LOS p: Identify and interpret the major approaches to forecasting exchange rates.

Q1. The savings-investment imbalances approach would most likely project a strong domestic currency during which phase of the economy?

A)   Late recession.

B)   Early expansion.

C)   Slowdown.

Q2. Which of the following statements regarding the relationship between a domestic currency value and interest rates is most accurate?

A)   An increase in short-term interest rates decreases the value of the domestic currency.

B)   An increase in short-term interest rates may increase or decrease the value of the domestic currency.

C)   An increase in short-term interest rates increases the value of the domestic currency.

Q3. Suppose the U.S. has a persistent current account deficit. Which of the following approaches to forecasting currencies best explains why the U.S. dollar will be strong during this time period?

A)   The savings-investment imbalances approach.

B)   The capital flows approach.

C)   The relative economic strength approach.

Q4. Which of the following approaches to forecasting currencies states that long-term investors will affect the values of currencies?

A)   The PPP.

B)   The savings-investment imbalances approach.

C)   The capital flows approach.

LOS p: Identify and interpret the major approaches to forecasting exchange rates. fficeffice" />

Q1. The savings-investment imbalances approach would most likely project a strong domestic currency during which phase of the economy?

A)   Late recession.

B)   Early expansion.

C)   Slowdown.

Correct answer is B)

A savings deficit exists when investment is greater than domestic savings. To compensate for a savings deficit, a country’s currency must increase in value and stay strong to attract and keep foreign capital. This scenario typically occurs during an economic expansion when businesses are optimistic and use their savings to make investments. Eventually though the economy slows, investment slows, and domestic savings increase. It is at this point that the currency will decline in value.

Q2. Which of the following statements regarding the relationship between a domestic currency value and interest rates is most accurate?

A)   An increase in short-term interest rates decreases the value of the domestic currency.

B)   An increase in short-term interest rates may increase or decrease the value of the domestic currency.

C)   An increase in short-term interest rates increases the value of the domestic currency.

Correct answer is B)

Higher interest rates generally attract capital and increase the domestic currency value. At some level though, higher interest rates will result in lower currency values because the high rates may stifle an economy and make it less attractive to invest there.

Q3. Suppose the ffice:smarttags" />U.S. has a persistent current account deficit. Which of the following approaches to forecasting currencies best explains why the U.S. dollar will be strong during this time period?

A)   The savings-investment imbalances approach.

B)   The capital flows approach.

C)   The relative economic strength approach.

Correct answer is A)

The savings-investment imbalances approach begins by stating that a savings deficit exists when investment is greater than domestic savings. To compensate for a savings deficit, a country’s currency must increase in value and stay strong to attract and keep foreign capital. At the same time the country will have a current account deficit where exports are less than imports. Although a current account deficit would normally indicate that the currency would weaken, the currency must stay strong to attract foreign capital.

Q4. Which of the following approaches to forecasting currencies states that long-term investors will affect the values of currencies?

A)   The PPP.

B)   The savings-investment imbalances approach.

C)   The capital flows approach.

Correct answer is C)

The capital flows approach states that long-term capital flows will flow to where the best opportunities are, thus increasing that country’s currency value.

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