Chapter 6

Government Influence on Exchange Rates

1. To force the value of the pound to appreciate against the dollar, the Federal Reserve should:
A) sell dollars for pounds in the foreign exchange market and the European Central Bank (ECB)
should sell dollars for pounds in the foreign exchange market.
B) sell pounds for dollars in the foreign exchange market and the European Central Bank (ECB)
should sell dollars for pounds in the foreign exchange market.
C) sell pounds for dollars in the foreign exchange market and the European Central Bank (ECB)
should not intervene.
D) sell dollars for pounds in the foreign exchange market and the European Central Bank (ECB)
should sell pounds for dollars in the foreign exchange market.

ANSWER: A

2. A weak dollar is normally expected to cause:

A) high unemployment and high inflation in the U.S.
B) high unemployment and low inflation in the U.S.
C) low unemployment and low inflation in the U.S.
D) low unemployment and high inflation in the U.S.

ANSWER: D

3. A strong dollar is normally expected to cause:

A) high unemployment and high inflation in the U.S.
B) high unemployment and low inflation in the U.S.
C) low unemployment and low inflation in the U.S.
D) low unemployment and high inflation in the U.S.

ANSWER: B

4. To force the value of the British pound to depreciate against the dollar, the Federal Reserve
should:
A) sell dollars for pounds in the foreign exchange market and the Bank of England should sell
dollars for pounds in the foreign exchange market.
B) sell pounds for dollars in the foreign exchange market and the Bank of England should sell
dollars for pounds in the foreign exchange market.
C) sell pounds for dollars in the foreign exchange market and the Bank of England should sell
pounds for dollars in the foreign exchange market.
D) sell dollars for pounds in the foreign exchange market and the Bank of England should sell
pounds for dollars in the foreign exchange market.

ANSWER: C

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Chapter 6: Government Influence on Exchange Rates 447

5. Consider two countries that trade with each other, called X and Y. According to the text, inflation
in Country X will have a greater impact on inflation in Country Y under the _______ system.
Now, consider two other countries that trade with each other, called A and B. Unemployment in
Country A will have a greater impact on unemployment in Country B under the _______ system.
A) floating rate; fixed rate
B) floating rate; floating rate
C) fixed rate; fixed rate
D) fixed rate; floating rate

ANSWER: C

6. A primary result of the Bretton Woods Agreement was:

A) the establishment of the European Monetary System (EMS).
B) establishing specific rules for when tariffs and quotas could be imposed by governments.
C) establishing that exchange rates of most major currencies were to be allowed to fluctuate 1%
above or below their initially set values.
D) establishing that exchange rates of most major currencies were to be allowed to fluctuate
freely without boundaries (although the central banks did have the right to intervene when
necessary).

ANSWER: C

7. A primary result of the Smithsonian Agreement was:

A) the establishment of the European Monetary System (EMS).
B) establishing that exchange rates of most major countries were to be allowed to fluctuate
2.25% above or below their initially set values.
C) establishing specific rules for when tariffs and quotas could be imposed by governments.
D) establishing that exchange rates of most major currencies were to be allowed to fluctuate
freely without boundaries (although the central banks did have the right to intervene when
necessary).

ANSWER: B

8. Under a fixed exchange rate system:

A) a foreign exchange market does not exist.
B) central bank intervention in the foreign exchange market is not necessary.
C) central bank intervention in the foreign exchange market is often necessary.
D) central bank intervention in the foreign exchange market is not allowed.

ANSWER: C

9. Under a managed float exchange rate system, the Fed may attempt to stimulate the U.S. economy
by _______ the dollar. Such an adjustment in the dollar’s value should _______ the U.S. demand
for products produced by major foreign countries.
A) weakening; increase
B) weakening; decrease
C) strengthening; increase
D) strengthening; decrease

ANSWER: B
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10. The value of the Canadian dollar, Japanese yen, and Australian dollar with respect to the U.S.
dollar are part of a:
A) pegged system.
B) fixed system.
C) managed float system.
D) crawling peg system.

ANSWER: C

11. The interest rate of a country with a currency board:

A) is less stable than it would be without a currency board.
B) is typically below the interest rate of the currency to which it is tied.
C) will move in tandem with the interest rate of the currency to which it is tied.
D) is completely independent of the interest rate of the currency to which it is tied.

ANSWER: C

12. The currency of country X is pegged to the currency of country Y. Assume that country Y’s
currency depreciates against the currency of country Z. It is likely that country X will export
_______ to country Z and import _______ from country Z.
A) more; more
B) less; less
C) more; less
D) less; more

ANSWER: C

13. Assume countries A, B, and C produce goods that are substitutes of each other and that these
countries engage in trade with each other. Assume that country A’s currency floats against
country B’s currency, and that country C’s currency is pegged to B’s. If A’s currency depreciates
against B, then A’s exports to C should _______, and A’s imports from C should _______.
A) decrease; increase
B) decrease; decrease
C) increase; decrease
D) increase; increase

ANSWER: C

14. Assume a central bank exchanges its currency for other foreign currencies in the foreign exchange
market, but does not adjust for the resulting change in the money supply. This is an example of:
A) pegged intervention.
B) indirect intervention.
C) nonsterilized intervention.
D) sterilized intervention.

ANSWER: C
Chapter 6: Government Influence on Exchange Rates 449

15. If the Fed desires to weaken the dollar without affecting the dollar money supply, it should:
A) exchange dollars for foreign currencies, and sell some of its existing Treasury security
holdings for dollars.
B) exchange foreign currencies for dollars, and sell some of its existing Treasury security
holdings for dollars.
C) exchange dollars for foreign currencies, and buy existing Treasury securities with dollars.
D) exchange foreign currencies for dollars, and buy existing Treasury securities with dollars.

ANSWER: A

16. Which of the following is an example of direct intervention in foreign exchange markets?
A) lowering interest rates.
B) increasing the discount rate.
C) exchanging dollars for foreign currency.
D) imposing barriers on international trade.

ANSWER: C

17. A strong dollar places _______ pressure on inflation, which in turn places _______ pressure on
the dollar.
A) upward; upward
B) downward; upward
C) upward; downward
D) downward; downward

ANSWER: B

18. The Fed may use a stimulative monetary policy with least concern about causing inflation if the
dollar’s value is expected to:
A) remain stable.
B) strengthen.
C) weaken.
D) none of these will have an impact on inflation.

ANSWER: B

19. A weaker dollar places ____up___ pressure on U.S. inflation, which in turn places _______
pressure on U.S. interest rates, which places _______ pressure on U.S. bond prices.
A) upward; downward; upward
B) upward; downward; downward
C) upward; upward; downward
D) downward; upward; upward
E) downward; downward; upward

ANSWER: C
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20. The euro is the currency:

A) adopted in all western European countries as of 1999.
B) adopted in all eastern European countries as of 1999.
C) adopted in all European countries as of 1999.
D) none of these.

ANSWER: D

21. The euro has not been adopted by:

A) Slovenia.
B) the U.K.
C) Germany.
D) France.

ANSWER: B

22. The exchange rate mechanism (ERM) refers to the method of linking _______ currencies to each
other within boundaries.
A) Latin American
B) European
C) Asian
D) North American

ANSWER: B

23. Countries that have adopted the euro must agree on a single _______ policy.
A) monetary
B) fiscal
C) worker compensation
D) foreign relations

ANSWER: A

24. The exchange rate mechanism (ERM) crisis in 1992 represents the _______ in German interest
rates that caused other European interest rates to _______, and resulted in less aggregate
spending.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase

ANSWER: A

25. The risk-free interest rates among countries that have adopted the euro should:
A) not necessarily be similar to risk-free rates in other countries.
B) equal the U.S. risk-free rate.
C) equal the risk-free rates in other European countries.
D) equal the risk-free rates in Asian countries.

ANSWER: A
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26. Which of the following is true regarding the euro?

A) Exchange rate risk between participating European currencies is completely eliminated,
encouraging more trade and capital flows across European borders.
B) It allows for more consistent economic conditions across countries.
C) It prevents each country from conducting its own monetary policy.
D) All of these are true.

ANSWER: D

27. It has been argued that the exchange rate can be used as a policy tool. Assume that the U.S.
government would like to reduce unemployment. Which of the following is an appropriate action
given this scenario?
A) weaken the dollar.
B) strengthen the dollar.
C) buy dollars with foreign currency in the foreign exchange market.
D) implement a tight monetary policy.

ANSWER: A

28. It has been argued that the exchange rate can be used as a policy tool. Assume that the U.S.
government would like to reduce inflation. Which of the following is an appropriate action given
this scenario?
A) sell dollars for foreign currency.
B) buy dollars with foreign currency.
C) lower interest rates.
D) none of these.

ANSWER: B

29. To strengthen the dollar using sterilized intervention, the Fed would _______ dollars and
simultaneously _______ Treasury securities.
A) buy; sell
B) sell; buy
C) buy; buy
D) sell; sell

ANSWER: C

30. As foreign exchange activity has grown:

A) central bank intervention has become more effective.
B) central bank intervention has become more frequent.
C) central bank intervention has become less effective.
D) none of these.

ANSWER: C
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31. When using indirect intervention, a central bank is likely to focus on:
A) inflation.
B) interest rates.
C) income levels.
D) expectations of future exchange rates.

ANSWER: B

32. Which of the following countries was probably the least affected (directly or indirectly) by
the Asian crisis?
A) Thailand.
B) Indonesia.
C) Russia.
D) China.
E) Malaysia.

ANSWER: D

33. Which of the following is not true regarding Thailand?

A) Thailand was one of the slowest growing countries over the 1985–1994 period.
B) High levels of spending and low levels of saving placed upward pressure on prices of real
estate, products, and on Thailand’s local interest rate.
C) Thailand’s baht was linked to the dollar prior to July 1997, which made Thailand an attractive
site for foreign investors.
D) Thai banks provided many loans that were very risky in their attempt to make use of all of
their funds.
E) All of these are true.

ANSWER: A

34. The term “target zone arrangement” refers to a:

A) situation where countries adjust their national economic policies to maintain exchange rates
within some predetermined limits.
B) system where several central banks act in a coordinated intervention to keep the price of one
country’s currency within reasonable trading ranges.
C) system where currencies are pegged to gold, or to hard currency.
D) system where local currencies are replaced by dollars.

ANSWER: A

35. During the period 1944–1971, the U.S. used a _______ system.
A) euro exchange rate
B) fixed
C) dirty float
D) flexible

ANSWER: B
Chapter 6: Government Influence on Exchange Rates 453

36. Which of the following are examples of currency controls?

A) import restrictions.
B) prohibition of remittance of funds.
C) ceilings on granting credit to foreign firms.
D) all of these.

ANSWER: D

37. From a financial management perspective, which of the following is true regarding the
introduction of the euro?
A) U.S.-based MNCs are not subject to exchange rate risk when they have transactions in euros.
B) The euro is pegged to all other European currencies.
C) Transactions costs decline for MNCs that conduct transactions within Europe.
D) The euro replaced the British pound.

ANSWER: C

38. Which of the following countries have not adopted the euro?
A) Germany
B) Italy
C) Iceland
D) Denmark

ANSWER: C

39. Which of the following is true about the Southeast Asian currency crisis?
A) It was preceded by several years of large capital inflows to Asia.
B) It was preceded by a five-year recession in Asia.
C) Asian interest rates declined during the crisis.
D) Asian exchange rates were converted from floating to fixed to resolve the crisis.

ANSWER: D

40. Under a fixed exchange rate system, U.S. inflation would have a greater impact on
inflation in other countries than it would under a freely floating exchange rate system.(3ashan fel
freely betkon insilated)
A) true.
B) false.

ANSWER: A

41. An advantage of a fixed exchange rate system is that governments are not required to
constantly intervene in the foreign exchange market to maintain exchange rates within specified
boundaries.(pegged)
A) true.
B) false.

ANSWER: B
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42. Under the system known as the “dirty” float, official boundaries for the exchange rate
exist, but they are wider than they are under a fixed exchange rate system.
A) true.
B) false.

ANSWER: B

43. Under a pegged exchange rate system, the home currency’s value is pegged to a foreign currency
or to some unit of account.
A) true.
B) false.

ANSWER: A

44. A major advantage of the euro is the complete elimination of exchange rate risk on
transactions between participating European countries, which encourages more trade and capital
flows within Europe.
A) true.
B) false.

ANSWER: A

45. The European countries conforming to the euro are completely insulated from
movements in the euro’s value with respect to other currencies.
A) true.
B) false.

ANSWER: B

46. The establishment of the euro allows for more consistent economic conditions across
countries but eliminates the power of any individual European country to solve local economic
problems with its own unique monetary policy.
A) true.
B) false.

ANSWER: A

47. The Asian crisis is generally believed to have started in Japan.

A) true.
B) false.

ANSWER: B

48. A possible reason why China was less affected by the Asian crisis is that its
government exerts more influence on private enterprise than the governments of other Asian
countries.
A) true.
B) false.

ANSWER: A
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456 International Financial Management

49. Currency devaluation can boost a country’s exports, but currency revaluation can
increase foreign competition.
A) true.
B) false.

ANSWER: A

50. Market forces are the determinant of exchange rates in a freely floating exchange rate
system.
A) true.
B) false.

ANSWER: A

51. If a government wishes to stimulate its economy in the form of increased foreign
demand for its country’s products, it could attempt to weaken its currency.
A) true.
B) false.

ANSWER: A

52. In a sterilized exchange rate arrangement, a country’s home currency value is pegged
to a foreign currency or to some unit of account.
A) true.
B) false.

ANSWER: B

53. The Bank of England is responsible for setting the monetary policy for the European
countries participating in the euro.
A) true.
B) false.

ANSWER: B

54. The Fed’s indirect method of intervention is to trade dollars for or against other
currencies.
A) true.
B) false.

ANSWER: B

55. A potential advantage of exchange rate target zones is that they may stabilize
international trade patterns by reducing exchange rate volatility.
A) true.
B) false.

ANSWER: A
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56. The Bretton Woods Agreement created a system under which exchange rates are
determined by market forces without intervention by various governments.
A) true.
B) false.

ANSWER: B

57. Nonsterilized intervention is intervention by a central bank in the foreign exchange

market without adjusting for the change in money supply.
A) true.
B) false.

ANSWER: A

58. The euro is pegged to other currencies of European countries that have not adopted
the euro.
A) true.
B) false.

ANSWER: A

59. The Smithsonian Agreement was reached in September 1985 by seven major
industrialized countries to systematically weaken the dollar.
A) true.
B) false.

ANSWER: B

60. An example of indirect intervention by the Bank of Japan would be for the Bank of
Japan to use interest rates to increase the value of the yen vs. the dollar.
A) true.
B) false.

ANSWER: A

61. A strong home currency can harm exports; exporters typically benefit from a weaker
home country currency.
A) true.
B) false.

ANSWER: A

62. An advantage of freely floating exchange rates is that a country with floating
exchange rates is more insulated from unemployment problems in other countries.
A) true.
B) false.

ANSWER: A
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63. All European countries now use the euro as their currency.
A) true.
B) false.

ANSWER: B

64. A country with a currency board does not have control over its local interest rates.
A) true.
B) false.

ANSWER: A

65. Dollarization refers to the replacement of local currency with U.S. dollars.
A) true.
B) false.

ANSWER: A

66. A country with fixed exchange rates often faces constraints on growth.
A) true.
B) false.

ANSWER: A

67. The European Central Bank is responsible for monetary policy in all participating
European countries.
A) true.
B) false.

ANSWER: A

69. A currency peg is insulated from economic or political conditions, such that the exchange rate in
the market will only change if the country’s government breaks the peg and sets a new exchange
rate.
A) true.
B) false.

ANSWER: B
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70. If foreign investors fear that a peg may be broken because of fund outflows from that country,
they may attempt to purchase more of that currency before the peg is broken.
A) true.
B) false.

ANSWER: B

71. Normally, a broken peg in a country places downward pressure on the local currency of that
country.
A) true.
B) false.

ANSWER: B