Reading 17: The Exchange Rate and Balance of Payments - LO

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Q1. In 2005, Tunisia’s merchandise imports exceeded the value of its merchandise exports. In this case, Tunisia would most likely have which of the following?

A) Capital account surplus.

B) Balance of trade surplus.

C) Current account surplus.

Q2. 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.

Q3. Which of these statements about international finance is most accurate?

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

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

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.

Q4. 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) both are correct.

B) both are incorrect.

C) only one is correct.