Concept Check #2

Question 1

Exchange Rate Regimes:

Free Float

Answer 1

leave it to supply and demand

Can be subject to high volatility

Question 2

Dirty Float

Answer 2

allow float within a certain bandwidth

How ‘dirty’ depends on the bandwidth

Question 3

Fixed

Answer 3

set at a rate specified by governments

Pegged: linked to a single strong currency

Question 4

What is foreign exchange?

Answer 4

A commodity that consists of currencies issued by countries other than one’s own.

Question 5

Strong vs Weak Dollar

Answer 5

A strong dollar buys more foreign currency.

A weak dollar buys less foreign currency.

Question 6

Exchange rates

Answer 6

The price of your currency in terms of my own currency

its important because it determines how much I have to export to pay for my imports, so it effects terms of trade.

Question 7

What would you want in your primary currency?

Answer 7

Stable, convertible, and commonly traded

Question 8

Hard Currencies

Answer 8

Currencies that are freely tradable, or convertible

They tend to maintain value Ex: Euro, US dollar, Canadian dollar, Japanese yen

Question 9

Soft Currencies

Answer 9

Currencies that are not freely tradable because of domestic laws or the unwillingness of foreigners to hold them
They Often lose value Ex: ruble, dong, cuban peso

Question 10

Supply Demand

Answer 10

Exchange rate is a price function: a function of supply and demand

As demand for a given currency goes up (at a given supply) so does the price of that currency in terms of the other currency (i.e., the exchange rate)

As demand goes down (at a given supply), the price of that currency will drop in terms of the other currency

Question 11

Money Supply

Answer 11

The aggregate value of the money supply should reflect the value of the national economy
Changes in the money supply will put pressure on exchange rates

Question 12

Trade

Answer 12

Current account balance affects x-rates:
• trade surplus = more money coming into the country than leaving it; this pushes $ up
• trade deficit = more money leaving the country, this
pushes the $ down
• US used to have a current account surplus: it exported more than it imported, which propped up the dollar’s value

Question 13

Strong $ good or bad

Answer 13

Appreciating currency is both good and bad
A strengthening dollar helps importers (and consumers of imported goods)
U.S firms with offshoring
foreign debt holders

A weakening dollar helps:
Domestic, import-competing industries
•Exporters
•MNEs repatriating income from abroad