T/F: the PPP theory suggests that the exchange rate will not remain constant but will adjust to maintain the parity in purchasing power

True

False

Question 2

Assume that the exchange rate between US and Australia is initially in equilibrium. Then the US has a 5% inflation rate and Aussies have a 3% inflation rate the following year...all else equal. According to PPP, the FOREX rate will adjust by:

2.2%

1.94%

.6%

1.67%

Question 3

Because of the small values in the US - Aussie question above, a shortcut can be used to find an approximate value. The shortcut value of the above is:

-2%

.6%

1.7%

2%

Question 4

T/F: A major tenet of PPP theory is that as soon as prices become relatively higher in the home country (e.g., the USA), consumers in the foreign country (e.g., the UK) will stop buying US goods and instead purchase UK goods. This shift affects the exchange rate. This assumes that SUBSTITUTES are available.

True

False

Question 5

The Fisher Effect is named after economist Irving Fisher and suggests that the real rate of interest is defined as the return on investment to savers after an adjustment; it is measured as the ___ minus the ___.

risk free interest rate; inflation rate

normal interest rate; historical inflation rate

normal interest rate; expected inflation rate

nominal interest rate; expected inflation rate

domestic nominal interest rate; foreign interest rate

Question 6

T/F: We can directly observe the inflation rate in a country.

True

False

Question 7

T/F: In using the Fisher Effect to predict exchange rate movements, the derivation suggests that you must first know the nominal interest rates, assume that real interest rates are the same in both countries, then deduce the EXPECTED inflation rates, and then apply PPP to predict the effect on exchange rates.

True

False

Question 8

Given the following:

US banking 1yr interest rate = 11%

Number of goals scored by midfielder Bradley in this week's USA-Mexico qualifier = 1

Mexico 1yr bank rate = 12%

How would the exchange rate have to move over the next year for IFE/PPP to hold ? (best answer)

12.36%

.89%

-.89%

9%

-1%

Question 9

IFE Theory is inconsistent with which of the following:

Chapter 4 arguments re: how a country wit high interest rates can attract capital flows and strengthen the currency

All of the other responses are correct

Higher interest rates seen in a foreign market are attributable to changes in income levels or government controls

Chapter 6 arguments re: how a central bank can may purposefully raise interest rates in order to attract funds and strengthen the local currency

Question 10

T/F: in theory, IRP is affected by real interest rates.

True

False