MaxMarkCh16QuestionsOnly.docx

MaxMarkCh16QuestionsOnly.docx

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MaxMarkCh16QuestionsOnly

MaxMark—Viney

MenuItem16:

（Topic16）Foreignexchange:

Factorsthatinfluencetheexchangerate

Question1:

TheexchangerateisthepriceofacurrencythatisdeterminedintheFXmarkets.Whichofthefollowingisnotcorrect?

A:

theequilibriumexchangerateisthepriceatwhichthedemandforacurrencyequalsthesupplyofthecurrency

B:

mostmajorcountriesapplyapeggedexchangerateregime

C:

underafloatingexchangerateregime,thevalueofacurrencydependsonthesupplyanddemandconditionsintheFXmarkets

D:

achangeinthesupplyof,ordemandfor,acurrencywillcauseashiftintheequilibriumexchangerate

Feedback:

ThestatementsinA,CandDaretruebutBisfalse,inthatwhilesomecurrencieshavepeggedexchangerates,themajorityofmajorcountriesfollowafloatingexchangerateregime,soBisthecorrectanswer.

MORE:

FinancialInstitutions,InstrumentsandMarkets5/e,p.632.

Beforeproceeding,itisnecessarytonotethatdifferentexchangeratedeterminationregimesexistbetweencountries.Forexample,acountrymayapplyapeggedexchangerateregime,wherebytheexchangerateorvalueofadomesticcurrencyislockedintoaspecifiedmultipleofanothercurrency,orbasketofcurrencies.Forexample,thisisthecasewiththeHongKongdollar,whichispeggedtotheUSD.Mostmajorinternationalcurrenciesuseafloatingexchange-rateregime,wherebythevalueofthecurrencyisdeterminedbythedemandandsupplyconditionsthatprevailwithintheFXmarkets.

Question2:

Whichofthefollowingbestdescribesthedegreeofdifficultyassociatedwiththetaskofforecastingexchangerates?

A:

forecastingexchangeratemovementsisrelativelyeasybecauseonlyafewfactorshavesignificanteffectsonthevalueofacurrency

B:

reliableforecastsofexchangeratechangescanbemadebasedontextbookmodels

C:

toaccuratelyforecasttheexchangerateitisusuallysufficienttoidentifythemainfactorinfluencingtherateatthetime

D:

itisverydifficulttomakeaccurateforecastsofexchangeratechanges

Feedback:

Thelinksbetweentheexchangerateandthefactorsthatinfluenceitsuchasinterestratesandinflation,arewellknownbutthisdoesnotmeanthatforecastingexchangeratechangesiseasy.Oneproblemisthatchangesinfactorssuchasinterestratescanbedifficulttoforecast.Anotherproblemisthatseveralfactorsthatinfluencethevalueofacurrencycanchangesimultaneouslysotheneteffectofthesechangescanbeextremelydifficulttoidentify,soDisthecorrectanswer.

MORE:

FinancialInstitutions,InstrumentsandMarkets5/e,p.632.

Forecastingexchangeratemovementswithreliabilityandaccuracyisadifficulttask,andsomeresearchersandmarketparticipantscontendthatitisalmostimpossible.Theapproachinthischapterisnotquitesopessimistic.Itisarguedthatsomefactorscanbeidentifiedashavinganimportanteffectonthevalueofacurrency.However,itisapparentthatanumberofthesefactorsmaychangeatthesametime,andthattheirinfluencesmaywellactinopposingdirections,renderinganalysisofthesefactorsdifficult.TheFXmarketsexistintherealworld,notinatextbook,andparticipantsintheday-to-dayactivitiesofthemarketsdonothavetheluxuryofbeingabletochangeonevariableatatime,holdingallothervariablesconstant,sothattheeffectsofasinglechangecanbeanalysed.

Question3:

Inafloatingexchangerateregime,changesinthedemandforacurrencywillcausechangesintheequilibriumexchangerate.WhichofthefollowingstatementsinrelationtotheAUDdemandcurveintheFXmarketisnotcorrect?

A:

thepurchaseofAustraliangoods,servicesorassetsgeneratesademandforAUD

B:

adepreciationoftheAUDequatestoafallinthepricesofAustraliangoods,servicesandassets

C:

thedemandcurveisdownwardsloping;asthepriceoftheAUDincreasesthedemandfortheAUDalsoincreases

D:

afallinthecostofAustraliangoods,servicesorassetswillresultinincreaseddemandfortheAUD

Feedback:

ThestatementsinA,BandDarevalidandwhilethedemandcurveisdownwardsloping,thismeansthatasthepriceoftheAUDincreases,thedemandfortheAUDdecreases,soCisthecorrectanswer.

MORE:

FinancialInstitutions,InstrumentsandMarkets5/e,p.634.

Figure16.1providesaconceptualdemandcurveforalocalcurrency.Itshowsthequantityofthelocalcurrencydemandedatarangeofprices.Thecurveisdownward-sloping,sinceitisreasonabletoexpectthatthecheaperthelocalcurrency,thegreaterwouldbethedemandforthecurrencybytherestoftheworld.ThereasonwhythereisademandforanycurrencyintheFXmarketisthatinordertopurchasegoods,servicesorfinancialassetsthathaveapricedenominatedinthatcurrency,thecurrencyitselfmustfirstbeobtained.Fromthepointofviewoftherestoftheworld,afallinthepriceofacountry’scurrencyisequivalenttoareductioninthepriceofgoodsandservicesinthatcountry.Itisreasonable,therefore,toexpectmoreofthosegoods,servicesandfinancialassetstobedemanded,withaconsequentincreaseinthequantityofthelocalcurrencydemandedintheFXmarkets.

Question4:

Inafloatingexchangerateregime,changesinthesupplyofacurrencywillcausechangesintheequilibriumexchangerate.Whichofthefollowingstatements,inrelationtotheAUDsupplycurveintheFXmarket,isnotcorrect?

A:

forAUDholders,ariseinthepriceofforeignexchangemeansthatforeigncurrencypricedgoods,servicesandassetsbecomecheaper

B:

theAUDsupplycurveisupwardsloping;reflectingthedemandforforeigncurrencybyAUDholders

C:

supplyofAUDontotheFXmarketarisesasholdersofAUDbuyforeigncurrency

D:

asthepriceoftheAUDincreases,thepriceoftheforeigncurrencyfalls

Feedback:

ThestatementinAisfalsebecauseariseinthepriceofforeignexchangemeansthatforeigncurrencypricedgoods,servicesandassetsbecomemoreexpensiveinAUDterms,soAisthecorrectanswer.

MORE:

FinancialInstitutions,InstrumentsandMarkets5/e,p.635.

ThecurveshowingthesupplyofalocalcurrencyontheFXmarketisprovidedinFigure16.2.Itshowsthequantityofthelocalcurrencyofferedforsaleatvariousprices.Thesupplycurveisupward-sloping;thereasonforthisisthatthesupplyofalocalcurrencyintheFXmarketscomesaboutasaresultofholdersofthatcurrencybuyingforeigncurrency.AsthepriceofthelocalcurrencyincreasesintheFXmarkets,therelativepricesofforeigncurrenciesfall;andthereforethepriceofallgoods,servicesandfinancialassetsdenominatedinforeigncurrenciesalsofalls.Thedemand（fromholdersofthelocalcurrency）forthosegoods,servicesandfinancialassetscanbepresumedtoincrease,andwithitthedemandfortheforeigncurrencies.ThereforethequantityofthelocalcurrencysuppliedtotheFXmarketsincreases.

Question5:

SupposethattheequilibriumvalueoftheAUDisUSD0.70andtheequilibriumvolumeisAUD50billion.However,disequilibriumexists,suchthattheactualexchangerateisAUD/USD0.68andthevolumeofAUDsuppliedatthatrateis$40billion.Whichofthefollowingisnotcorrect?

A:

thereisanexcessdemandforAustraliandollars

B:

buyersoftheAUDwouldhavetoofferahigherprice

C:

thepriceoftheAUDwouldincreaseaboveUSD0.68

D:

asthepriceoftheAUDincreased,thequantitysuppliedwoulddecrease

Feedback:

ThestatementsinA,BandCarevalidbutasthepriceoftheAUDincreased,thequantitysuppliedwouldincrease,soDisthecorrectanswer.

MORE:

FinancialInstitutions,InstrumentsandMarkets5/e,p.636.

ThedataincorporatedintoFigure16.3willhelptounderstandtheconceptofanequilibriumrate.InthefigureanindirectAUD/USDquoteisapplied.TheequilibriumexchangerateisAUD/USD0.7500.If,however,theactualexchangeratewasAUD/USD0.7200,thequantityofAUDdemandedwouldbe$40billionbutonly$20billionwouldbesupplied,leavinganexcessdemandfortheAUD.TherewouldbealargenumberoffrustrateddemandersoftheAUD;FXdealerswouldnotbeabletomeetthedemandsoftheirclients;andclientswouldhavetoinstructtheirFXdealerstoofferahigherprice.Thehigherpricewouldhaveatwofoldeffect:

first,asthepriceoftheAUDwasbidup,thequantitysuppliedwouldincrease;and,second,someofthosewhodemandedtheAUDatUSD0.7200wouldwithdrawfromthemarketasthepricerose.Thecombinedeffectoftheincreaseinpricewouldbetoreducetheexcessdemand.ThepricewouldcontinuetobebiduptoarateofAUD/USD0.7500,atwhichpointthereisnopressureinthemarketplaceforthepricetochangefurther.

RefertoFigure16.3.

Question6:

ConsiderthesituationwhereAustraliaandtheUKwereexperiencingsimilarinflationrates.SupposethattherateofinflationincreasedsubstantiallyinAustralia,relativetotheUK.Iftherewerenogovernmentactionstolowertherateofinflation,whichofthefollowingimpactswouldbeexpectedtooccur?

A:

therewouldbeanincreaseddemandbyAustraliansforUKgoodsandservices

B:

overseas’demandforAustraliangoodswouldswitchtorelativelycheaperUKgoods

C:

thevalueoftheAUDrelativetothepoundsterlingwoulddecrease

D:

alloftheabove

Feedback:

WithhigherinflationinAustralia,thepricesofgoodsandservicesmanufacturedinAustraliawouldincreaseinAUDterms,anddemandwoulddecline.Therefore,demandwouldswitchtotherelativelycheaperUKgoodsandservices,soAandBarebothtrue.WithincreaseddemandforpoundsandanincreaseinthesupplyofAUDthevalueoftheAUDwoulddecrease,soCisalsotrue,makingDthecorrectanswer.