RobertA

The current account balance reflects the exchange of:

A) goods, services, and investment income.

B) goods, services, investment income, and unilateral transfers.

C) goods and services only.

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The current account balance reflects the exchange of merchandise, services, investment income, and unilateral transfers.

RobertA

At an International Trade forum in Shanghai, China, a special panel of leaders advocating free trade was discussing the balance of payments in their respective countries. During the forum the following statements were made:

China’s Delegate: 2006 was a wonderful year for China economically speaking. However, the U.S. has experienced greater difficulties because of its widening trade deficit. The U.S. is running a trade deficit because it is spending more on public services than it is raising in tax revenues.

Uruguay’s Delegate: Since 1997 the U.S. has run a current account deficit and a smaller surplus in its capital account. This has led to a small surplus in the country’s official reserve account in order to balance the balance-of-payments account.

With respect to these statements:

A) only one is correct.

B) both are correct.

C) both are incorrect.

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If the U.S. is spending more on public services than it is collecting in tax revenues, it is experiencing a budget deficit, not a trade deficit. If the U.S. is experiencing a current account deficit that is larger than its capital account surplus there will be a change in the country’s official reserve account so that its balance-of-payments will net to zero.

RobertA

In 20X5, Tunisia’s merchandise imports exceeded the value of its merchandise exports. In this case, Tunisia would most likely have which of the following?

A) Balance of trade surplus.

B) Capital account surplus.

C) Current account surplus.

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The capital account includes investment in real assets and financial securities. If a country is running a current account deficit, as in the case of Tunisia, a way to make up the difference in the current account is to be a net borrower creating a surplus in the capital account.

RobertA

In response to exchange rate volatility, a central bank intervenes in the currency market by buying foreign currencies. What effect will this intervention most likely have on the foreign exchange value of the domestic currency and on the country’s official reserves, respectively?

A) Only one will increase.

B) Both will decrease.

C) Both will increase.

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If the central bank intervenes by buying foreign currencies, then it is selling its domestic currency, which will decrease the domestic currency’s foreign exchange value. Official reserves consist of a government’s foreign currency holdings. Buying foreign currencies will increase official reserves.

RobertA

Which of these statements about international finance is most accurate?

A) Purchasing power parity implies that exchange rates should adjust so that investments in any country offer the same risk-adjusted return.

B) Investments in a country by foreign citizens and foreign investments by that country’s own citizens will be reflected in the capital account.

C) Exchange rates tend to be more volatile than the quantity of a currency traded because the factors that affect the supply of a currency are independent of the factors that affect the demand for a currency.

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The capital account measures the principal value of inward investments by foreign citizens and outward investments by domestic citizens. The idea that investments in any country with the same amount of risk should offer the same return is an implication of interest rate parity, not purchasing power parity. Volatility in exchange rates that is large compared to changes in trading volume arises from the fact that the same factors (domestic interest rates and expected future exchange rates) affect both supply and demand for a currency.

RobertA

Which of the following statements is most accurate?

A) Running a deficit in the current account balance simply means a country imports more than it exports, but a country can do this only for a short time.

B) Capital inflows from foreigners are not bad even if the foreigners buy up domestic real estate, domestic industries and own other productive assets.

C) A nation's current account surplus or deficit is a good measure of the health of its economy.

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All statements except for the capital inflows statement are incorrect. Current account deficits are neither good nor bad and countries can run such deficits for long periods of time. Current account deficits are usually accompanied by financial account surpluses that can sustain current account deficits for long periods.

RobertA

Current account deficits are:

A) the result of a country importing less than it exports.

B) an indication that the economy is growing rapidly.

C) not an indication of a nation's economic health.

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A current account deficit occurs when a country imports more than it exports, and it is not an indication of economic health. There is no requirement that the current account balance be zero, in surplus or in deficit.

RobertA

A current account surplus:

A) occurs when a country exports less than it imports.

B) is an indication of significant foreign investment in the domestic market.

C) is not an indication of a nation's economic health.

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A current account surplus occurs when a country exports more than it imports, and it is not an indication of economic health. There is no requirement that the current account balance be zero, in surplus, or in deficit.

RobertA

Under a flexible exchange rate system, a nation that offers more attractive investment opportunities than its trading partners will be likely to experience a:

A) surplus on current account transactions.

B) deficit on its capital account transactions.

C) deficit on current account transactions.

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Higher interest rates attract foreign investment and discourage domestic investment from leaving the country. Thus, the increased aggregate demand encourages imports, which moves the current account towards deficit.

RobertA

The primary reason why the balance of payments method is difficult to implement in determining exchange rates is that:

A) the timeliness of trade flow data tends to affect the current account more dramatically than the capital account and thus gives rise to volatility in the foreign exchange markets.

B) foreign exchange markets affect trade flows and help determine the values of the balance of payments and not the other way around.

C) data on trade flow elasticity is difficult to obtain and the sensitivity of such trade flows to the movement of exchange rates is not determinable.

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The traditional approach to foreign exchange rate determination suggests that exchange rate adjustments are required to restore balance of payments equilibrium. This is a difficult model to implement, however. An analysis of these potential adjustments requires an estimate of trade flow elasticity in response to movements in exchange rates. Further, the model must be dynamic and complex enough to handle the impact of capital flows and the effect on the balance of payment components. Ultimately, small changes in current account flows cannot substantiate the dramatic points of inflection and volatility in the exchange rate markets, meaning an analysis of the elements of the balance of payments is not useful in explaining how exchange rates are determined.