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ch10

Student: ___________________________________________________________________________

1.

The institutional arrangements that govern exchange rates are referred to as the international monetary system. True False

2.

The exchange rates of all currencies are determined by the free play of market forces. True False

3.

A pegged rate means that the value of a currency is fixed relative to a reference currency, and then the exchange rate between that currency and other currencies is determined by the reference currency exchange rate. True False

4.

Many of the world's developing nations peg their currencies, primarily to the dollar or the yen. True False

5.

If a country tries to hold the value of its currency within some range against an important reference currency, the country has a dirty float system. True False

6.

The gold standard called for a fixed exchange rate system against the U.S. dollar. True False

7.

With the exception of Great Britain, most of the world's major trading nations, including the United States, Germany, and Japan had adopted the gold standard by 1880. True False

8.

The amount of currency needed to purchase one ounce of gold under the gold standard was referred to as the gold par value. True False

9.

It was claimed that the strength of the gold standard was that it contained a powerful mechanism for achieving balance-of-trade equilibrium. True False

10. The World Bank is responsible for maintaining order in the international monetary system. True False

11. The Bretton Woods system called for a system of floating exchange rates. True False

12. Under the Bretton Woods system, only the dollar, the pound, and the yen were convertible to gold. True False

13. Devaluations of up to 10 percent were permitted under the Bretton Woods system. True False

14. The World Bank's initial mission was to lend money to Third World nations. True False

15. The strength of the Bretton Woods system was that it could work even if its key currency, the U.S. dollar, was under speculative attack. True False

16. Under the Jamaica Agreement, floating exchange rates were declared acceptable, and gold was abandoned as a reserve asset. True False

17. Since 1973, exchange rates have been relatively stable thanks to the floating exchange rate system currently in place. True False

18. In 1997, the currencies of several Asian nations including South Korea, Indonesia, and Thailand lost between 50 percent between 80 percent of the value against the U.S. dollar over the period of a few months. True False

19. The so-called Group of Five major industrial countries includes Great Britain, the United States, Japan, Switzerland, and Germany. True False

20. The Plaza Accord, signed in 1985, suggested that it would be desirable for most major currencies to fall relative to the U.S. dollar. True False

21. The Louvre Accord pledged to support the stability of exchange rates around their 1987 levels by intervening in the foreign exchange markets when necessary to buy and sell currency. True False

22. Under a fixed exchange rate regime, countries were limited in their ability to use monetary policy to expand or contract their economies. True False

23. A pure free float is one in which exchange rates are determined by market forces. True False

24. In 2007, about a quarter of the IMF's members had an exchange rate policy that allowed their currency to float freely. True False

25. Under a currency board system, a country commits itself to converting its currency on demand into another currency at a fixed exchange rate. True False

26. Evidence shows that adopting a pegged exchange rate regime increases inflationary pressures in a country. True False

27. Under a strict currency board system, interest rates rise until investors eventually find holding the local currency attractive again. True False

28. If local inflation rates remain lower than the inflation rate in the country to which the currency is pegged, the currencies of countries with currency boards can become uncompetitive and overvalued. True False

29. A foreign debt crisis refers to a loss of confidence in the banking system that leads to a run on banks. True False

30. When a country cannot service its foreign debt obligations, a banking crisis has occurred. True False

31. High relative price inflation, a widening current account deficit, excessive expansion of domestic borrowing, and asset price inflation are all underlying causes of banking or foreign debt crises. True False

32. The financial crisis that erupted across Southeast Asia during the fall of 1997 emerged as the biggest challenge to date for the IMF. True False

33. The Asian meltdown began in mid-1997 in Japan when it became clear that several key Japanese financial institutions were on the verge of default. True False

34. IMF loan packages typically include conditions such as cuts in public spending, higher interest rates, and tight monetary policy. True False

35. One criticism of the IMF's policy prescriptions is that its "one-size-fits-all" approach to microeconomic policy is inappropriate for many countries. True False

36. The IMF can force countries to adopt the policies required to correct economic mismanagement. True False

37. While a government may commit to taking corrective action in return for an IMF loan, internal political problems may make it difficult for a government to act on that commitment. True False

38. Speculative buying and selling of currencies can create very volatile movements in exchange rates. True False

39. MNEs can hedge against currency fluctuations by dispersing production to different locations around the globe. True False

40. An MNE can build strategic flexibility and reduce economic exposure by contracting out manufacturing. True False

41. The institutional arrangement that governs exchange rates is known as the: A. B. C. D. financial control system. international monetary system. international monetary fund. international financial regime.

42. When the foreign exchange market determines the relative value of a currency, we say that the currency is adhering to a(n): A. B. C. D. volatile exchange rate. pegged exchange rate. floating exchange rate. fixed exchange rate.

43. A _____ means the value of the currency is fixed relative to a reference currency. A. B. C. D. pegged exchange rate dynamic exchange rate floating exchange rate fixed exchange rate

44. When the central bank of a country intervenes in the foreign exchange market to try to maintain the value of its currency if it depreciates too rapidly against an important reference currency, the country is said to be following a _____ system. A. B. C. D. fixed exchange rate clean float floating exchange rate dirty float

45. In a _____ exchange rate system, the value of a set of currencies is fixed against each other at some mutually agreed on exchange rate. A. B. C. D. pegged dirty fixed direct

46. The gold standard had its origin in the use of _____ as a medium of exchange, unit of account, and store of value. A. B. C. D. the U.S. dollar the British pound paper currency gold coins

47. When a country pegs its currencies to gold and guarantees convertibility, the country is following the: A. B. C. D. gold standard. Bretton Woods system. fixed exchange system. floating exchange rate system.

48. Under the gold standard, the U.S. dollar could be converted into _____ grains of fine gold. A. B. C. D. 10.1 17.3 23.33 480

49. The amount of a currency need to purchase one ounce of gold under the gold standard was known as the: A. B. C. D. gold par value. gold standard. fixed gold rate. pegged rate.

50. The great strength claimed for the gold standard was that it contained a powerful mechanism for achieving _____ by all countries. A. B. C. D. balance-of-trade equilibrium economic stability interest rate parity equal tariff levels

51. When the income a country's residents earn from exports is equal to the money its residents pay to other countries for imports, the country is said to: A. B. C. D. be in current account equilibrium. be in capital account equilibrium. be in balance-of-trade equilibrium. have a managed float.

52. Bretton Woods set a restriction of _____ percent for devaluations of currency, if a currency became too weak to defend, without permission from the IMF. A. B. C. D. 5 10 15 20

53. Under the Bretton Woods, all countries fixed the value of their currency in terms of: A. B. C. D. the British pound. the euro. the U.S. dollar. gold.

54. The Bretton Woods IMF Articles of Agreement, tried to impose discipline by adopting a _____ exchange rate system that was seen as a mechanism for controlling inflation and imposing economic discipline on countries. A. B. C. D. fixed floating dirty float pegged

55. The Bretton Woods agreement differed from the gold standard in that it: A. B. C. D. incorporated both discipline and flexibility. was a floating rate system. was based on the British pound. was a rigid system of fixed exchange rates.

56. The International bank for Reconstruction and Development is also known as the: A. B. C. D. IMF. World Bank. European Central Bank. International Development Agency.

57. Most economists trace the breakup of the Bretton Woods fixed exchange rate system, in 1973, to the: A. B. C. D. rise of communism in Eastern Europe. economic integration movement sweeping Western Europe. macroeconomic policy package in the U.S. during 1965 to 1968. increase in inflation and the worsening of the British foreign trade position.

58. The Bretton Woods Agreement could only work if the U.S. had: A. B. C. D. high inflation and no balance-of-payments deficit. low inflation and no balance-of-payments deficit. low inflation and a current account deficit. high inflation and a capital account surplus.

59. In 1976, the _____ formalized the floating exchange rate system that followed the collapse of fixed exchange rate system. A. B. C. D. gold standard Plaza Accord Jamaica Agreement Louvre Accord

60. The main elements of the 1976 Jamaica agreement include all of the following except: A. B. C. D. floating rates were declared unacceptable. gold was abandoned as a reserve asset. total annual IMF quotas were increased to $41 billion. IMF members were permitted to sell their own gold reserves at the market price.

61. The _____ suggested that it would be desirable for most major currencies to appreciate relative to the dollar, and signatories pledged to intervene in the foreign exchange markets, selling dollars, to achieve this objective. A. B. C. D. Louvre Accord Plaza Accord Bretton Woods Agreement gold standard

62. Under the _____ of 1987, the Group of Five agreed that exchange rates had realigned sufficiently from earlier levels and pledged to support the stability of exchange rates around their current levels by intervening in the foreign exchange market when necessary. A. B. C. D. Plaza Accord Jamaica Agreement Louvre Accord Bretton Woods Agreement

63. A managed-float system is also known as a: A. B. C. D. fixed exchange rate system. floating exchange rate system. pegged exchange rate system. dirty-float exchange rate system.

64. According to some analysts, under a _____ regime, countries are limited in their ability to use monetary policy to expand or contract their economies by the need to maintain exchange rate parity. A. B. C. D. managed float dirty float fixed exchange rate floating exchange rate

65. A fixed exchange rate regime: A. modeled along the lines of the Bretton Woods system will not work. B. allows each country to choose its own inflation rate. C. is characterized by speculation that adds to the uncertainty surrounding future currency movements. D leads to a situation where governments under political pressures expand monetary supply too rapidly, . causing unacceptably high price inflation. 66. In 2006, about a quarter of the IMF members had a(n) _____ exchange rate policy. A. B. C. D. fixed peg currency board free float adjustable peg

67. Under a pegged exchange rate regime, a country will peg the value of its currency to _____ so that its own currency rises too. A. B. C. D. its domestic inflation rate that of a major currency its interest rates its foreign exchange reserves

68. Pegged exchange rates are popular among many of the world's: A. B. C. D. highly developed nations. richest nations. smaller nations. large economies.

69. The great virtue claimed for a pegged exchange rate is that it: A. B. C. D. imposes monetary discipline on a country. leads to high inflation. leads to devaluation. increases fluctuations in exchange rates.

70. Under a strict currency board system, interest rates: A. B. C. D. adjust automatically. are constant. decline consistently. rarely move.

71. When a country commits itself to converting its domestic currency on demand into another currency at a fixed exchange rate, the country has adopted a _____ system of exchange rates. A. B. C. D. pegged floating currency board fixed

72. When a speculative attack on the exchange value of a currency results in a sharp depreciation in the value of a currency, a(n) _____ has occurred. A. B. C. D. foreign debt crisis banking crisis currency crisis exchange crisis

73. A banking crisis: A is a situation in which consumer spending patterns significantly affect a country's balance of payments, . thereby affecting its currency. B. is a situation in which a country cannot service its debt obligations. C. refers to a loss of confidence in the banking system that leads to a run on banks, as individuals withdraw their deposits. D. occurs when a speculative attack on the exchange value of a currency results in a sharp depreciation in the value of the currency. 74. A foreign debt crisis: A is a situation in which consumer spending patterns significantly affect a country's balance of payments, . thereby affecting its currency. B. is a situation in which a country cannot service its debt obligations. C. refers to a loss of confidence in the banking system that leads to a run on banks, as individuals withdraw their deposits. D. occurs when a speculative attack on the exchange value of a currency results in a sharp depreciation in the value of the currency. 75. The 1995 Mexican currency crisis and the 1997 Asian financial crisis were the result of all of the following except: A. B. C. D. excessive foreign borrowings. a weak or poorly regulated banking system. high inflation rates. high balance-of-trade surplus.

76. In 1997, the IMF agreed to provide the Thai government with $17.2 billion in loans to help its shattered economy. While doing so, IMF imposed all of the following restrictions except: A. B. C. D. the government was to increase taxes. public spending needed to be cut. several state-owned businesses were to be privatized. interest rates were to be reduced.

77. _____ arises when people behave recklessly because they know they will be saved if things go wrong. A. B. C. D. A debt situation Moral hazard A conflict of interest Policy failure

78. The IMF has been criticized because of all of the following reasons except: A. it has a "one-size-fits-all" approach to macroeconomic policy is inappropriate for many countries. B. its rescue efforts are exacerbating a problem known to economists as moral hazard. C. it has become too powerful for an institution that lacks any real mechanism for accountability. D its lax macroeconomic policies in the Asian crisis were not well suited to countries suffering from a . private sector debt crisis with deflationary undertones. 79. The use of the forward market and swaps to protect against foreign exchange risk has increased markedly since: A. B. C. D. the breakdown of the gold standard. the collapse of the Bretton Woods system in 1973. the end of the Plaza Accord. the Louvre Accord ended in 1968.

80. Because of the long-term implications of volatile exchange rates, firms should: A. B. C. D. use the forward market because it is a perfect predictor of future exchange rates. get complete insurance coverage for exchange rates that might occur several years in the future. pursue strategies that reduce economic exposure. avoid transactions that involve foreign currencies.

81. Discuss the international monetary system. What are the major trading currencies?

82. Explain the notion of a floating exchange rate regime. Give examples.

83. What is a pegged exchange rate system? Give example of a country following it.

84. Compare and contrast a pegged exchange system and a dirty float system of exchange rates.

85. How does a floating exchange rate regime differ from a dirty float system? Why would a country choose a dirty float system over a free float?

86. How does a fixed exchange rate system work?

87. What was the gold standard? Who participated in the system? What was the major advantage of the system?

88. With the help of an example, discuss the notion of balance-of-trade equilibrium.

89. What was the Bretton Woods agreement? How was it different from the gold standard?

90. What two multinational institutions were established at the Bretton Woods agreement? What are their roles in the international monetary system?

91. Why did the Bretton Woods system fail?

92. Discuss the Jamaica Agreement. What relevance does the agreement have on today's exchange rate system?

93. Describe how exchange rates have been since the collapse of the fixed exchange rate system in 1973. What factors account for the changes in exchange rates since that time?

94. Discuss the arguments for a floating exchange rate system.

95. Consider the case for fixed exchange rates.

96. What is a currency board? Why do countries choose this type of system? What are the disadvantages of this type of arrangement?

97. Compare and contrast currency crises, banking crises, and foreign debt crises.

98. Recent policies by the IMF have drawn a lot of fire. Discuss the criticisms of the IMF. Do you agree with the critics? Why or why not?

99. Discuss the notion of moral hazard. What is the relationship between moral hazard and the IMF?

100.How can international companies reduce their economic exposure in a world of constantly fluctuating exchange rates?

ch10 Key
1.
(p. 342)

The institutional arrangements that govern exchange rates are referred to as the international monetary system. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #1 Learning Objective: 10-1

2.
(p. 342)

The exchange rates of all currencies are determined by the free play of market forces. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #2 Learning Objective: 10-1

3.
(p. 342)

A pegged rate means that the value of a currency is fixed relative to a reference currency, and then the exchange rate between that currency and other currencies is determined by the reference currency exchange rate. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #3 Learning Objective: 10-1

4.
(p. 342)

Many of the world's developing nations peg their currencies, primarily to the dollar or the yen. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #4 Learning Objective: 10-1

5.
(p. 342)

If a country tries to hold the value of its currency within some range against an important reference currency, the country has a dirty float system. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #5 Learning Objective: 10-1

6.
(p. 342)

The gold standard called for a fixed exchange rate system against the U.S. dollar. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #6 Learning Objective: 10-1

7.
(p. 343)

With the exception of Great Britain, most of the world's major trading nations, including the United States, Germany, and Japan had adopted the gold standard by 1880. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #7 Learning Objective: 10-1

8.
(p. 344)

The amount of currency needed to purchase one ounce of gold under the gold standard was referred to as the gold par value. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #8 Learning Objective: 10-1

9.
(p. 344)

It was claimed that the strength of the gold standard was that it contained a powerful mechanism for achieving balance-of-trade equilibrium. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #9 Learning Objective: 10-1

10.
(p. 342)

The World Bank is responsible for maintaining order in the international monetary system. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #10 Learning Objective: 10-2

11.
(p. 345)

The Bretton Woods system called for a system of floating exchange rates. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #11 Learning Objective: 10-2

12.
(p. 345)

Under the Bretton Woods system, only the dollar, the pound, and the yen were convertible to gold. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #12 Learning Objective: 10-2

13.
(p. 345)

Devaluations of up to 10 percent were permitted under the Bretton Woods system. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #13 Learning Objective: 10-2

14.
(p. 347)

The World Bank's initial mission was to lend money to Third World nations. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #14 Learning Objective: 10-2

15.
(p. 348)

The strength of the Bretton Woods system was that it could work even if its key currency, the U.S. dollar, was under speculative attack. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #15 Learning Objective: 10-2

16.
(p. 348)

Under the Jamaica Agreement, floating exchange rates were declared acceptable, and gold was abandoned as a reserve asset. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #16 Learning Objective: 10-2

17.
(p. 349)

Since 1973, exchange rates have been relatively stable thanks to the floating exchange rate system currently in place. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #17 Learning Objective: 10-2

18.
(p. 349)

In 1997, the currencies of several Asian nations including South Korea, Indonesia, and Thailand lost between 50 percent between 80 percent of the value against the U.S. dollar over the period of a few months. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Easy Hill - Chapter 10 #18 Learning Objective: 10-2

19.
(p. 350)

The so-called Group of Five major industrial countries includes Great Britain, the United States, Japan, Switzerland, and Germany. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #19 Learning Objective: 10-2

20.
(p. 350)

The Plaza Accord, signed in 1985, suggested that it would be desirable for most major currencies to fall relative to the U.S. dollar. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #20 Learning Objective: 10-2

21.
(p. 350)

The Louvre Accord pledged to support the stability of exchange rates around their 1987 levels by intervening in the foreign exchange markets when necessary to buy and sell currency. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #21 Learning Objective: 10-2

22.
(p. 353)

Under a fixed exchange rate regime, countries were limited in their ability to use monetary policy to expand or contract their economies. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #22 Learning Objective: 10-3

23.
(p. 355)

A pure free float is one in which exchange rates are determined by market forces. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #23 Learning Objective: 10-4

24.
(p. 355)

In 2007, about a quarter of the IMF's members had an exchange rate policy that allowed their currency to float freely. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #24 Learning Objective: 10-4

25.
(p. 356)

Under a currency board system, a country commits itself to converting its currency on demand into another currency at a fixed exchange rate. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #25 Learning Objective: 10-4

26.
(p. 356)

Evidence shows that adopting a pegged exchange rate regime increases inflationary pressures in a country. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Easy Hill - Chapter 10 #26 Learning Objective: 10-4

27.
(p. 356)

Under a strict currency board system, interest rates rise until investors eventually find holding the local currency attractive again. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #27 Learning Objective: 10-4

28.
(p. 356)

If local inflation rates remain lower than the inflation rate in the country to which the currency is pegged, the currencies of countries with currency boards can become uncompetitive and overvalued. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #28 Learning Objective: 10-4

29.
(p. 357)

A foreign debt crisis refers to a loss of confidence in the banking system that leads to a run on banks. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #29 Learning Objective: 10-5

30.
(p. 357)

When a country cannot service its foreign debt obligations, a banking crisis has occurred. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #30 Learning Objective: 10-5

31.
(p. 357)

High relative price inflation, a widening current account deficit, excessive expansion of domestic borrowing, and asset price inflation are all underlying causes of banking or foreign debt crises. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #31 Learning Objective: 10-5

32.
(p. 359)

The financial crisis that erupted across Southeast Asia during the fall of 1997 emerged as the biggest challenge to date for the IMF. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #32 Learning Objective: 10-5

33.
(p. 361)

The Asian meltdown began in mid-1997 in Japan when it became clear that several key Japanese financial institutions were on the verge of default. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #33 Learning Objective: 10-5

34.
(p. 363)

IMF loan packages typically include conditions such as cuts in public spending, higher interest rates, and tight monetary policy. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #34 Learning Objective: 10-5

35.
(p. 363)

One criticism of the IMF's policy prescriptions is that its "one-size-fits-all" approach to microeconomic policy is inappropriate for many countries. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #35 Learning Objective: 10-5

36.
(p. 366)

The IMF can force countries to adopt the policies required to correct economic mismanagement. FALSE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #36 Learning Objective: 10-5

37.
(p. 366)

While a government may commit to taking corrective action in return for an IMF loan, internal political problems may make it difficult for a government to act on that commitment. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #37 Learning Objective: 10-5

38.
(p. 367)

Speculative buying and selling of currencies can create very volatile movements in exchange rates. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #38 Learning Objective: 10-6

39.
(p. 367)

MNEs can hedge against currency fluctuations by dispersing production to different locations around the globe. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #39 Learning Objective: 10-6

40.
(p. 368)

An MNE can build strategic flexibility and reduce economic exposure by contracting out manufacturing. TRUE
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #40 Learning Objective: 10-6

41.
(p. 342)

The institutional arrangement that governs exchange rates is known as the: A. B. C. D. financial control system. international monetary system. international monetary fund. international financial regime.

The 1944 Bretton Woods conference established the basic framework for the post-World War II international monetary system.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #41 Learning Objective: 10-1

42.
(p. 342)

When the foreign exchange market determines the relative value of a currency, we say that the currency is adhering to a(n): A. B. C. D. volatile exchange rate. pegged exchange rate. floating exchange rate. fixed exchange rate.

Since 1973 the world has operated with a floating exchange rate regime, and exchange rates have become more volatile and far less predictable.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #42 Learning Objective: 10-1

43.
(p. 342)

A _____ means the value of the currency is fixed relative to a reference currency. A. B. C. D. pegged exchange rate dynamic exchange rate floating exchange rate fixed exchange rate

Many of the world's developing nations peg their currencies, primarily to the dollar or the euro.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #43 Learning Objective: 10-1

44.
(p. 342)

When the central bank of a country intervenes in the foreign exchange market to try to maintain the value of its currency if it depreciates too rapidly against an important reference currency, the country is said to be following a _____ system. A. B. C. D. fixed exchange rate clean float floating exchange rate dirty float

Some countries 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.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #44 Learning Objective: 10-1

45.
(p. 342)

In a _____ exchange rate system, the value of a set of currencies is fixed against each other at some mutually agreed on exchange rate. A. B. C. D. pegged dirty fixed direct

Before the introduction of the euro, several member states of the European Union operated with fixed exchange rates within the context of the European Monetary System. For a quarter of a century after World War II, the world's major industrial nations participated in a fixed exchange rate system.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #45 Learning Objective: 10-1

46.
(p. 343)

The gold standard had its origin in the use of _____ as a medium of exchange, unit of account, and store of value. A. B. C. D. the U.S. dollar the British pound paper currency gold coins

When international trade was limited in volume, payment for goods purchased from another country was typically made in gold or silver.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #46 Learning Objective: 10-1

47.
(p. 343)

When a country pegs its currencies to gold and guarantees convertibility, the country is following the: A. B. C. D. gold standard. Bretton Woods system. fixed exchange system. floating exchange rate system.

Given a common gold standard, the value of any currency in units of any other currency was easy to determine.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #47 Learning Objective: 10-1

48.
(p. 343)

Under the gold standard, the U.S. dollar could be converted into _____ grains of fine gold. A. B. C. D. 10.1 17.3 23.33 480

Given a common gold standard, the value of any currency in units of any other currency was easy to determine.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Hard Hill - Chapter 10 #48 Learning Objective: 10-1

49.
(p. 344)

The amount of a currency need to purchase one ounce of gold under the gold standard was known as the: A. B. C. D. gold par value. gold standard. fixed gold rate. pegged rate.

From the gold par values of pounds and dollars, one can calculate what the exchange rate was for converting pounds into dollars.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #49 Learning Objective: 10-1

50.
(p. 344)

The great strength claimed for the gold standard was that it contained a powerful mechanism for achieving _____ by all countries. A. B. C. D. balance-of-trade equilibrium economic stability interest rate parity equal tariff levels

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.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #50 Learning Objective: 10-1

51.
(p. 344)

When the income a country's residents earn from exports is equal to the money its residents pay to other countries for imports, the country is said to: A. B. C. D. be in current account equilibrium. be in capital account equilibrium. be in balance-of-trade equilibrium. have a managed float.

The great strength claimed for the gold standard was that it contained a powerful mechanism for achieving balance-of-trade equilibrium by all countries.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #51 Learning Objective: 10-1

52.
(p. 345)

Bretton Woods set a restriction of _____ percent for devaluations of currency, if a currency became too weak to defend, without permission from the IMF. A. B. C. D. 5 10 15 20

One aspect of the Bretton Woods agreement was a commitment not to use devaluation as a weapon of competitive trade policy. However, if a currency became too weak to defend, a devaluation of up to 10 percent would be allowed without any formal approval by the IMF. Larger devaluations required IMF approval.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Hard Hill - Chapter 10 #52 Learning Objective: 10-2

53.
(p. 345)

Under the Bretton Woods, all countries fixed the value of their currency in terms of: A. B. C. D. the British pound. the euro. the U.S. dollar. gold.

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.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #53 Learning Objective: 10-2

54.
(p. 345346)

The Bretton Woods IMF Articles of Agreement, tried to impose discipline by adopting a _____ exchange rate system that was seen as a mechanism for controlling inflation and imposing economic discipline on countries. A. B. C. D. fixed floating dirty float pegged

A fixed exchange rate regime imposes discipline in two ways. First, the need to maintain a fixed exchange rate puts a brake on competitive devaluations and brings stability to the world trade environment. Second, a fixed exchange rate regime imposes monetary discipline on countries, thereby curtailing price inflation.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #54 Learning Objective: 10-2

55.
(p. 345346)

The Bretton Woods agreement differed from the gold standard in that it: A. B. C. D. incorporated both discipline and flexibility. was a floating rate system. was based on the British pound. was a rigid system of fixed exchange rates.

The IMF Articles of Agreement were heavily influenced by the worldwide financial collapse, competitive devaluations, trade wars, high unemployment, hyperinflation in Germany and elsewhere, and general economic disintegration that occurred between the two world wars. The aim of the Bretton Woods agreement, of which the IMF was the main custodian, was to try to avoid a repetition of that chaos through a combination of discipline and flexibility.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Hard Hill - Chapter 10 #55 Learning Objective: 10-2

56.
(p. 347)

The International bank for Reconstruction and Development is also known as the: A. B. C. D. IMF. World Bank. European Central Bank. International Development Agency.

The official name for the World Bank is the International Bank for Reconstruction and Development (IBRD). When the Bretton Woods participants established the World Bank, the need to reconstruct the war-torn economies of Europe was foremost in their minds.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #56 Learning Objective: 10-2

57.
(p. 347)

Most economists trace the breakup of the Bretton Woods fixed exchange rate system, in 1973, to the: A. B. C. D. rise of communism in Eastern Europe. economic integration movement sweeping Western Europe. macroeconomic policy package in the U.S. during 1965 to 1968. increase in inflation and the worsening of the British foreign trade position.

As the only currency that could be converted into gold, and as the currency that served as the reference point for all others, the dollar occupied a central place in the system of fixed exchange rates. Any pressure on the dollar to devalue could wreak havoc with the system, and that is what occurred.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #57 Learning Objective: 10-2

58.
(p. 348)

The Bretton Woods Agreement could only work if the U.S. had: A. B. C. D. high inflation and no balance-of-payments deficit. low inflation and no balance-of-payments deficit. low inflation and a current account deficit. high inflation and a capital account surplus.

The Bretton Woods system could not work if its key currency, the U.S. dollar, was under speculative attack. Once inflation or a deficit occurred, the system soon became strained to the breaking point.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #58 Learning Objective: 10-2

59.
(p. 348)

In 1976, the _____ formalized the floating exchange rate system that followed the collapse of fixed exchange rate system. A. B. C. D. gold standard Plaza Accord Jamaica Agreement Louvre Accord

The floating exchange rate regime that followed the collapse of the fixed exchange rate system was formalized in January 1976 when IMF members met in Jamaica and agreed to the rules for the international monetary system that are in place today.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #59 Learning Objective: 10-2

60.
(p. 348349)

The main elements of the 1976 Jamaica agreement include all of the following except: A. B. C. D. floating rates were declared unacceptable. gold was abandoned as a reserve asset. total annual IMF quotas were increased to $41 billion. IMF members were permitted to sell their own gold reserves at the market price.

Floating rates were declared acceptable. IMF members were permitted to enter the foreign exchange market to even out "unwarranted" speculative fluctuations.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Hard Hill - Chapter 10 #60 Learning Objective: 10-2

61.
(p. 350)

The _____ suggested that it would be desirable for most major currencies to appreciate relative to the dollar, and signatories pledged to intervene in the foreign exchange markets, selling dollars, to achieve this objective. A. B. C. D. Louvre Accord Plaza Accord Bretton Woods Agreement gold standard

In September 1985, the finance ministers and central bank governors of the so-called Group of Five major industrial countries met at the Plaza Hotel in New York and reached what was later referred to as the Plaza Accord.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #61 Learning Objective: 10-2

62.
(p. 350)

Under the _____ of 1987, the Group of Five agreed that exchange rates had realigned sufficiently from earlier levels and pledged to support the stability of exchange rates around their current levels by intervening in the foreign exchange market when necessary. A. B. C. D. Plaza Accord Jamaica Agreement Louvre Accord Bretton Woods Agreement

The dollar continued to decline until 1987. The governments of the Group of Five began to worry that the dollar might decline too far, so the finance ministers of the Group of Five met in Paris in February 1987 and reached a new agreement known as the Louvre Accord.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #62 Learning Objective: 10-2

63.
(p. 351)

A managed-float system is also known as a: A. B. C. D. fixed exchange rate system. floating exchange rate system. pegged exchange rate system. dirty-float exchange rate system.

The 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.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #63 Learning Objective: 10-2

64.
(p. 353)

According to some analysts, under a _____ regime, countries are limited in their ability to use monetary policy to expand or contract their economies by the need to maintain exchange rate parity. A. B. C. D. managed float dirty float fixed exchange rate floating exchange rate

Monetary expansion can lead to inflation, which puts downward pressure on a fixed exchange rate. Similarly, monetary contraction requires high interest rates. Higher interest rates lead to an inflow of money from abroad, which puts upward pressure on a fixed exchange rate.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #64 Learning Objective: 10-3

65.
(p. 354)

A fixed exchange rate regime: A. modeled along the lines of the Bretton Woods system will not work. B. allows each country to choose its own inflation rate. C. is characterized by speculation that adds to the uncertainty surrounding future currency movements. D leads to a situation where governments under political pressures expand monetary supply too rapidly, . causing unacceptably high price inflation. Speculation ultimately broke the Bretton Woods system, a phenomenon that advocates of fixed rate regimes claim is associated with floating exchange rates.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Hard Hill - Chapter 10 #65 Learning Objective: 10-3

66.
(p. 355)

In 2006, about a quarter of the IMF members had a(n) _____ exchange rate policy. A. B. C. D. fixed peg currency board free float adjustable peg

The exchange rate policies IMF member states adopted in late 2007 shows that some countries use more inflexible systems, including a fixed peg arrangement (26 percent) under which they peg their currencies to other currencies, such as the U.S. dollar or the euro, or to a basket of currencies.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Hard Hill - Chapter 10 #66 Learning Objective: 10-4

67.
(p. 355)

Under a pegged exchange rate regime, a country will peg the value of its currency to _____ so that its own currency rises too. A. B. C. D. its domestic inflation rate that of a major currency its interest rates its foreign exchange reserves

Example: As the U.S. dollar rises in value, its own currency rises too.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #67 Learning Objective: 10-4

68.
(p. 355)

Pegged exchange rates are popular among many of the world's: A. B. C. D. highly developed nations. richest nations. smaller nations. large economies.

Under a pegged exchange rate regime, a country will peg the value of its currency to that of a major currency so that its own currency rises too. As with a full fixed exchange rate regime, the great virtue claimed for a pegged exchange rate is that it imposes monetary discipline on a country and leads to low inflation.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #68 Learning Objective: 10-4

69.
(p. 355)

The great virtue claimed for a pegged exchange rate is that it: A. B. C. D. imposes monetary discipline on a country. leads to high inflation. leads to devaluation. increases fluctuations in exchange rates.

For a pegged exchange rate to impose monetary discipline on a country, the country whose currency is chosen for the peg must also pursue sound monetary policy. Evidence shows that adopting a pegged exchange rate regime moderates inflationary pressures in a country.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #69 Learning Objective: 10-4

70.
(p. 356)

Under a strict currency board system, interest rates: A. B. C. D. adjust automatically. are constant. decline consistently. rarely move.

Under a strict currency board system, interest rates adjust automatically. If investors want to switch out of domestic currency into, for example, U.S. dollars, the supply of domestic currency will shrink. This will cause interest rates to rise until investors eventually find holding the local currency attractive again.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #70 Learning Objective: 10-4

71.
(p. 356)

When a country commits itself to converting its domestic currency on demand into another currency at a fixed exchange rate, the country has adopted a _____ system of exchange rates. A. B. C. D. pegged floating currency board fixed

To make the currency board's 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. Under this arrangement, the currency board can issue additional domestic notes and coins only when foreign exchange reserves are available to back it.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #71 Learning Objective: 10-4

72.
(p. 357)

When a speculative attack on the exchange value of a currency results in a sharp depreciation in the value of a currency, a(n) _____ has occurred. A. B. C. D. foreign debt crisis banking crisis currency crisis exchange crisis

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.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #72 Learning Objective: 10-5

73.
(p. 357)

A banking crisis: A.is a situation in which consumer spending patterns significantly affect a country's balance of payments, thereby affecting its currency. B. is a situation in which a country cannot service its debt obligations. C. refers to a loss of confidence in the banking system that leads to a run on banks, as individuals withdraw their deposits. D. occurs when a speculative attack on the exchange value of a currency results in a sharp depreciation in the value of the currency. A banking crisis refers to a loss of confidence in the banking system that leads to a run on banks, as individuals and companies withdraw their deposits.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #73 Learning Objective: 10-5

74.
(p. 357)

A foreign debt crisis: A.is a situation in which consumer spending patterns significantly affect a country's balance of payments, thereby affecting its currency. B. is a situation in which a country cannot service its debt obligations. C. refers to a loss of confidence in the banking system that leads to a run on banks, as individuals withdraw their deposits. D. occurs when a speculative attack on the exchange value of a currency results in a sharp depreciation in the value of the currency. A foreign debt crisis is a situation in which a country cannot service its foreign debt obligations, whether private-sector or government debt.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #74 Learning Objective: 10-5

75.
(p. 358)

The 1995 Mexican currency crisis and the 1997 Asian financial crisis were the result of all of the following except: A. B. C. D. excessive foreign borrowings. a weak or poorly regulated banking system. high inflation rates. high balance-of-trade surplus.

Two crises that have been of particular significance in terms of IMF involvement since the early 1990sthe 1995 Mexican currency crisis and the 1997 Asian financial crisis were the result of excessive foreign borrowings, a weak or poorly regulated banking system, and high inflation rates. These factors came together to trigger simultaneous debt and currency crises. Checking the resulting crises required IMF involvement.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #75 Learning Objective: 10-5

76.
(p. 361)

In 1997, the IMF agreed to provide the Thai government with $17.2 billion in loans to help its shattered economy. While doing so, IMF imposed all of the following restrictions except: A. B. C. D. the government was to increase taxes. public spending needed to be cut. several state-owned businesses were to be privatized. interest rates were to be reduced.

The IMF required the Thai government to increase taxes, cut public spending, privatize several stateowned businesses, and raise interest rates.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Hard Hill - Chapter 10 #76 Learning Objective: 10-5

77.
(p. 364)

_____ arises when people behave recklessly because they know they will be saved if things go wrong. A. B. C. D. A debt situation Moral hazard A conflict of interest Policy failure

One criticism of the IMF is that its rescue efforts are exacerbating a problem known to economists as moral hazard. Moral hazard arises when people behave recklessly because they know they will be saved if things go wrong.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Easy Hill - Chapter 10 #77 Learning Objective: 10-5

78.
(p. 363)

The IMF has been criticized because of all of the following reasons except: A. it has a "one-size-fits-all" approach to macroeconomic policy is inappropriate for many countries. B. its rescue efforts are exacerbating a problem known to economists as moral hazard. C. it has become too powerful for an institution that lacks any real mechanism for accountability. D its lax macroeconomic policies in the Asian crisis were not well suited to countries suffering from a . private sector debt crisis with deflationary undertones. In the case of the Asian crisis, critics argue that the tight macroeconomic policies imposed by the IMF are not well suited to countries that are suffering not from excessive government spending and inflation, but from a private-sector debt crisis with deflationary undertones.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Hard Hill - Chapter 10 #78 Learning Objective: 10-5

79.
(p. 367)

The use of the forward market and swaps to protect against foreign exchange risk has increased markedly since: A. B. C. D. the breakdown of the gold standard. the collapse of the Bretton Woods system in 1973. the end of the Plaza Accord. the Louvre Accord ended in 1968.

The foreign exchange market has developed a number of instruments, such as the forward market and swaps, that can help to insure against foreign exchange risk. The use of these instruments has increased markedly since the breakdown of the Bretton Woods system in 1973.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #79 Learning Objective: 10-6

80.
(p. 367)

Because of the long-term implications of volatile exchange rates, firms should: A. B. C. D. use the forward market because it is a perfect predictor of future exchange rates. get complete insurance coverage for exchange rates that might occur several years in the future. pursue strategies that reduce economic exposure. avoid transactions that involve foreign currencies.

It makes sense to pursue strategies that will increase the company's strategic flexibility in the face of unpredictable exchange rate movementsthat is, to pursue strategies that reduce the economic exposure of the firm.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #80 Learning Objective: 10-6

81.
(p. 342)

Discuss the 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.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Easy Hill - Chapter 10 #81 Learning Objective: 10-1

82.
(p. 342)

Explain the notion of a floating exchange rate regime. Give examples. When the foreign exchange market determines the relative value of a currency, the country is adhering to a floating exchange rate system. The world's four major trading currencies, the Japanese yen, the U.S. dollar, the British pound, and the European Union's euro are all free to float against each other. Consequently, their exchange rates are determined by market forces and fluctuate against each other daily.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Application Difficulty: Easy Hill - Chapter 10 #82 Learning Objective: 10-1

83.
(p. 342)

What is a pegged exchange rate system? Give example of a country following it. Many developing countries follow a pegged exchange rate system in which their currencies are pegged, or fixed, to another currency such as the dollar or the euro. Latvia, for example, has pegged its exchange rate to the euro.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Application Difficulty: Medium Hill - Chapter 10 #83 Learning Objective: 10-1

84.
(p. 342)

Compare and contrast a pegged exchange system and a dirty float system of exchange rates. A country following a pegged exchange rate system fixes or pegs the value of its currency 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. In contrast, in a dirty float, a country tries to hold the value of their currency within some range against an important reference currency such as the U.S. dollar. This system is considered to be a float because in theory, the value of the currency is determined by market forces, but it is a dirty float because the central bank of a country will intervene in the foreign exchange market to try to maintain the value of its currency if it depreciates too rapidly against an important reference currency.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #84 Learning Objective: 10-1

85.
(p. 342)

How does a floating exchange rate regime differ from a dirty float system? Why would a country choose a dirty float system over a free float? In a floating exchange rate system, the foreign exchange market determines the value of a currency with no government intervention. In a dirty float system, however, a country pegs its currency to a reference currency such as the U.S. dollar and the government intervenes in the market to influence the value of its currency. A country might choose to follow a dirty float system because it allows the country to intervene in the market to avoid a rapid depreciation, and thus provides more stability to the currency.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #85 Learning Objective: 10-1

86.
(p. 342)

How does a fixed exchange rate system work? In a fixed exchange rate system, the values of a set of currencies are fixed against each other at some mutually agreed upon exchange rate. Prior to the introduction of the euro, many EU countries participated in a fixed exchange rate system. A worldwide fixed exchange rate system was in place prior to 1973 under the auspices of the Bretton Woods system.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #86 Learning Objective: 10-1

87.
(p. 343344)

What was the gold standard? Who participated in the system? What was the major advantage of the system? The gold standard was a system where currencies were pegged to gold, and convertibility was guaranteed. Most of the world's major trading nations including Great Britain, Germany, Japan, and the U.S. had adopted the gold standard by 1880. Because each currency was linked to gold under the system, it was easy to determine the value of any currency in units of any other currency. The great strength of the gold standard was that it contained a powerful mechanism for achieving balance-of-trade equilibrium by all countries.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #87 Learning Objective: 10-1

88.
(p. 344)

With the help of an example, discuss the notion of balance-of-trade equilibrium. A country is 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. In other words, the country's current account is in balance. Under the gold standard, when Japan has a trade surplus, there will be a net flow of gold from the U.S. to Japan. These gold flows automatically reduce the U.S. money supply and swell Japan's money supply. An increase in money supply will raise prices in Japan, while a decrease in the U.S. money supply will push U.S. prices downward. The rise in the price of Japanese goods will decrease demand for these goods, while the fall in the prices of U.S. goods will increase demand for these goods. Thus, Japan will start to buy more from the U.S., and the U.S. will buy less from Japan, until a balanceof-trade equilibrium is achieved.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Application Difficulty: Medium Hill - Chapter 10 #88 Learning Objective: 10-1

89.
(p. 345)

What was the Bretton Woods agreement? How was it different from the gold standard? The Bretton Woods agreement, signed in 1944, called for a system of fixed exchange rates whereby countries would fix the value of their currency to gold, but unlike the gold standard, countries were not required to exchange their currencies for gold. Instead, only the dollar remained convertible to gold, and each country decided what its exchange rate relative to the dollar was to be and then calculated the gold par value of the currency based on that selected dollar exchange rate. All participating countries agreed to try to maintain the value of their currencies within one percent of the par value by intervening in the market as necessary.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #89 Learning Objective: 10-2

90.
(p. 345347)

What two multinational institutions were established at the Bretton Woods agreement? What are their roles in the international monetary system? At the Bretton Woods meeting in 1944, two multinational institutions, the International Monetary Fund (IMF) and the World Bank, were established. The IMF was established to maintain order in the international monetary system. The IMF sought to achieve this goal through a combination of discipline and flexibility. The World Bank, also known as the International Bank for Reconstruction and Development, was established to help the war-torn economies of Europe rebuild. However, the World Bank soon turned its attention to providing assistance to other countries, particularly Third World countries.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #90 Learning Objective: 10-2

91.
(p. 347348)

Why did the Bretton Woods system fail? The Bretton Woods system started to fall apart in the late 1960s, and finally collapsed in 1973. The system fell apart because the U.S. dollar, which played a central role in the regime, was being pressured to devalue. The U.S.' macroeconomic policy package for 1965-1968 involved increased spending to finance the Vietnam War and also domestic welfare programs. Inflation followed an increase in the money supply, imports rose, and the U.S. trade balance moved toward a deficit position. In the end, speculation that the dollar would be devalued led to chaos in the foreign exchange market. Under the Bretton Woods system, the dollar could only be devalued if all the other countries agreed to revalue their currencies relative to the dollar. Other countries were reluctant to make this adjustment because doing so would cause their exports to be more expensive to Americans. Then President Nixon finally announced in 1971 that the dollar was no longer convertible to gold, and that a 10 percent tariff would remain in effect until all trading partners agreed to revalue their currencies relative to the dollar. Even after this move and a subsequent revaluation of currencies relative to the dollar, speculation continued that dollar would be further devalued until at last, currencies were allowed to float freely, and the fixed exchange rate system ended.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Hard Hill - Chapter 10 #91 Learning Objective: 10-2

92.
(p. 348349)

Discuss the Jamaica Agreement. What relevance does the agreement have on today's exchange rate system? The 1976 Jamaica Agreement formalized the floating exchange rate regime that followed the collapse of Bretton Woods. The agreement established the rules for the international monetary system that are still in place today. Under the agreement, floating rates were declared to be acceptable, gold was abandoned as a reserve asset, and total annual IMF quotas were increased. Under the Jamaica Agreement, the IMF continued in its role of helping countries cope with macroeconomic and exchange rate problems.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #92 Learning Objective: 10-2

93.
(p. 349)

Describe how exchange rates have been since the collapse of the fixed exchange rate system in 1973. What factors account for the changes in exchange rates since that time? Since 1973, exchange rates have become much more volatile and less predictable than they were under the Bretton Woods system. Several factors have contributed to this volatility including the 1971 oil crisis that prompted inflation in the U.S. and a further decline in the value of the dollar, the loss of confidence in the dollar following a sharp rise in U.S. inflation rates in 1977 and 1978, the 1979 oil crisis that doubled the price of oil, the rise of the dollar between 1980 and 1985, the rapid fall of the dollar versus the German deutschemark and the Japanese yen in the late 1980s and early 1990s, the partial collapse of the European Monetary System in 1992, the 1997 Asian currency crisis, and the decline in the value of the U.S. dollar from 2001 to 2008.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Hard Hill - Chapter 10 #93 Learning Objective: 10-2

94.
(p. 352353)

Discuss the arguments for a floating exchange rate system. There are two main elements in the case for floating exchange rates: monetary policy autonomy and automatic trade balance adjustments. Under a fixed exchange rate system, a country's ability to expand or contract its money supply is limited by the need to maintain exchange rate parity. Under a floating exchange rate system, however, monetary control is restored to the government enabling a government to pursue domestic polices that involve expanding or contracting the money supply without worrying about maintaining exchange rate parity. Similarly, a floating exchange rate system a country can correct a trade imbalance through currency adjustments, a practice that is impossible under a fixed rate system.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Hard Hill - Chapter 10 #94 Learning Objective: 10-3

95.
(p. 353354)

Consider the case for fixed exchange rates. The case for fixed exchange rates revolves around arguments about monetary discipline, speculation, uncertainty, and the lack of connection between the trade balance and exchange rates. Supporters of a fixed exchange rate system suggest that the monetary discipline required by a fixed exchange rate system allows a government to ignore political pressures that might result in a rapid expansion of the money supply and high inflation. Advocates of fixed exchange rates argue that the system limits the destabilizing effects of speculation. Similarly, because the fixed rate system is more predictable, according to supporters, international trade and investment will be encouraged. Finally, advocates of fixed exchange rates suggest that trade deficits are determined by the balance between savings and investment in a country, not by the external value of its currency. Therefore, the need for floating exchange rates to correct trade imbalances is not valid.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Hard Hill - Chapter 10 #95 Learning Objective: 10-3

96.
(p. 356)

What is a currency board? Why do countries choose this type of system? What are the disadvantages of this type of arrangement? 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 the 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. The system is attractive because it limits the ability of the government to print money, and thereby create inflationary pressure. Under a strict currency board, interest rates will adjust automatically. However, critics point out that if local inflation rates remain higher than the inflation rate in the country to which the currency is pegged, the currencies of countries with currency boards can become uncompetitive and overvalued. Also, the system does not permit governments to set interest rates.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #96 Learning Objective: 10-4

97.
(p. 357)

Compare and contrast currency crises, banking crises, and foreign debt crises. 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. In contrast, a banking crisis refers to a loss of confidence in the banking system that leads to a run on banks as individuals and companies withdraw their deposits. Finally, a foreign debt crisis is a situation in which a country cannot service its foreign debt obligations, whether private sector or government debt.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Easy Hill - Chapter 10 #97 Learning Objective: 10-4

98.
(p. 363366)

Recent policies by the IMF have drawn a lot of fire. Discuss the criticisms of the IMF. Do you agree with the critics? Why or why not? The IMF's policies designed to cool overheated economies by reining in inflation and reducing government spending have been highly criticized. One criticism is that the IMF's "one-size-fits-all" approach to macroeconomic policy is inappropriate for many countries. The IMF has also been accused of exacerbating moral hazard through its rescue packages. Finally, it has been suggested that the IMF has become too powerful for an institution that lacks any real mechanism for accountability.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #98 Learning Objective: 10-5

99.
(p. 364366)

Discuss the notion of moral hazard. What is the relationship between moral hazard and the IMF? Moral hazard arises when people behave recklessly because they know they will be saved if things go wrong. The IMF has been criticized for exacerbating moral hazard with its rescue programs. According to critics, many Japanese and Western banks made loans to overleveraged Asian companies during the 1990s, and should now be forced to pay the price for their actions. Instead, the IMF, through its rescue package, is reducing the probability of debt default and effectively bailing out the banks. However, others suggest that forcing debt default would have only served to exacerbate the problem and lead to a serious decline in stock markets around the world. Moreover, at the insistence of the IMF, some Asian banks were closed.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Comprehension Difficulty: Medium Hill - Chapter 10 #99 Learning Objective: 10-5

100.
(p. 367368)

How can international companies reduce their economic exposure in a world of constantly fluctuating exchange rates? For companies operating in a world of volatile exchange rates, it is important to pursue strategies that reduce the economic exposure of the firm. One way to maintain strategic flexibility is to disperse production to different locations around the globe. This strategy allows companies to hedge currency fluctuations. Companies can also build strategic flexibility by contracting out their manufacturing. This strategy allows a company to shift suppliers from country to country in response to changes in relative costs brought about by exchange rate movements. Finally, companies should be aware of IMF macroeconomic policies that might affect their operations. IMF policies often result in a sharp contraction in demand in the short run, and an expansion of demand in the long run. Companies need to follow the IMF policies and adjust their strategies accordingly.
AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Knowledge Difficulty: Medium Hill - Chapter 10 #100 Learning Objective: 10-6

ch10 Summary
Category AACSB: Financial Theories, Analysis, Reporting, and Markets Bloom's: Application Bloom's: Comprehension Bloom's: Knowledge Difficulty: Easy Difficulty: Hard Difficulty: Medium Hill - Chapter 10 Learning Objective: 10-1 Learning Objective: 10-2 Learning Objective: 10-3 Learning Objective: 10-4 Learning Objective: 10-5 Learning Objective: 10-6 # of Questions 100 3 30 67 21 12 67 100 28 29 5 14 18 6