AP Macro International Finance 3 — Questions and Answers
Question 1: If the interest rate in the United States rises relative to other countries, what is the most likely short-run effect on the U.S. dollar?
- The dollar depreciates as capital flows out
- The dollar appreciates as foreign investors seek higher returns (Correct answer)
- The dollar remains unchanged because interest rates don't affect exchange rates
- The dollar depreciates due to increased inflation expectations
Correct answer: The dollar appreciates as foreign investors seek higher returns
Higher U.S. interest rates attract foreign capital seeking better returns, increasing demand for dollars and causing appreciation.
Question 2: A country that imports more than it exports is said to have a:
- Trade surplus and a current account surplus
- Trade deficit and a current account deficit (Correct answer)
- Balance of payments surplus
- Capital account deficit
Correct answer: Trade deficit and a current account deficit
When imports exceed exports, a country has a trade deficit, which typically contributes to a current account deficit.
Question 3: Which of the following transactions would be recorded as a credit in the U.S. balance of payments?
- A U.S. tourist spends money in France
- A U.S. company buys a factory in Germany
- A Japanese investor buys U.S. Treasury bonds (Correct answer)
- An American imports cars from Japan
Correct answer: A Japanese investor buys U.S. Treasury bonds
A foreign investor purchasing U.S. assets represents a capital inflow, recorded as a credit in the U.S. balance of payments.
Question 4: Under a managed float exchange rate system, exchange rates are determined by:
- Solely by market supply and demand with no intervention
- Government decree with no market influence
- Market forces but with occasional central bank intervention (Correct answer)
- A fixed peg to gold or another currency
Correct answer: Market forces but with occasional central bank intervention
A managed float (dirty float) allows market forces to set exchange rates, but the central bank intervenes occasionally to reduce volatility.
Question 5: If the Marshall-Lerner condition is satisfied, a currency depreciation will:
- Worsen the trade balance permanently
- Have no effect on the trade balance
- Improve the trade balance in the long run (Correct answer)
- Only affect capital flows, not trade flows
Correct answer: Improve the trade balance in the long run
The Marshall-Lerner condition states that if the sum of export and import demand elasticities exceeds one, depreciation improves the trade balance.
Question 6: Speculative attacks on a fixed exchange rate are most likely to occur when:
- The country holds large foreign exchange reserves
- The currency appears overvalued and reserves are dwindling (Correct answer)
- The country runs a current account surplus
- Domestic interest rates are higher than foreign rates
Correct answer: The currency appears overvalued and reserves are dwindling
Speculators bet against currencies that appear overvalued and whose reserves signal an inability to maintain the peg.
Question 7: The balance of payments always sums to zero because:
- International trade is always balanced by law
- The current account and capital account are mirror images of each other (Correct answer)
- The IMF ensures countries maintain balanced accounts
- Exchange rates automatically adjust to balance all transactions
Correct answer: The current account and capital account are mirror images of each other
Every international transaction has two sides; current account deficits must be financed by capital account surpluses, keeping the overall balance at zero.
AP Macro International Finance 3
If the interest rate in the United States rises relative to other countries, what is the most likely short-run effect on the U.S. dollar?