Exchange Rates in the Short Run
1) The theory of asset demand suggests that the most important factor affecting the demand for
domestic and foreign assets is
A) the level of trade and capital flows.
B) the expected return on these assets relative to one another.
C) the liquidity of these assets relative to one another.
D) the riskiness of these assets relative to one another.
Answer: B
Ques Status: Revised
2) The ________ suggests that the most important factor affecting the demand for domestic and
foreign assets is the expected return on domestic assets relative to foreign assets.
A) theory of asset demand
B) law of one price
C) interest parity condition
D) theory of foreign capital mobility
Answer: A
Ques Status: Revised
3) The theory of asset demand suggests that the most important factor affecting the demand for
domestic and foreign assets is the ________ on these assets relative to one another.
A) interest rate
B) risk
C) expected return
D) liquidity
Answer: C
Ques Status: Revised
4) The condition that states that the domestic interest rate equals the foreign interest rate minus
the expected appreciation of the domestic currency is called
A) the purchasing power parity condition.
B) the interest parity condition.
C) money neutrality.
D) the theory of foreign capital mobility.
Answer: B
Ques Status: Previous Edition
444 Mishkin · Economics of Money, Banking, and Financial Markets, Eighth Edition
5) As the relative expected return on dollar assets increases, foreigners will want to hold more
________ assets and less ________ assets, everything else held constant.
A) foreign; foreign
B) foreign; dollar
C) dollar; foreign
D) dollar; dollar
Answer: C
Ques Status: Revised
6) When Americans or foreigners expect the return on ________ assets to be high relative to the
return on ________ assets, there is a higher demand for dollar assets and a correspondingly
lower demand for foreign assets.
A) dollar; dollar
B) dollar; foreign
C) foreign; dollar
D) foreign; foreign
Answer: B
Ques Status: Revised
7) When Americans or foreigners expect the return on ________ assets to be high relative to the
return on ________ assets, there is a ________ demand for dollar assets, everything else held
constant.
A) dollar; foreign; constant
B) dollar; foreign; higher
C) foreign; dollar; higher
D) foreign; dollar; constant
Answer: B
Ques Status: Revised
8) When Americans or foreigners expect the return on dollar assets to be high relative to the
return on foreign assets, there is a ________ demand for dollar assets and a correspondingly
________ demand for ________ foreign assets.
A) higher; higher
B) higher; lower
C) lower; higher
D) lower; lower
Answer: B
Ques Status: Revised
Chapter 17 The Foreign Exchange Market 445
9) If the interest rate is 7 percent on euro-denominated assets and 5 percent on
dollar-denominated assets, and if the dollar is expected to appreciate at a 4 percent rate, for
Francois the Frenchman the expected rate of return on dollar-denominated assets is
A) 11 percent.
B) 9 percent.
C) 5 percent.
D) 3 percent.
E) 1 percent.
Answer: B
Ques Status: Revised
10) If the interest rate is 7 percent on euro-denominated assets and 5 percent on
dollar-denominated assets, and if the dollar is expected to appreciate at a 4 percent rate, the
expected return on ________-denominated assets in ________ percent.
A) dollar; euros is 3
B) euro; dollars is 1
C) dollar; euros is 1
D) euro; dollars is 3
Answer: D
Ques Status: Revised
11) If the interest rate on euro-denominated assets is 13 percent and it is 15 percent on
peso-denominated assets, and if the euro is expected to appreciate at a 4 percent rate, for
Manuel the Mexican the expected rate of return on euro-denominated assets is
A) 11 percent.
B) 13 percent.
C) 17 percent.
D) 19 percent.
Answer: C
Ques Status: Revised
12) If the interest rate on euro-denominated assets is 13 percent and it is 15 percent on
peso-denominated assets, and if the euro is expected to appreciate at a 4 percent rate, for
Francois the Frenchman the expected rate of return on peso-denominated assets is
A) 11 percent.
B) 15 percent.
C) 17 percent.
D) 19 percent.
Answer: A
Ques Status: Revised
446 Mishkin · Economics of Money, Banking, and Financial Markets, Eighth Edition
13) With a 10 percent interest rate on dollar deposits, and an expected appreciation of 7 percent
over the coming year, the expected return on dollar deposits in terms of the foreign currency is
A) 3 percent.
B) 10 percent.
C) 13.5 percent.
D) 17 percent.
Answer: D
Ques Status: Revised
14) With a 10 percent interest rate on dollar deposits, and an expected appreciation of 7 percent
over the coming year, the expected return on dollar deposits in terms of the dollar is
A) 3 percent.
B) 10 percent.
C) 13.5 percent.
D) 17 percent.
Answer: B
Ques Status: Revised
15) The expected return on dollar deposits in terms of foreign currency can be written as the
________ of the interest rate on dollar deposits and the expected appreciation of the dollar.
A) product
B) ratio
C) sum
D) difference
Answer: C
Ques Status: Revised
16) In a world with few impediments to capital mobility, the domestic interest rate equals the sum
of the foreign interest rate and the expected depreciation of the domestic currency, a situation
known as the
A) interest parity condition.
B) purchasing power parity condition.
C) exchange rate parity condition.
D) foreign asset parity condition.
Answer: A
Ques Status: Previous Edition
Chapter 17 The Foreign Exchange Market 447
17) According to the interest parity condition, if the domestic interest rate is 12 percent and the
foreign interest rate is 10 percent, then the expected ________ of the foreign currency must be
________ percent.
A) appreciation; 4
B) appreciation; 2
C) depreciation; 2
D) depreciation; 4
Answer: B
Ques Status: Revised
18) According to the interest parity condition, if the domestic interest rate is 10 percent and the
foreign interest rate is 12 percent, then the expected ________ of the foreign currency must be
________ percent.
A) appreciation; 4
B) appreciation; 2
C) depreciation; 2
D) depreciation; 4
Answer: C
Ques Status: Revised
19) Everything else held constant, when the current value of the domestic currency increases, the
________ domestic assets ________.
A) demand for; increases
B) quantity demanded of; increases
C) demand for; decreases
D) quantity demanded of; decreases
Answer: D
Ques Status: New
20) Everything else held constant, when the current value of the domestic exchange rate increases,
the ________ of domestic assets ________.
A) quantity supplied; does not change
B) supply; decreases
C) quantity supplied; increases
D) supply; increases
Answer: A
Ques Status: New
448 Mishkin · Economics of Money, Banking, and Financial Markets, Eighth Edition
21) Explain the interest parity condition. What key assumption underlies this condition? What
factors affect the returns on domestic and foreign assets?
Answer: The interest parity condition states that returns on domestic and foreign assets will be
equal. The key assumption for this condition is capital mobility. The return on domestic
assets is equal to the domestic interest rate. The return on foreign assets is equal to the
foreign interest rate minus the expected rate of appreciation of the domestic currency.
Ques Status: Previous Edition
17.4 Explaining Changes in Exchange Rates
1) An increase in the domestic interest rate causes the demand for domestic assets to ________
and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: A
Ques Status: New
2) An increase in the domestic interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: A
Ques Status: New
3) A decrease in the domestic interest rate causes the demand for domestic assets to ________
and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: D
Ques Status: New
Chapter 17 The Foreign Exchange Market 449
4) A decrease in the domestic interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: D
Ques Status: New
5) ________ in the domestic interest rate causes the demand for domestic assets to increase and
the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: A
Ques Status: New
6) ________ in the domestic interest rate causes the demand for domestic assets to shift to the
right and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: A
Ques Status: New
7) ________ in the domestic interest rate causes the demand for domestic assets to decrease and
the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: D
Ques Status: New
450 Mishkin · Economics of Money, Banking, and Financial Markets, Eighth Edition
8) ________ in the domestic interest rate causes the demand for domestic assets to shift to the left
and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: D
Ques Status: New
9) ________ in the domestic interest rate causes the demand for domestic assets to ________ and
the domestic currency to appreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: A
Ques Status: New
10) ________ in the domestic interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to appreciate, everything else held constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Answer: A
Ques Status: New
11) ________ in the domestic interest rate causes the demand for domestic assets to ________ and
the domestic currency to depreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: D
Ques Status: New
Chapter 17 The Foreign Exchange Market 451
12) ________ in the domestic interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to depreciate, everything else held constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Answer: D
Ques Status: New
13) Suppose that the Federal Reserve enacts expansionary policy. Everything else held constant,
this will cause the demand for U.S. assets to ________ and the U.S. dollar to ________.
A) increase; appreciate
B) decrease; appreciate
C) increase; depreciate
D) decrease; depreciate
Answer: D
Ques Status: New
14) Suppose that the Federal Reserve conducts an open market sale. Everything else held constant,
this will cause the demand for U.S. assets to ________ and the U.S. dollar will ________.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: A
Ques Status: New
15) An increase in the foreign interest rate causes the demand for domestic assets to ________ and
the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: D
Ques Status: New
452 Mishkin · Economics of Money, Banking, and Financial Markets, Eighth Edition
16) An increase in the foreign interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: D
Ques Status: New
17) A decrease in the foreign interest rate causes the demand for domestic assets to ________ and
the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: A
Ques Status: New
18) A decrease in the foreign interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: A
Ques Status: New
19) ________ in the foreign interest rate causes the demand for domestic assets to increase and the
domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: C
Ques Status: New
Chapter 17 The Foreign Exchange Market 453
20) ________ in the foreign interest rate causes the demand for domestic assets to shift to the right
and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: C
Ques Status: New
21) ________ in the foreign interest rate causes the demand for domestic assets to decrease and the
domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: B
Ques Status: New
22) ________ in the foreign interest rate causes the demand for domestic assets to shift to the left
and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: B
Ques Status: New
23) ________ in the foreign interest rate causes the demand for domestic assets to ________ and
the domestic currency to appreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: C
Ques Status: New
454 Mishkin · Economics of Money, Banking, and Financial Markets, Eighth Edition
24) ________ in the foreign interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to appreciate, everything else held constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Answer: C
Ques Status: New
25) ________ in the foreign interest rate causes the demand for domestic assets to ________ and
the domestic currency to depreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: B
Ques Status: New
26) ________ in the foreign interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to depreciate, everything else held constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Answer: B
Ques Status: New
27) Suppose that the European Central Bank enacts expansionary policy. Everything else held
constant, this will cause the demand for U.S. assets to ________ and the U.S. dollar to
________.
A) increase; appreciate
B) decrease; appreciate
C) increase; depreciate
D) decrease; depreciate
Answer: A
Ques Status: New
Chapter 17 The Foreign Exchange Market 455
28) Suppose that the European Central Bank conducts a main refinancing sale. Everything else
held constant, this would cause the demand for U.S. assets to ________ and the U.S. dollar will
________.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: D
Ques Status: New
29) An increase in the expected future domestic exchange rate causes the demand for domestic
assets to ________ and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: A
Ques Status: New
30) An increase in the expected future domestic exchange rate causes the demand for domestic
assets to shift to the ________ and the domestic currency to ________, everything else held
constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: A
Ques Status: New
31) A decrease in the expected future domestic exchange rate causes the demand for domestic
assets to ________ and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: D
Ques Status: New
456 Mishkin · Economics of Money, Banking, and Financial Markets, Eighth Edition
32) A decrease in the expected future domestic exchange rate causes the demand for domestic
assets to shift to the ________ and the domestic currency to ________, everything else held
constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: D
Ques Status: New
33) ________ in the expected future domestic exchange rate causes the demand for domestic assets
to increase and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: A
Ques Status: New
34) ________ in the expected future domestic exchange rate causes the demand for domestic assets
to shift to the right and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: A
Ques Status: New
35) ________ in the expected future domestic exchange rate causes the demand for domestic assets
to decrease and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: D
Ques Status: New
Chapter 17 The Foreign Exchange Market 457
36) ________ in the expected future domestic exchange rate causes the demand for domestic assets
to shift to the left and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: D
Ques Status: New
37) ________ in the expected future domestic exchange rate causes the demand for domestic assets
to ________ and the domestic currency to appreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: A
Ques Status: New
38) ________ in the expected future domestic exchange rate causes the demand for domestic assets
to shift to the ________ and the domestic currency to appreciate, everything else held constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Answer: A
Ques Status: New
39) ________ in the expected future domestic exchange rate causes the demand for domestic assets
to ________ and the domestic currency to depreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: D
Ques Status: New
458 Mishkin · Economics of Money, Banking, and Financial Markets, Eighth Edition
40) ________ in the expected future domestic exchange rate causes the demand for domestic assets
to shift to the ________ and the domestic currency to depreciate, everything else held constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Answer: D
Ques Status: New
41) Suppose the Federal Reserve releases a policy statement today which leads people to believe
that the Fed will be enacting expansionary monetary policy in the near future. Everything else
held constant, the release of this statement would immediately cause the demand for U.S.
assets to ________ and the U.S. dollar to ________.
A) increase; appreciate
B) decrease; appreciate
C) increase; depreciate
D) decrease; depreciate
Answer: D
Ques Status: New
42) Suppose a report was released today that showed the Euro-Zone inflation rate is running
above the European Central Bankʹs inflation rate target. This leads people to expect that the
European Central Bank will enact contractionary policy in the near future. Everything else
held constant, the release of this report would immediately cause the demand for U.S. assets to
________ and the U.S. dollar will ________.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: A
Ques Status: New
43) Suppose that the latest Consumer Price Index (CPI) release shows a higher inflation rate in the
U.S. than was expected. Everything else held constant, the release of the CPI report would
immediately cause the demand for U.S. assets to ________ and the U.S. dollar would ________.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: D
Ques Status: New
Chapter 17 The Foreign Exchange Market 459
44) In the long run, a one-time percentage increase in the money supply is matched by the same
one-time percentage rise in the price level, leaving unchanged the real money supply and
________. This proposition is called money ________.
A) other economic variables such as interest rates; neutrality
B) the nominal exchange rate; neutrality
C) all other economic variables such as interest rates; illusion
D) the nominal exchange rate; illusion
Answer: A
Ques Status: Revised
45) Money neutrality means that in the long run the domestic interest rate remains unchanged
from an increase in the money supply, implying that the fall in the exchange rate is greater in
the ________ run than in the ________ run, a phenomenon called exchange rate overshooting.
A) short; short
B) short; long
C) long; short
D) long; long
Answer: B
Ques Status: Revised
46) Evidence from the United States during the period 1973-2002 indicates that the value of the
dollar and the measure of the ________ interest rate rose and fell together.
A) real
B) nominal
C) expected
D) actual
Answer: A
Ques Status: Revised
460 Mishkin · Economics of Money, Banking, and Financial Markets, Eighth Edition
47) Explain and show graphically the effect of an increase in the expected future exchange rate on
the equilibrium exchange rate, everything else held constant.
Answer: See figure below.
When the expected future exchange rate increases, the relative expected return on the
domestic assets increases. This will cause the demand for domestic assets to increase
and the current value of the exchange rate will appreciate.
Ques Status: Revised
Chapter 17 The Foreign Exchange Market 461
48) Explain and show graphically the effect of an increase in the expected inflation rate on the
equilibrium exchange rate, everything else held constant.
Answer: See figure below.
When the expected inflation rate increases, the relative expected return on domestic
assets is affected two ways. First, through the Fisher effect, the domestic nominal
interest rate will increase the expected return on domestic assets. Second, through
purchasing power parity, the future value of the domestic exchange rate will decline
which will decrease the expected return on domestic assets. Since it is generally
believed that the effect of the change in the expected future value of the domestic
exchange rate is larger than the Fisher effect, the net effect is a lower expected return on
domestic assets. This will decrease the demand for domestic assets, which will cause
the current value of the domestic exchange rate to depreciate.
