1. A fixed exchange rate regime (a) forces a country to give up free international flows of capital. (b) forces a country to abandon independent monetary policy (c) can eliminate exchange rate uncertainty (d) is the model used by the U.S. Federal Reserve. 2. If the exchange rate between the Australian dollar and the US dollar is expressed in direct quotation from an Australian perspective, then a rise in the exchange rate implies (a) appreciation of the US dollar. (b) depreciation of the US dollar. (c) appreciation of the Australian dollar. (d) (b) and (c). (Direct from Australian perspective – AUD/USD. An increase from, say, AUD 1.2 to AUD 1.3 per USD implies that the USD is now buying more AUD. Note than when the exchange rate is in direct terms and increase in the exchange rate is actually a depreciation of the domestic currency.) 3. If the AUD/USD exchange rate declines from 1.2500 to 1.2430, then the fall is equal to (a) 70 points. (b) 7000 pips. (c) 700 points. (d) 70 pips. (1 point = 0.0001) 4. Bank XYX quotes 1.2500 – 1.2550 for the AUD/USD exchange rate to a customer. What is the price at which the customer can buy one unit of the Australian dollar? (a) 1.2500. (b) 1.2550. (c) 0.8000. (d) 0.7968. (Answer: USD: 0.7968 – 0.8000/ AUD [Customer buys at the higher price]) 5. If a fixed exchange rate is set below the equilibrium rate in a fixed exchange rate system it will create (a) a deficit in the balance of payments. (b) a surplus in the balance of payments. (c) inflation. (d) deflation. (Here we are referring to the BOT model, which only considers the balance of the merchandise trade account. Keep in mind that the currency of interest is the one in the denominator, and this allows us to get around the confusion caused by direct/indirect quotations. If the ex/r is set above the equilibrium rate the country, whose currency is in the denominator, will run a trade deficit. Refer to the lecture notes or the tutorial solutions for the explanation.) 6. Which of the following items is not a flow? (a) Unilateral transfers. (b) The increase in foreign assets held by Australian investors over a period of six months. (c) Foreign exchange reserves lost by the Reserve Bank as a result of intervention in the foreign exchange market. (d) The foreign currency and gold reserves of the Reserve Bank. (Foreign currency and gold reserves are a STOCK). 7. The balancing item appears on the balance of payments to (a) account for errors and omissions in the data. (b) equate the trade and services accounts. (c) account for changes in official reserves. (d) balance the current account. 8. The sale of foreign bonds leads to (a) an increase in the supply of the foreign currency. (b) an increase in the demand for the foreign currency. (c) an increase in the supply of the domestic currency. (d) (b) and (c). (It is the equivalent of a sale of foreign assets or issue of foreign bonds by Australian companies. For example, BHP (Australian firm) issues bonds denominated in USD in the US. The sale would result in an increase in foreign currency (i.e. USD) 9. If the US inflation rate is lower than the Australian inflation rate by 5 per cent then according to relative PPP (Hint: please use the approximate version of PPP to answer this question) (a) the Australian dollar should depreciate by 5 per cent. (b) the Australian dollar should depreciate by less than 5 per cent. (c) the Australian dollar should appreciate by 5 per cent. (d) anything could happen depending on the interest rate differential. [This is an implication of the approximate version of PPP. However, should you know the exact inflation rate of the two countries, say 10% (Aust.) and 5% (US), using the “proper” PPP formula we find that the US$ will appreciate by 4.8%.] 10. If the foreign currency equivalent of the domestic price of a commodity is less than the foreign price of the same commodity, then the LOP implies that (a) the foreign currency is overvalued. (b) the foreign currency is undervalued. (c) the domestic currency is overvalued. (d) none of the above. (PPP states that P = SP*. The foreign currency equivalent of the domestic price is just P/S and this should be equal to P*. Here P/S < P*. For example, refer to the LOP problem in the lecture. The British pound (foreign currency) price of Australian wheat is GBP 2.35, which is less than the price of British wheat. The reason for