NAME: _____________________________

Econ 442 – Exam 1

Directions: This exam consists of 15 multiple choice questions (6 pts. each, 90 pts. total), 3 numerical/short answer
questions (12 pts. each, 36 pts. total), and 2 short essay/analysis questions (17 pts. each, 34 pts. total) for a total of 160
points. Mark all responses clearly on your exam. For the short answer questions, please use the space provided on the
exam itself. You are only allowed to use a calculator and a pencil or pen. Show your work on the short answers and be
clear, concise, and legible. Good luck!

Multiple Choice Section, choose the single best answer (15 questions, 6 pts each)

1. Vietnam is more dependent on trade than the United States because

a. the United States is a "Superpower."
b. Vietnam has less military power.
c. Vietnam is a smaller country with less diverse resources.
d. Vietnam does not invest in many other countries.
e. many countries invest in the United States.

2. An important insight of international trade theory is that when two countries engage in voluntary trade
a. one country always benefits at the expense of the other.
b. it is almost always beneficial to both countries.
c. it only benefits the low wage country.
d. it only benefits the high wage country.
e. it is almost never beneficial to both countries.

3. The international capital market is

a. a set of arrangements by which individuals and firms exchange money now for promises to pay in the
future.
b. the arrangement where banks build up their capital by borrowing from the Central Bank.
c. the place where emerging economies accept capital invested by banks.
d. exclusively concerned with the debt crisis that ended in the 1990s.

4. GNP equals GDP

a. minus net receipts of factor income from the rest of the world.
b. plus receipts of factor income from the rest of the world.
c. minus receipts of factor income from the rest of the world.
d. plus net receipts of factor income from the rest of the world.
e. minus depreciation.

5. A closed economy
a. can save either by building up its capital stock or by acquiring foreign wealth.
b. can save only by building up its capital stock.
c. can save only by acquiring foreign wealth.
d. cannot save either by building up its capital stock or by acquiring foreign wealth.
e. can save by avoiding excessive imports.

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6. For open economies,
a. S = I.
b. S = I + CA.
c. S = I - CA.
d. S > I + CA.
e. S < I + CA.

7. A country's current account

a. balance equals the change in its net foreign wealth.
b. surplus equals the change in its foreign wealth.
c. deficit equals the change in its foreign wealth.
d. balance equals its GNP.

8. A current account surplus in Vietnam implies Vietnam is

a. borrowing from foreign countries.
b. selling financial assets to foreign countries.
c. lending to foreign countries.
d. worried about its debt.

9. Every international transaction automatically enters the balance of payments

a. once either as a credit or as a debit.
b. twice, once as a credit and once as a debit.
c. once as a credit.
d. twice, both times as debit.
e. three times, once as a credit, once as a debit, and once as an exchange.

10. An American buys a Japanese car, paying by writing a check on an account with a bank in New York. How
would this be accounted for in the balance of payments?
a. current account, a Japanese good import
b. current account, a U.S. good import and financial account, a U.S. service export
c. financial account, a U.S. asset export and capital account, a U.S. good export
d. financial account, a U.S. asset import
e. current account as a U.S. good import and financial account, a U.S. asset export

11. If the goods' money prices do NOT change, an appreciation of the dollar against the pound
a. makes British sweaters cheaper in terms of American jeans.
b. makes British sweaters more expensive in terms of American jeans.
c. doesn't change the relative price of sweaters and jeans.
d. makes British jeans more expensive in Britain.

12. Makita (a Japanese firm) is expecting a payment from Ace Hardware in US dollars one month from now.
Makita can hedge its foreign currency risk by:
a. buying yen in a forward-exchange deal.
b. selling yen in a forward-exchange deal.
c. buying yen at the spot-exchange rate 1 month from now.
d. selling yen at the spot-exchange rate 1 month from now.

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 13. Which of the following is NOT a major actor in the foreign exchange market?
a. corporations
b. central banks
c. commercial banks
d. non-bank financial institutions
e. tourists

14. If the dollar interest rate is 10 percent and the euro interest rate is 6 percent, then an investor should
a. invest only in dollars if the expected dollar depreciation against the euro is 8 percent.
b. invest only in euros if the expected dollar depreciation against the euro is 8 percent.
c. be indifferent between dollars and euros if the expected dollar depreciation against the euro is 8
percent.
d. invest only in dollars.
e. invest only in euros.

15. Which one of the following statements is the MOST accurate?

a. For a fixed interest rate, a rise in the expected future exchange rate causes a rise in the current
exchange rate.
b. For a fixed interest rate, a rise in the expected future exchange rate causes a fall in the current
exchange rate.
c. For a fixed interest rate, a rise in the expected future exchange rate does not cause a change in the
current exchange rate.
d. For a given dollar interest rate and a constant expected exchange rate, a rise in the interest rate of the
euro causes the dollar to depreciate.

Numerical Answer Section (3 questions, 12 pts each)

16. How many British pounds would it cost to buy a pair of American designer jeans costing $45 if the exchange
rate is 1.80 dollars per British pound?

Answer: 45 / 1.80 = 25 British pounds

17. What is the expected dollar rate of return on euro deposits if today's exchange rate is $1.167 per euro, next
year's expected exchange rate is $1.10 per euro, the dollar interest rate is 10%, and the euro interest rate is
5%?

Answer: E = 5% + 1.1/1.167 -1 = -0.7% (or rounded to -1% is ok)

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 18. Based on your answer to the last question, does intertest parity hold in this case? Would investors prefer to
hold currency deposits in dollars, euros, or be indifferent?

Answer: interest parity does not hold, and investors should want to hold dollars as the
expected return is higher (10% vs -0.7%)

Short Answer Section (2 questions, 17 pts each)

19. Why might a country want to appreciate or depreciate their currency? Who are the winners and losers from an
appreciation/depreciation?

Answer:

A depreciation makes exports cheaper and can help improve a trade deficit or grow a
trade surplus. An appreciation makes imports cheaper and allows for greater
consumption. A currency depreciation benefits exporters and hurts domestic consumers
by lowering the cost of exports and raising the cost of imports. A currency appreciation
hurts exporters by making exports more expensive, but it makes imports cheaper.

Could also include depreciation benefits foreign consumers and hurts foreign exporters,
while appreciation does the opposite.

Rubric:
• 3 points – want to depreciate to stimulate exports
• 2 points – appreciate to make imports cheaper
• 3 points – depreciation winners are domestic exporters
• 3 points – deprecation losers are domestic consumers/importers
• 3 points – appreciation losers are domestic exporters
• 3 points – appreciation winners are domestic consumers/importers

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20. On the figure below, add and label an equilibrium in the dollar/euro foreign exchange market. Then use the
figure to show the effect of an increase in the interest rate on euro deposits on the dollar/euro exchange rate
(without changing expectations). Does the dollar appreciate or depreciate against the euro?

Answer:

A rise in the interest rate paid by euro deposits causes the dollar to depreciate from

(point 1) to (point 2).

Rubric:
• 2 points – Draws and labels vertical dollar interest rate line
• 3 points – Draws and labels downward sloping expected euro return line
• 2 points – Correctly labels initial equilibrium (point 1)
• 4 points – Correctly draws expected euro return line shifting right
• 2 points – Correctly labels new equilibrium (point 2)
• 4 points – States that the dollar depreciates against the euro