Chapter 8

Relationships
Among
Inflation,Interest
Inflation,Interest
Rates, and
Exchange Rates
1.Assume
1.Ass ume a two-coun
two-country
try
world:
wor ld: Country
Country A and
Country
Coun try B. Whi
Which
ch of the
follo
fol lowi
wing
ng is correct
correct
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4.Because there are a
variety of factors in
addition to inflation that
affect exchange rates, this
will:A)reduce the
probability that PPP shall
hold.B)increase the
probability that PPP shall
hold C)increase the
Chapter 8: Relationships
Among Inflation, Interest
Rates, and Exchange
Rates
223
A)some corporations with
excess cash can lock in a
guaranteed higher return
on future foreignshort-term
investments.B)some
corporations with excess
cash could have
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14.Assume that U.S. and
British investors require a
real return of 2%. If the
nominal U.S. interest rateis
15%, and the nominal
British rate is 13%, then
according to the IFE, the
British inflation rate
isexpected to be about
Chapter 8: Relationships
Among Inflation, Interest
Rates, and Exchange
Rates
225
18.If interest rate parity
holds, then the one-year
forward rate of a
currency will be _______
the predicted spot rate of
the currency in one year
according to the
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22.The inflation rate in the
U.S. is 3%, while the
inflation rate in Japan is
1.3%. The current
exchangerate for the
Japanese yen (¥) is
$0.0075. After supply and
demand for the Japanese
yen has adjustedin the
Chapter 8: Relationships
Among Inflation, Interest
Rates, and Exchange
Rates
227
25.Which of the following
is indicated by research
regarding purchasing power
parity (PPP)?A)PPP
clearly holds in the short
run.B)Deviations from
PPP are reduced in the
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29.
Which of the following is
not 
true regarding IRP, PPP,
and the IFE?A)IRP
suggests that a currency’s
spot rate will change
according to interest rate
differentials.B)PPP
Chapter 8: Relationships
Among Inflation, Interest
Rates, and Exchange
Rates
229
35.If interest rate parity
holds, and the international
Fisher effect (IFE) holds,
foreign currencies
withrelatively high interest
rates should have forward
discounts and those