Table of Contents
CFA Level 2 – Economics, Session 4 – Reading 19, Foreign Exchange Parity Relations – LOS a
(Practice Questions, Sample Questions)
1. If the exchange rate value of the euro goes from $0.95 to $1.10, then the euro has:
A) depreciated and the Dutch will find U.S. goods more expensive.
B) depreciated and the Dutch will find U.S. goods cheaper.
C) appreciated and the Dutch will find U.S. goods cheaper
{Explanation: An exchange rate is a ratio that describes how many units of one currency you can buy per unit of another currency. The numerator will be in the currency in which the quote is made, and the denominator is the other unit of the currency you are comparing. A currency appreciates when it rises in value relative to another foreign currency. Likewise, a currency depreciates when it falls in value relative to another foreign currency. An appreciation in value of a currency makes that country’s goods more expensive to residents of other countries. The depreciation of the value of a currency makes a country’s goods more attractive to foreign buyers}
2. You observe that the exchange rate for pesos is 8 per U.S. dollar, and the exchange rate for Danish krones is 6 per U.S. dollar. What is the peso to krone (MXN/DKK) exchange rate?
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A) Cannot be determined with the data given.
B) 1.333.
C) 0.750
{Explanation: 8 MXN/USD / 6 DKK/USD = 1.333 MXN/DKK}
3. In a floating exchange rate system, if there is an excess demand for:
A) British pounds by the Belgians, Belgians will lower their interest rates so as to enable their citizens to borrow more easily in order to buy British goods.
B) German goods by Americans, Americans will have to sell more goods to Germans so as to be able to buy more German goods.
C) United States dollars by the British, then the British will sell pounds and buy dollars. This will cause the pound to depreciate relative to the dollar
{Explanation: In a floating exchange rate system, exchange rates between countries are based on the demand and supply of currencies relative to each other. If British demand dollars, they will sell pounds and buy dollars in exchange, thus depressing their own currency. The dollar will appreciate relative to the pound. Both remaining choices are incorrect because they are not based on the supply and demand argument underlying floating exchange rates}
4. If the exchange rate value of the English pound goes from $1.75 to $1.50, determine if the pound depreciates or appreciates relative to the dollar and if the English will find U.S. goods cheaper or more expensive.
Pound U.S. goods
A) appreciated cheaper
B) depreciated more expensive
C) appreciated more expensive
{Explanation: An exchange rate is a ratio that describes how many units of one currency you can buy per unit of another currency. The numerator will be in the currency in which the quote is made, and the denominator is the other unit of the currency you are comparing. A currency appreciates when it rises in value relative to another foreign currency, and likewise, a currency depreciates when it falls in value relative to another foreign currency. An appreciation in value of a currency makes that country’s goods more expensive to residents of other countries. The depreciation of the value of a currency makes a country’s goods more attractive to foreign buyers}
5. If there is an excess demand for dollars by Croatians, Croatians will least likely:
A) sell kunas for dollars.
B) make the dollar appreciate.
C) sell dollars for kunas
{Explanation: If there is excess demand for dollars by Croatians, they will sell kunas and buy dollars thereby making the dollar appreciate relative to the kuna}
6. A German parts manufacturer builds a manufacturing plant in the United States. In the foreign exchange market, this action creates:
A) supply of both dollars and euros.
B) demand for dollars and a supply of euros.
C) supply of dollars and a demand for euros.
{Explanation: The German manufacturer will need to purchase U.S. assets, labor, etc., to build the plant. In order to pay the workers, they will need to sell euros and buy dollars, thus increasing the supply of euros and increasing the demand for dollars}
7. If the U.S. dollar appreciates relative to the Elbonian peso, it becomes:
A) more expensive for U.S. citizens to buy Elbonian goods.
B) cheaper for foreigners to buy U.S. goods.
C) more expensive for foreigners to buy U.S. goods
{Explanation: Appreciation is an increase in the value of a domestic currency, relative to foreign currencies, leading to increased purchasing power of the domestic currency for foreign goods. As a result of appreciation of a domestic currency, domestic goods become more expensive to foreigners}
8. An English textile manufacturer builds a plant in the United States. In the foreign exchange market, this action creates a:
A) supply of dollars and a demand for pounds.
B) supply of both dollars and pounds.
C) demand for dollars and a supply of pounds
{Explanation: The English manufacturer will need dollars to pay for the plant. Dollars will be bought and pounds sold, increasing the demand for dollars and increasing the supply of pounds}
