A Level Economics: Practice Questions on Exchange Rates

In a fixed exchange rate system, the central bank or government intervenes in the foreign exchange market to:

1. a) Increase interest rates b) Devalue the domestic currency c) Maintain a constant exchange rate d) Allow the exchange rate to float freely

   Solution: c) Maintain a constant exchange rate

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3. The exchange rate in a floating exchange rate system is primarily determined by: a) Central bank interventions b) Market forces of demand and supply c) Government policies d) Trade imbalances

   Solution: b) Market forces of demand and supply

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5. In a managed exchange rate system, the central bank occasionally intervenes in the foreign exchange market to: a) Fix the exchange rate b) Allow the exchange rate to float freely c) Influence the exchange rate within a certain range d) Prevent any exchange rate fluctuations

   Solution: c) Influence the exchange rate within a certain range

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7. What happens to the value of a currency in a free-float system when the demand for that currency exceeds its supply? a) The value appreciates b) The value depreciates c) The value remains constant d) The value fluctuates randomly

   Solution: a) The value appreciates

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9. Which factor does NOT contribute to the demand for a currency? a) Exports b) Capital outflows c) Capital inflows d) Investments

   Solution: b) Capital outflows

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11. In a free-float exchange rate system, what happens when a country imports goods and services from other countries? a) The supply of its currency increases b) The supply of its currency decreases c) The value of its currency appreciates d) The value of its currency depreciates

    Solution: a) The supply of its currency increases

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13. What factor can cause a country's currency to appreciate in value? a) Higher interest rates b) Large-scale quantitative easing c) Trade deficits d) Global uncertainty

    Solution: a) Higher interest rates

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15. Which policy objective may be affected by exchange rate changes in a country with an inflation targeting regime? a) Economic growth b) Trade balance c) Inflation d) Exchange rate stability

    Solution: c) Inflation

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17. In a floating exchange rate system, how can a weaker currency impact a country's trade balance? a) Improve the trade balance by making exports cheaper b) Worsen the trade balance by making imports cheaper c) Have no effect on the trade balance d) Decrease the demand for exports

    Solution: a) Improve the trade balance by making exports cheaper

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19. How can a currency depreciation impact a firm with foreign debt? a) Reduce the firm's foreign debt burden b) Increase the firm's foreign debt burden c) Have no effect on the firm's foreign debt d) Reduce the firm's export competitiveness

    Solution: b) Increase the firm's foreign debt burden

1. The current exchange rate between the US Dollar (USD) and the Euro (EUR) is 1 USD = 0.85 EUR. If you exchange 500 USD into EUR, how much EUR will you receive? a) 425 EUR b) 500 EUR c) 425 USD d) 589 EUR

Solution: To convert USD to EUR, we multiply the amount in USD by the exchange rate. 500 USD * 0.85 EUR/USD = 425 EUR

Correct answer: a) 425 EUR

2. The exchange rate between the British Pound (GBP) and the Japanese Yen (JPY) is 1 GBP = 150 JPY. If you have 10,000 JPY and want to convert it to GBP, how much GBP will you receive? a) 0.0667 GBP b) 66.67 GBP c) 150 GBP d) 15,000 GBP

Solution: To convert JPY to GBP, we divide the amount in JPY by the exchange rate. 10,000 JPY / 150 JPY/GBP = 66.67 GBP

Correct answer: b) 66.67 GBP

3. The central bank of a country decides to devalue its currency by 10%. If the current exchange rate is 1 USD = 100 units of the domestic currency, what will be the new exchange rate after the devaluation? a) 1 USD = 110 units b) 1 USD = 100 units c) 1 USD = 90 units d) 1 USD = 10 units

Solution: To calculate the new exchange rate after the devaluation, we need to reduce the value of the domestic currency by 10%. New exchange rate = 100 units - (10% of 100 units) = 100 units - 10 units = 90 units

Correct answer: c) 1 USD = 90 units

4. The Euro to Swiss Franc (CHF) exchange rate has increased from 1 EUR = 1.10 CHF to 1 EUR = 1.25 CHF. By what percentage has the Euro appreciated against the Swiss Franc? a) 12.5% b) 13.6% c) 14.8% d) 25%

Solution: To calculate the percentage appreciation, we use the formula: Percentage appreciation = ((New rate - Old rate) / Old rate) * 100 Percentage appreciation = ((1.25 CHF - 1.10 CHF) / 1.10 CHF) * 100 Percentage appreciation = (0.15 CHF / 1.10 CHF) * 100 Percentage appreciation = 13.6%

Correct answer: b) 13.6%

5. A tourist from Country A visits Country B and converts 1,000 units of Country A's currency to Country B's currency at an exchange rate of 1 Country A unit = 0.75 Country B units. The tourist spends all the money and converts the remaining Country B currency back to Country A currency at an exchange rate of 1 Country A unit = 0.80 Country B units. How much Country A currency does the tourist get after converting back the money? a) 750 units b) 800 units c) 933.33 units d) 1,066.67 units

Solution: First, we calculate how much Country B currency the tourist receives in Country B. Amount in Country B currency = 1,000 units (Country A currency) * 0.75 Country B units / 1 Country A unit = 750 units (Country B currency)

Now, the tourist converts the 750 units of Country B currency back to Country A currency using the new exchange rate. Amount in Country A currency = 750 units (Country B currency) * 1 Country A unit / 0.80 Country B units = 937.5 units (Country A currency)

Correct answer: c) 933.33 units (rounded to two decimal places)

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Long Answer Questions

1. Analyze the advantages and disadvantages of a fixed exchange rate system compared to a floating exchange rate system, considering factors such as monetary policy flexibility, trade balance adjustments, and exchange rate stability.

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3. Evaluate the impact of a managed exchange rate system on a country's economy. Discuss the effectiveness of occasional central bank interventions in stabilizing the currency while allowing it to float within a certain range. Consider how this system addresses trade imbalances and speculative trading.

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5. Assess the implications of a country's currency depreciation on its domestic economy and international trade. Analyze how a weaker currency affects export-oriented industries, import-dependent sectors, and inflation levels, and discuss possible policy responses to manage these effects.

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7. Analyze the role of interest rates in influencing exchange rate fluctuations. Evaluate the relationship between higher interest rates, capital inflows, and currency appreciation, and discuss the potential challenges a country may face when adopting such a policy to attract foreign investment.

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9. Evaluate the impact of major global events, such as the COVID-19 pandemic or geopolitical tensions, on exchange rates and currency movements. Analyze how safe-haven demand, quantitative easing measures, and changes in trade flows can affect the exchange rates of specific currencies and their implications on international trade dynamics.