Question

1. If a fixed exchange rate is set below the equilibrium rate in a fixed exchange rate system it will create

1.     a deficit in the balance of payments.
2.    a surplus in the balance of payments.
3.     inflation.
4.     deflation.

2. Which of the following items is not a flow?

A.Unilateral transfers.

B. The increase in foreign assets held by Australian investors over a period of six months.

C. Foreign exchange reserves lost by the Reserve Bank as a result of intervention in the foreign exchange market.

D. The foreign currency and gold reserves of the Reserve Bank

3. If the foreign currency equivalent of the domestic price of a commodity is less than the foreign price of the same commodity, then the LOP implies that

A. the foreign currency is overvalued.

B. the foreign currency is undervalued.

C. the domestic currency is overvalued.

D. none of the above

4. The $/DM exchange rate is DM1 = $0.35 and the DM/FF exchange rate is FF1 = DM0.31. What is the FF/$ exchange rate?

A. 3.226 French francs per dollar

B. 1.129 French francs per dollar

C. 0.886 French francs per dollar

D. 9.217 French francs per dollar

5. none of the above

Answer 1

1)

Right Answer: (B)

When exchange rate is kept below the equilibrium rate. it means currency has been devalued or undervalued. Undervaluation of currency would make export competitive and on other hand, import will become costly. Eventually export rises and import falls, so net export will rise. So balance of payment will improve for country.

thus practice is typically followed by the developing countries.