Chapter 4

Question 1

What does it mean when a currency depreciates?

Answer 1

The value of the currency has declined relative to another currency

Question 2

What causes the demand for a currency to increase in foreign exchange markets?

Answer 2

The demand for a currency increases when its value decreases, making foreign goods cheaper

Question 3

How is the equilibrium exchange rate determined?

Answer 3

It is determined by the point where the demand for a currency equals its supply

Question 4

How do inflation rates affect exchange rates?

Answer 4

Higher inflation in a country increases demand for foreign goods and foreign currencies, causing the local currency to depreciate

Question 5

What is the effect of higher interest rates on a currency’s value?

Answer 5

Higher interest rates attract foreign investment, increasing demand for the local currency and appreciating its value

Question 6

How can government controls influence exchange rates?

Answer 6

Governments can influence exchange rates by imposing trade barriers, adjusting interest rates, and intervening in currency markets

Question 7

What role do market expectations play in exchange rate movements?

Answer 7

Market expectations about future interest rates or inflation can cause traders to buy or sell currencies in anticipation, affecting current exchange rates

Question 8

What is a cross exchange rate?

Answer 8

Represents the value of one foreign currency relative to another, rather than against the U.S. dollar.

Question 9

What is the carry trade in foreign exchange markets?

Answer 9

It involves borrowing in a currency with low interest rates and investing in one with higher interest rates to profit from the interest rate differential

Question 10

How can financial institutions capitalize on expected currency depreciation?

Answer 10

They can borrow in the currency expected to depreciate, convert it to another currency, and repay the loan after the currency loses value

Question 11

Factors that influence Exchange Rate