ANSWER OUTLINE
ECONOMICS 353 (SECTION 1) L. Tesfatsion/Spring 02
EXERCISE 7: 6 POINTS TOTAL DUE: Tuesday, March 26, 9:30 A.M.
*IMPORTANT REMINDER: LATE ASSIGNMENTS CANNOT BE ACCEPTED -- NO EXCEPTIONS*
*INSTRUCTIONS:*
(1) Please FILL IN YOUR NAME, BIRTH DATE, AND STUDENT ID NUMBER on Side 1
of your bubble sheet and write "353 SECTION 1-EXERCISE 7" in the top margin
of Side 1.
(2) Use a #2 pencil# to MARK YOUR ANSWERS on Side 1 of the bubble sheet to
the following six multiple choice questions.
(3) Please note that these six questions continue onto the back side of
this question sheet. Each question is worth 1 point.
Q1. In a two-country world divided between HC and ROW, the HC real exchange
rate is defined to be
A. the HC nominal exchange rate E minus the HC inflation rate
B. the HC nominal exchange rate E plus the ROW inflation rate minus the
HC inflation rate
C C. the HC nominal exchange rate E multiplied by P/PROW to correct for
HC and ROW price movements
D. the HC nominal exchange rate E multiplied by PROW/P to correct for
value changes through currency appreciations or depreciations
Q2. In a two-country world divided between HC and ROW, if V is an amount of
goods measured in ROW currency units, and E is the nominal exchange rate
(measured in ROW currency units per HC currency unit), then V divided by E is
an amount of goods measured in ______________
A. ROW currency units corrected for price movements
B B. HC currency units
C. ROW currency units per HC currency unit
D. HC currency units per ROW currency unit
Q3. In a two-country world divided between HC and ROW, in order to OFFSET a
DEPRECIATION of HC currency, the HC central bank could _______ HC currency in
the foreign exchange market, which would tend to shift _________.
A. sell; the supply curve for HC currency to the right
B. sell; the supply curve for HC currency to the left
C. sell; the demand curve for HC currency to the right
D D. buy; the demand curve for HC currency to the right
E. buy; the demand curve for HC currency to the left
Q4. Suppose (1) the U.S. price of U.S. sheepskin is 10 U.S. dollars per
square foot; (2) the Austrian price of Austrian sheepskin is 140 schillings
per square foot; (3) the quality of U.S. and Austrian sheepskin is the same;
and (4) there are no transaction costs. Then, according to the Law of One
Price, the exchange rate between the U.S. dollar and the Austrian schilling
should be about
A. 1.4 schillings per 1 dollar
B. 0.07 schillings per 1 dollar
C. 1 schilling per 1 dollar
D D. 14 schillings per 1 dollar
Q5. If the inflation rate in South Africa is 5 percent during 2002, and the
inflation rate in Malaysia is 9 percent during 2002, then the Purchasing
Power Parity (PPP) theory predicts that, during 2002, the value of the
Malaysian currency (ringitts) measured in terms of South African currency
(rands) -- i.e., the number of rands per ringitt -- will
A. appreciate by 14 percent
B. appreciate by 4 percent
C C. depreciate by 4 percent
D. depreciate by 14 percent
Q6. For a two-country world divided between HC and ROW, the derivation of
the Interest Parity condition assumes that
A. the price levels in the HC and ROW are both constant over time.
B. an investor choosing between equally risky financial assets in the HC
and ROW will choose the one with the higher expected real return rate.
C. a ROW or HC investor will take into account expected movements in the
real exchange rate when determining the expected real return rate of
a financial asset issued by a country other than his/her own.
D. All of the above.
E E. Only B and C.
