bapswarrior

Suppose you are an investor that holds foreign bonds. What does it mean if bonds have positive currency exposure to the foreign currency?

A) The exposure is always a return enhance attribute of the foreign bond.

B) As interest rates go up, the value of the foreign currency increases.

C) As interest rates go up, the value of the foreign currency falls.

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Positive exposure implies that interest rate changes and currency valuation changes amplify the impact of each other. That is, as local rates increase (bad for bond investors) the value of the local currency tends to fall (bad for foreign bond investors).

bapswarrior

Sally Metford, CFA, has just accepted a position working for the Canadian government. As an economic advisor, Metford has been asked to comment on the implications of changes in domestic currency, government policy, and inflation expectations.According to money demand theory, an increase in economic activity in Canada will most likely lead to a(n):

A) increase in demand for Canadian dollars causing a depreciation in Canadian currency.

B) increase in demand for Canadian dollars causing an appreciation in Canadian currency.

C) decrease in demand for Canadian dollars causing a depreciation in Canadian currency.

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According to money demand theory, an increase in economic activity in Canada will most likely lead to an increase in demand for Canadian dollars causing an appreciation in Canadian currency. Therefore, the money demand model explains the positive short-run correlation between exchange rate movements and stock returns.

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Metford’s supervisor has asked for recommendations regarding interest rate policies. The Canadian government is concerned that the value of the Canadian dollar has approached the upper target range. Assuming the Canadian government introduces a “leaning-against-the-wind” policy, the Canadian government will most likely:

A) induce negative currency exposure.

B) ease interest rates.

C) raise interest rates.

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A strong domestic currency will lead local governments to ease interest rates. This is often referred to as a “leaning-against-the-wind” policy that induces positive currency exposure.

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Which of the following are most likely to occur if the Canadian real rate of interest increases? There will be a(n):

A) a positive currency exposure from bond investors.

B) capital flow out of Canada.

C) increased demand for Canadian currency from abroad.

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An increase in the Canadian real rate of interest will cause capital to flow into Canada from foreign investors. This increased demand for Canadian dollars causes an increase in the value of the Canadian dollar. This in turn will create negative currency exposure for bond investors.

bapswarrior

What is the likely long-term impact of real depreciation of a nation’s currency?

A) Decreased standard of living.

B) Increased competitiveness of domestic industry.

C) Increased budget deficits.

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In the long run, real depreciation makes a nation’s domestic industry more competitive in the international marketplace.

bapswarrior

Assume that a country has a negative trade balance. In the traditional model of the impact of currency appreciation on domestic economic activities, what is the likely short-run impact of currency depreciation?

A) The cost of imports increases widening the trade balance.

B) Domestic industry becomes more competitive narrowing the trade balance.

C) The cost of imports decreases narrowing the trade balance.

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In the short run, if a country’s currency depreciates in real terms, the cost of imports increases causing a widening in the trade balance (exports – imports) and an increase in domestic inflation. Currency depreciation tends to reduce economic activity in the short run.

bapswarrior

According to the traditional model, a decline in the value of a country’s currency has what effect upon national competitiveness in the long run and domestic inflation in the short run?

A) Both will increase.

B) Both will decrease.

C) Only one will increase.

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Under the traditional model, a decline in the value of a country’s currency increases national competitiveness in the long run and increases domestic inflation in the short run. This will occur due to an increase in exports for the country whose currency is less valuable. In the short run the cost of imports increases for the country with the decline in currency value.

bapswarrior

Suppose a nation’s monetary authority increases real interest rates. What does economic theory tell us will happen to the value of the nation’s currency?

A) Changes in the nominal rate, not the real rate, cause appreciation.

B) The value of the currency will fall.

C) The value of the currency will rise.

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If the monetary authority (e.g., the central bank) increases real rates, capital will flow into the country. The increased demand for the nation's currency will cause the currency to appreciate

bapswarrior

In the money demand model, what is the relationship between appreciation in the domestic currency and the equity markets? Currency appreciation:

A) is negatively correlated with equity returns.

B) hurts competitiveness and stock market returns.

C) is positively correlated with equity returns.

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In the money demand model, an increase in real economic activity leads to an increase in the demand for the domestic currency. The increased currency demand causes the value of the currency to appreciate. Because stock prices are highly correlated with gross domestic product growth, the money demand model explains the positive short-run correlation between exchange rate movements and stock returns.