods.

D) the price of the domestic aggregate basket of goods.

E) the nominal exchange rate in terms of the domestic aggregate basket of goods.

7) Which one of the following statements is the MOST accurate?

A) A rise in domestic real income raises aggregate demand for home output.

 B) A rise in domestic real income decreases aggregate demand for home output because of the increase demand for import.

C) A rise in domestic real income keeps aggregate demand for home output at the same level.

D) It is difficult to tell whether a rise in domestic real income affects positively or negatively aggregate demand for home output.

E) A rise in domestic real income decreases aggregate demand for home output because the CA is raised.

 8) If an economy is in a liquidity trap, then the nominal interest rate is ________ and the only effective policy that can be used to stimulate the economy is ________.

A) zero; expansionary fiscal policy

B) zero; expansionary monetary policy

C) high and rising; contractionary monetary policy

D) high and rising; expansionary monetary policy

E) high and rising; expansionary fiscal policy

9) Under fixed exchange rate, in general which one of the following statements is the MOST accurate?

A) The following condition should hold for domestic money market equilibrium: Ms/P = L(R , Y).

 B) The following condition should hold for domestic money market equilibrium: Ms/P = L(R , Y ).

C) The following condition should hold for domestic money market equilibrium: Ms = L(R , Y).

 D) The following condition should hold for domestic money market equilibrium: P = L(R , Y).

E) The following condition should hold for domestic money market equilibrium: R*Md/P = L(Y).

10) By fixing the exchange rate and in the absence of a risk-premium, the central bank gives up its ability to

 A) adjust taxes.

B) increase government spending.

C) influence the economy through fiscal policy.

D) increase foreign reserves.

E) influence the economy through monetary policy.

11) Which one of the following statements is the MOST accurate?

 A) Fiscal policy has the same effect on output under fixed and flexible exchange rate regimes.

B) Fiscal policy affects output less under fixed than under flexible exchange rate regimes.

C) Fiscal policy affects output more under fixed than under flexible exchange rate regimes.

D) Fiscal policy cannot affect output under fixed exchange rate but does affect output under flexible exchange rate regimes.

E) Fiscal policy can affect output under fixed exchange rate regimes, but does not affect output under flexible exchange rate regimes.

 12) In the interest rate parity condition with imperfect substitutes and a risk premium of ρ on the domestic bonds:

 A) an increased stock of domestic government debt will raise the difference between the expected returns on domestic and foreign currency deposits (i.e. domestic – foreign return).

B) a decreased stock of domestic government debt will raise the difference between the expected returns on domestic and foreign currency deposits (i.e. domestic – foreign return).

C) an increased stock of domestic government debt will reduce the difference between the expected returns on domestic and foreign currency deposits (i.e. domestic – foreign return).

D) an increased stock of domestic government debt will have no effect on the difference between the expected returns on domestic and foreign currency deposits (i.e. domestic – foreign return).

E) a decreased stock of domestic government debt will have no effect on the difference between the expected returns on domestic and foreign currency deposits (i.e. domestic – foreign return).

13) Under purchasing power parity (i.e. in the long-run), if U.S. monetary growth leads to a long run doubling of the U.S. price level, while Germany's price level remains constant, PPP predicts that the USD/DM exchange rate (dollars per 1 DM):

A) will double in the long-run

B) will be halved in the long-run

C) will remain the same in the long-run, but double in the short-run

D) will be halved in the short-run.

E) will not change in the long-run 14) The aggregate real money demand schedule L(R,Y)

A) slopes upward because a fall in the interest rate raises the desired real money holdings of each household and firm in the economy.

B) slopes downward because a fall in the interest rate reduces the desired real money holdings of each household and firm in the economy.

 C) has a zero slope because a fall in the interest rate keeps constant the desired real money holdings of each household and firm in the economy.

D) has a slope that cannot be determined

E) slopes downward because a rise in the interest rate makes consumers less attracted to the liquidity of money.

15) Which of the following statements is the MOST accurate? In the long-run, an increase in the growth rate of money supply will

A) depreciate the exchange rate

B) Increase inflation, but will not affect interest rates or the exchange rate

C) Increase inflation and interest rates and appreciate the exchange rate

D) Increase inflation and interest rates and depreciate the exchange rate

E) Depreciate the exchange rate, but will not change the interest rate

16) A permanent increase in the long-run U.S. output relative to Euro area output causes

A) a short-run real depreciation of the dollar against the euro.

B) a long-run real appreciation of the dollar against the euro.

C) a long-run real depreciation of the dollar against the euro.

D) an ambiguous effect on the exchange rate, both in the short and long-run.

E) a long-run real appreciation of the euro against the dollar.

17) In the short-run, any rise in the real exchange rate, EP /P, will cause

A) an upward shift in the aggregate demand function and a reduction in output.

B) an upward shift in the aggregate demand function and an expansion of output.

C) a downward shift in the aggregate demand function and an expansion of output.

D) an downward shift in the aggregate demand function and a reduction in output.

E) an upward shift in the aggregate demand function but leaves output intact.

18) In the 1990s the EUR emerged as the first modern-era viable competitor to the USD in the realm of international reserve currencies. Since then,

A) The EUR is still gaining share relative to the USD today

B) The EUR has risen to equal the USD

C) EUR has not managed to unseat the USD at any point, and today USD remains the only viable international currency

 D) The EUR rose to equal to USD for a brief period in the mid-2000s, and has since fallen out of contention

E) The EUR has overtaken the USD as the major international currency

19) Which answer is MOST accurate: Valuation effects are likely to make the biggest contribution to the Net Foreign Asset (NFA) position of countries that

A) Have small Current Account balances

B) Have a large, positive NFA position

C) Have a large, negative NFA position

D) Have a zero NFA position

 E) Enjoy significantly higher rate of return on their foreign assets, than the rate of return they pay on their foreign liabilities

20) The evidence of positive returns on the currency trading strategy called the “carry trade” suggests that

 A) the returns are too small, hence we can conclude interest parity holds with no modifications

B) returns are big, but are well explained by the risk foreign currency investors face, hence the interest parity condition augmented with a risk-premium holds in the data

C) returns are big and are not well explained by risk-considerations

D) returns are on average negative, suggesting there are no profits to be made hence interest parity holds at least in one direction E) returns are big, but in line with the direction implied by interest parity

SHORT-ANSWER QUESTIONS (120 points)

 Let ! be the domestic nominal interest rate, and !∗ is similarly the foreign interest rate. The nominal exchange rate, E, is defined, as usual, to be the number of home currency units per foreign currency. M, P, Y are the domestic money supply, aggregate price level and output respectively and starred variables are the foreign counterparts. Unless told otherwise, assume that output is fixed in both the short and long-runs, the economy is initially at its long-run equilibrium, i.e .#$%& = #( and !$%& = !( , and that the two countries are symmetric #( = #( ∗ , !( = ! ∗ . For all graphical analysis, explain why curves shift (if necessary use graphs for multiple markets).

  1. (6 pts) We have derived the expression for the demand of foreign currency deposits from first principles. Write down the optimal demand for foreign currency deposits, and describe how it combines the two key characteristics of foreign investments that investors trade-off.

b) (6 pts) Using the above expression, derive the equilibrium condition that guarantees market clearing in the market for foreign currency deposits. What assumption do you need to make so that this equation simplifies to the interest parity condition?

c) (6 pts) What does the AA curve characterize and how is it derived?

d) (6 pts) Define the real exchange rate and explain how the nominal exchange rate relates to the real exchange rate in the long-run.

e) (6 pts) Do the nominal and real exchange rates move one-to-one with one another in the short-run? What about in the long-run? Explain why or why not

f) (10 pts) Using figures for both the short and the long-run, explain the effects of a temporary increase in domestic money supply on the exchange rate and output. Show the initial impact, the long-run impact and the transition between the two.

g) (10 pts) Using figures for both the short and the long-run, explain the effects of a temporary increase in domestic taxes on the exchange rate and output. Show the initial impact, the long-run impact and the transition between the two.

h) (10 pts) Now assume that while there is a temporary increase in taxes, the CB is also committed to keeping the exchange rate fixed. Using appropriate graphs, show what happens to the exchange rate and the output in the short and long-run in this case.

i) (15 pts) Using figures for both the short and the long-run, explain the effects of a permanent decrease in domestic money supply on the exchange rate and output. Show the initial impact, the long-run impact and the transition between the two.

j) (15 pts) For this question assume that physical investment I is a decreasing function of R – i.e. that I’(R)

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ECON3372 International Finance - In open economies

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