

40. Firms should not utilize the forward exchange market when they are faced with uncertainty about the
future value of currencies.

FALSE
Faced with uncertainty about the future value of currencies, firms can utilize the forward exchange
market.


Multiple Choice Questions


41. The international monetary system refers to the institutional arrangements that govern _____.

A.microeconomic parameters
B.exchange
rates
C.gross domestic produce
D.foreign direct
investment
The international monetary system refers to the institutional arrangements that govern exchange
rates.


42. When the foreign exchange market determines the relative value of a currency, we say that the
country is adhering to a _____ regime.

A.currency board exchange

B.pegged exchange
rate
C.fixed exchange rate
D.floating exchange
rate
When the foreign exchange market determines the relative value of a currency, we say that the
country is adhering to a floating exchange rate regime. Four of the world's major trading
currencies—the U.S. dollar, the European Union's euro, the Japanese yen, and the British
pound—are all free to float against each other.


43. A pegged exchange rate means that the value of a currency is _____.

A.fixed against other currencies based on an

agreement
B.not determined by free market
forces
C.fixed relative to a reference currency
D.independent of the valuations of other
currencies
 A pegged exchange rate means the value of the currency is fixed relative to a reference currency,
such as the U.S. dollar, and then the exchange rate between that currency and other currencies is
determined by the reference currency exchange rate.


44. A dirty float refers to a situation in which _____.

A.a set of currencies are fixed against each other at some mutually agreed on exchange
rate
B.many countries join hands to form a monetary system and an exchange rate
C.more than one foreign currency is used as the formal reference for a country's currency
D.a country tries to hold its currency against an important reference currency without a formal
pegged rate
Countries, while not adopting a formal pegged rate, try to hold the value of their currency within
some range against an important reference currency such as the U.S. dollar, or a "basket" of
currencies. This is often referred to as a dirty float.


45. After World War II, world's major industrial nations arranged their currencies against each other at a
mutually agreed on exchange rate. This is an example of a _____ system.

A.fixed exchange rate

B.dirty float exchange
C.pegged exchange
rate
D.floating exchange
rate
With a fixed exchange rate system, the values of a set of currencies are fixed against each other at
some mutually agreed on exchange rate.


46. Which of the following statements is true of the Gold standard?

A.Gold standard was adopted only by the smaller nations of the

world.
B.Currencies were pegged to gold under the gold standard.
C.Convertibility to gold was not guaranteed under the gold standard.
D.Gold standard was not helpful in maintaining balance-of-trade
equilibrium.
Pegging currencies to gold and guaranteeing convertibility is known as the gold standard. By 1880,
most of the world's major trading nations, including Great Britain, Germany, Japan, and the United
States, had adopted the gold standard.


47. Gold par value refers to the _____.

A.ratio of price of gold in a currency to price of gold in U.S. dollars

B.amount of a currency needed to purchase one ounce of gold
 C.ratio of price of gold in a currency to price of gold in
euros
D.amount of gold required to equal the reference currency that a nation is
using
The amount of a currency needed to purchase one ounce of gold is referred to as the gold par value.


48. A country is said to be in balance-of-trade equilibrium when _____.

A.it has the potential to produce all goods that its residents want without engaging in foreign
trade
B.the income its residents earn from exports is equal to the money its residents pay for imports
C.the country import all goods that its residents want by engaging in foreign trade
D.it has the potential to balance the production and procurement of the basic amenities that it
needs
A country is said to be in balance-of-trade equilibrium when the income its residents earn from
exports is equal to the money its residents pay to other countries for imports (the current account of
its balance of payments is in balance).


49. A country's trade balance is in surplus when _____

A.its exports are more than its

imports
B.it experiences negative
inflation
C.its exports equal the
imports
D.the prices of commodities are low in the country
A country's trade balance is in surplus when it exports more than what it imports.


50. Which of the following is an advantage of using the gold standard?

A.The standard makes sure that goods are not priced out from markets due to
inflation.
B.The standard does not require a commitment from nations to maintain its currency's value.
C.The standard effectively prevents the devaluation of currencies across the world.
D.It contains a powerful mechanism for achieving balance-of-trade equilibrium by all countries.
The great strength claimed for the gold standard was that it contained a powerful mechanism for
achieving balance-of-trade equilibrium by all countries.


51. The agreement reached at Bretton Woods established _____.

A.International Monetary
Fund
B.World Economic Forum
C.United Nations
 D.International Atomic Energy
Agency
The agreement reached at Bretton Woods established two multinational institutions— the
International Monetary Fund (IMF) and the World Bank.


52. Which of the following observations is true of the Bretton Woods agreement?

A.All countries agreed to fix the value of their currency in terms of gold under the
agreement.
B.The system accepted Pound as the official reference currency against gold.
C.The agreement established a floating system of monetary exchange.
D.Two multinational institutions, World Economic Forum and WTO, were formed under the
agreement.
The Bretton Woods agreement called for a system of fixed exchange rates that would be policed by
the IMF. Under the agreement, all countries were to fix the value of their currency in terms of gold but
were not required to exchange their currencies for gold.


53. The World Bank was established at the at Bretton Woods conference to _____.

A.establish an international monetary

system
B.promote general economic development
C.establish gold standard across the world
D.fund the initiatives of the United Nations
The agreement reached at Bretton Woods established the World Bank. The task of the World Bank
was to promote general economic development.


54. Identify the currency that was convertible to gold under the Bretton Woods system.

A.Poun
d
B.Yen
C.Euro
D.Dollar
Under the Bretton Woods agreement, all countries were to fix the value of their currency in terms of
gold but were not required to exchange their currencies for gold. Only the dollar remained
convertible into gold.


55. What will happen if a country increases its money supply rapidly under fixed exchange rate regime?

A.Imports will become less attractive in that country.

B.The country will face negative inflation.
C.Trade deficit would widen in that country.
D.The country's products will become more attractive in world
markets.
 A fixed exchange rate regime imposes monetary discipline on countries and curtails price inflation.
For example, if a country increases its money supply by printing more currency, the increase in
money supply would lead to price inflation. Given fixed exchange rates, inflation would make the
country's goods uncompetitive in world markets, while the prices of imports would become more
attractive in that country. The result would be a widening trade deficit in the country, with the country
importing more than it exports.


56. Which of the following is a disadvantage of using a rigid policy of fixed exchange rates?

A.It is likely to create high unemployment in some cases.

B.It will lead to inflationary economies across the
world.
C.It is likely to bring about trade wars between nations.
D.It will instigate competitive devaluations and intense
competition.
A rigid policy of fixed exchange rates would be too inflexible. In some cases, a country's attempts to
reduce its money supply growth and correct a persistent balance-of-payments deficit could force the
country into recession and create high unemployment.


57. Which of the following is a function of World Bank?

A.Implementing a rigid fixed exchange rate regime

B.Promoting gold standard across the
world
C.Lending money to governments for
development
D.Implementing a flexible fixed exchange rate
regime
The World Bank was established to reconstruct world economies. The bank lends money to entities
such as governments.


58. Which of the following is a factor that initiated the collapse of the fixed exchange rate system?

A.Worsening of Great Britain's balance of trade

B.Recession in third world
countries
C.Price inflation in Europe
D.Worsening of U.S. foreign trade position
U.S. dollar had a special role in the fixed exchange rate system as the only currency that could be
converted into gold. This meant that any pressure on the dollar would devalue the system. The
increase in inflation and the worsening of the U.S. foreign trade position gave rise to speculation in
the foreign exchange market that the dollar would be devalued. This initiated the demise of the fixed
exchange rate system.

59. Which of the following changes were made to IMF's Articles of Agreement in the Jamaica
agreement?

A.IMF members were permitted to use Dollar as the convertible currency.

B.Gold was declared as a formal reserve asset for IMF
members.
C.IMF members were permitted to sell their gold reserves at the market price.
D.IMF members were restricted from entering the foreign exchange
market.
IMF members met in Jamaica in January 1976 and agreed to the rules for the international monetary
system that are in place today. In the meeting, gold was abandoned as a reserve asset. IMF
members were permitted to sell their own gold reserves at the market price.


60. _____ exchange rates were declared as acceptable in the Jamaica agreement of IMF.

A.Pegge
d
B.Fixe
d
C.Floating
D.Gold standard
Floating rates were declared acceptable in the Jamaica agreement. IMF members were also
permitted to enter the foreign exchange market to even out "unwarranted" speculative fluctuations.


61. United States had large and growing trade deficit between 1980 and 1985. Despite this, the value of
U.S. dollar rose during this period. Which of the following is a factor that caused this occurrence?

A.United States attracted heavy inflows of capital from foreign investors during this period.
B.Banks in the United States offered low interest rates to investors during this period.
C.Markets across the world witnessed strong economies during this period.
D.Developed countries in Europe maintained trade equilibrium and supplied goods to
underdeveloped countries.
A number of favorable factors overcame the unfavorable effect of a trade deficit. Strong economic
growth in the United States was one such factor. It attracted heavy inflows of capital from foreign
investors seeking high returns on capital assets.


62. Which of the following is the reason why the current foreign-exchange system is sometimes thought
of as a managed-float system?

A.The exchange rates of a currency are determined by market forces.

B.Governments intervene frequently in the foreign exchange market.
C.Major currencies are allowed to freely float against each other.
D.Countries use a reference currency to estimate the value of their
currencies.
High frequency of government intervention in the foreign exchange market explains why the current
system is sometimes thought of as a managed-float system or a dirty-float system.


63. Which of the following arguments is in favor of floating exchange rates?

A.A country's ability to expand or contract its money supply should be limited by the need to
maintain exchange rate parity.
B.Maintaining balance of trade equilibrium is not in the best interest of a country.
C.Countries can isolate themselves from uncertainties when they trade using a mutually agreed on
exchange rate.
D.Governments can restore monetary control by removing the obligation to maintain exchange rate
parity.
Advocates of a floating exchange rate regime argue that removal of the obligation to maintain
exchange rate parity would restore monetary control to a government. If a government faced with
unemployment wanted to increase its money supply to stimulate domestic demand and reduce
unemployment, it could do so unencumbered by the need to maintain its exchange rate.


64. The monetary autonomy argument holds that _____.

A.each country should be allowed to choose its own inflation rate

B.inflation is beneficial to a country's economy and
growth
C.inflation is detrimental to a country's economy and growth
D.countries should restrict inflation based on the global
standards
Advocates of floating rates argue that each country should be allowed to choose its own inflation
rate. This is called the monetary autonomy argument.


65. Which of the following arguments is against the use of fixed exchange rates?

A.Monetary discipline is the most important determinant of a strong economy.

B.Each country has the freedom to choose its own inflation rate.
C.Market speculation can cause fluctuations in exchange
rates.
D.Governments are likely to expand the monetary supply far too rapidly due to political
pressures.
Advocates of floating rates argue that each country should be allowed to choose its own inflation
rate. This is called the monetary autonomy argument.


66. Which of the following arguments strengthen the idea of floating exchange rates?

A.External agencies should not interfere in the monetary policies of a country.

B.Trade deficits can be corrected through changes in exchange rates.
C.Changes in exchange rates will not impact the trade balance in a country.
D.Governments should act in ways to minimize the uncertainty in monetary markets.
 The supporters of floating exchange rates argue that floating rates can correct trade deficit by
making its exports cheaper and its imports more expensive. They argue that exchange rate
depreciation should correct the trade deficit.


67. Those in favor of floating exchange rate claim that _____.

A.uncertainty in monetary markets dampens the growth of international

trade
B.inflation is beneficial to a country if it is controlled
closely
C.trade imbalances can be adjusted by using floating exchange
rates
D.governments can have rigid control over monetary markets by using floating
rates
Those in favor of floating exchange rates argue that floating rates help adjust trade imbalances.


68. Which of the following is an exchange rate policy where the exchange rate is determined completely
by market forces?

A.Managed
float
B.Fixed
peg
C.Free float
D.Currency
board
Governments around the world pursue a number of different exchange rate policies. One such policy
is a pure "free float" where the exchange rate is determined by market forces.


69. Which of the following is the exchange rate policy where the government intervenes in the exchange
rate system only in a limited way?

A.Managed
float
B.Fixed
peg
C.Free float
D.Currency
board
In a managed float system governments intervene in only a limited way. About 26 percent of IMF's
members use this system.

70. Under a _____ exchange rate regime, a country will attach the value of its currency to that of a major
currency.

A.managed
float
B.pegge
d
C.free
float
D.currency board
Under a pegged exchange rate regime, a country will attach the value of its currency to that of a
major currency so that, for example, as the U.S. dollar rises in value, its own currency rises too.


71. Which of the following statements is true of pegged exchange rates?

A.A pegged exchange rate allows a country's currency to be determined by market

forces.
B.A pegged exchange rate weakens the monetary discipline of a country.
C.Pegged exchange rates are popular among many of the world's smaller
nations.
D.Adopting a pegged exchange rate regime increases inflationary pressures in a country.
Under a pegged exchange rate regime, a country will peg the value of its currency to that of a major
currency. Pegged exchange rates are popular among many of the world's smaller nations.


72. A country that introduces a currency board commits itself to converting its domestic currency on
demand into _____.

A.another currency at a fixed exchange

rate
B.gold or silver at a fixed exchange rate
C.gold or silver at a floating exchange rate
D.another currency at a floating exchange
rate
A country that introduces a currency board commits itself to converting its domestic currency on
demand into another currency at a fixed exchange rate. To make this commitment credible, the
currency board holds reserves of foreign currency equal at the fixed exchange rate to at least 100
percent of the domestic currency issued.


73. Under a currency board system, _____.

A.inflation rates are maintained at high

level
B.countries issue domestic notes at
will
C.interest rates remain constant
D.government lacks the ability to set interest rates
 Under a currency board system, government lacks the ability to set interest rates. Interest rates in
Hong Kong, for example, are effectively set by the U.S. Federal Reserve.


74. A currency crisis occurs due to _____.

A.the loss of confidence in a country's banking system

B.heavy foreign debt obligations
C.high levels of trade deficit
D.a speculative attack on the exchange value
A currency crisis occurs when a speculative attack on the exchange value of a currency results in a
sharp depreciation in the value of the currency or forces authorities to expend large volumes of
international currency reserves and sharply increase interest rates to defend the prevailing exchange
rate.


75. Moral hazard arises when people behave recklessly because _____.

A.of the restrictions that exist in a country's monetary

policy
B.of the restrictions that IMF has imposed on
them
C.they know they will be saved if things go wrong
D.they face financial difficulties arising out of external factors
Moral hazard arises when people behave recklessly because they know they will be saved if things
go wrong.


76. Which of the following is a common criticism against IMF?

A.IMF lacks any real mechanism for accountability.

B.It is hesitant to help banks when they are in
crisis.
C.IMF has not intervened to resolve the Asian crisis.
D.It did not try to resolve the Mexican currency
crisis.
One criticism of the IMF is that it has become too powerful for an institution that lacks any real
mechanism for accountability.


77. Which of the following observations is true of the current system of foreign exchange market?

A.Most of the currencies can be converted to gold in the current system of foreign
exchange.
B.The current system is driven by fixed exchange rates.
C.Currencies float freely against others in the current system.
D.The current system is a combination of government intervention and speculative activity.
The current system of foreign exchange is a mixed system in which a combination of government
intervention and speculative activity can drive the foreign exchange market.


78. Which of the following will help a company hedge against currency fluctuations?

A.Finding a large supplier to supply all the raw materials

B.In-house manufacturing of raw materials
C.Basing business in a single country
D.Dispersing production to different geographic locations
Maintaining strategic flexibility can take the form of dispersing production to different locations
around the globe as a real hedge against currency fluctuations.


79. Contracting out manufacturing allows companies to reduce economic exposure because _____.

A.having multiple suppliers attracts subsidies from government

B.it reduces the pressure on them to maintain a trade surplus
C.it allows companies to shift suppliers from country to country
D.quality issues are insignificant when manufacturing is contracted to
others
One way of building strategic flexibility and reducing economic exposure involves contracting out
manufacturing. This allows a company to shift suppliers from country to country in response to
changes in relative costs brought about by exchange rate movements.


80. Increasingly the _____ has been acting as macroeconomic police of the world economy, insisting
that countries seeking significant borrowings adopt certain macroeconomic policies.

A.ECOSO
C
B.IMF
C.U
N
D.World Bank
Increasingly the IMF has been acting as macroeconomic police of the world economy, insisting that
countries seeking significant borrowings adopt IMF-mandated macroeconomic policies.


Essay Questions

81. What is international monetary system? What are the major trading currencies?

The international monetary system refers to the institutional arrangements that govern exchange
rates. The four major trading currencies are the U.S. dollar, the European Union's euro, the
Japanese yen, and the British pound.
