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Name _____________________ Exam # ________
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Eco 212 Fall 2000

Midterm #1 Prof. S. Sullivan

Instructions: For part I, write your answer directly on the exam sheet. For part II, circle the one best answer.
Part I

Suppose the two countries of Canada and Japan trade only with each other. Both countries have adopted the gold standard. The official price of gold in Canada is 10 Canadian dollars per gram. The official price in Japan is 90 yen per gram.


Canada exports wheat and imports tractors. Canadian producers will sell any quantity of wheat Japan wants as long as they receive C$ 1 per kilo. The demand for wheat in Japan depends on the price per kilo, according to the following chart:
Price Quantity
8 yen 200

9 yen 180

10 yen 160
Japan exports tractors and imports wheat. Japan will export any quantity of tractors Canada wishes to buy, as long as the manufacturer receives 360 yen for each tractor. The demand for tractors in Canada depends on the price, according to the following chart:
Price Quantity
C$ 45 3

C$ 40 4


C$ 36 5
1. Sketch the supply and demand curve for Japanese yen in the foreign exchange market. Identify the exchange rate at which trade takes place by drawing a horizontal line on your graph.
(Feel free to use the back of the page for more space.)

2. Explain how the value of Japan’s exports is equal to the value of its imports in the short run. In other words, give me a statement saying, "Japan imports XXX worth of wheat and exports YYY worth of tractors..." and fill in numbers for XXX and YYY and identify whatever else is being imported and/or exported.

3. Explain the mechanism that will guarantee that the value of Japan’s exports will equal the value of its imports in the long run, assuming both countries continue to use the gold standard and uphold their commitments under the gold standard.

4. Suppose gold is discovered in Canada. The gold mine produces 40 grams of gold per year, all of which is sold by the Canadian miners to the Canadian Treasury. How would this change your answer to question 3? Is there now any way to ensure that Japan’s imports equal its exports over the long run?

5. The value of the single European currency (the euro) has fallen since its introduction from about $1.17 to about $0.85, despite the fact that there has been no large difference in inflation rates between the USA and Europe in that time. Assume that the initial ($1.17) value of the euro was set at approximately the level dicated by purchasing power parity. Does the current value -- assuming that it does not represent purchasing power parity -- represent an arbitrage opportunity? Explain why or why not. (If it is an arbitrage opportunity, explain to me what to do to become rich.)

Part II

1. Which of the following is investment?


a. foreign owners buy a majority of the shares of Bulbank.

b. the IMF loans $300 million to the Bulgarian government in order to speed up privatization.

c. the United States Agency for International Development (USAID) provides $100 million for an endowment fund for AUBG. (Don’t we wish!)

d. the AUBG bookstore buys textbooks that won’t be sold until next year.

e. none of the above.
2. The use of commodity money solves a problem associated with barter trade, but is still inefficient compared to a well-functioning fiat money. The inefficiency of commodity money is:
a. due to the double coincidence of wants.

b. due to the single coincidence of wants.

c. due to the commodity used as money, which cannot be used for alternative purposes.

d. due to the likelihood of high inflation with commodity money.

e. due to the excess seigniorage that the government is likely to collect.
3. In any economy, savings must always be equal to uses of savings. Uses of savings in an economy open to foreign trade are:
a. purchase of foreign assets, increasing international reserve assets, and investment.

b. government budget deficit and net exports.

c. wages, rents, interest payments, and profits.

d. investment, government expenditure, and imports.

e. none of the above.
4. When there is a sudden and unexpected rise in interest rates:
a. borrowers are obligated to re-issue their old debt and pay the new, higher interest rate.

b. anyone who was holding bonds loses money, but anyone who buys bonds after the rise in interest rates will earn higher returns.

c. anyone who was holding bonds gains money, and anyone who buys bonds after the rise in interest rates earns higher returns.

d. the losses suffered by holders of bonds causes the demand curve for bonds to shift to the left.

e. none of the above.

5. Factors that cause the demand curve for bonds to shift to the right include:


a. an increase of the liquidity of bonds.

b. higher expected profitability of firms' investment projects.

c. a decrease in government budget deficits.

d. all of the above.

e. none of the above.
6. The interest rate that is calculated by using the present value formula to set the present value of all payments to be received from owning the bond equal to the bond’s current price is the:
a. current yield.

b. yield to maturity.

c. discount yield.

d. real interest rate.

e. Lombard rate.
7. Suppose both borrowers and lenders expect inflation to rise in the near future. This change in expectations would be shown in the bond market as:
a. a shift to the left of the bond demand curve and a shift to the right of the bond supply curve.

b. a shift to the left of the bond demand curve and a shift to the left of the bond supply curve.

c. a shift to the right of the bond demand curve and a shift to the left of the bond supply curve.

d. a shift to the right of the bond demand curve and a shift to the right of the bond supply curve.

e. no shift of either curve.
8. Any event that increases the quantity of bonds supplied at a given price of bonds must also:
a. increase the quantity of bonds demanded at that price.

b. increase the quantity of loanable funds supplied at a given interest rate.

c. decrease the quantity of loanable funds demanded at a given interest rate.

d. increase the quantity of loanable funds demanded at a given interest rate.

e. none of the above.
9. How does an economist distinguish assets which should be counted as money from assets which should not be counted as money?
a. the money asset contains or can be easily converted into gold.

b. the money asset is produced or approved by the government.

c. the money asset is the best available store of value.

d. the money asset is completely inflation-proof.

e. the money asset is generally acceptable as payment for goods and services.
10. If the interest rate parity condition applies to the current exchange rate between the US$ and the euro, and interest rates on one-year bank deposits are 7% in the USA and 5% in Europe, then foreign exchange market participants must be expecting:
a. the dollar to depreciate by 2% relative to the euro over the next year.

b. US interest rates to fall by 2%.

c. the euro to depreciate by 2% relative to the dollar.

d. European inflation to be 2% higher than US inflation over the next year.

e. none of the above.
11. In the liquidity preference (money supply – money demand) framework, the _____ effect of an increase in the money supply tends to lower interest rates, and the _____ effect tends to raise interest rates.
a. liquidity price level

b. price level income

c. income liquidity

d. expected inflation price level

e. income expected inflation
12. Which of the following situations is most advantageous for a borrower?
a. the nominal interest rate is 20% and inflation is expected to be 20%.

b. the nominal interest rate is 3% and inflation is expected to be 0%.

c. the nominal interest rate is 7% and inflation is expected to be 2%.

d. the nominal interest rate is 50% and inflation is expected to be 80%.

e. the nominal interest rate is 10% and inflation is expected to be 6%.
13. The opportunity to buy and sell something simultaneously at two different prices is referred to as:
a. Gresham’s Law.

b. seigniorage.

c. purchasing power parity.

d. arbitrage.

e. interest rate parity.
14. According to the theory of portfolio choice, the quantity demanded of an asset is positively related to the asset’s __________ relative to alternative assets.
a. liquidity and expected return

b. liquidity, expected return, and risk

c. liquidity and risk

d. expected return and risk

e. none of the above.

15. Suppose the picture above describes the supply and demand for the currency of Hungary, the Hungarian forint, in terms of its value relative to the Polish zloty. Assume that Hungary and Poland use the gold standard and the official prices of gold are 5 forints per gram and 35 zloty per gram. Then:


a. The Polish government will gain 2 Polish zloty worth of gold.

b. The Hungarian government will gain 2 forints worth of gold.

c. The Hungarian government must lower its official price of gold.

d. The Hungarian government must sell 2 forints worth of gold.

e. The Polish government will lose 2 Polish zloty worth of gold.
16. In the RETd and RETf diagram, an event which causes foreign exchange market participants to anticipate a higher Et+1e than they had previously anticipated would:
a. cause the RETd line to shift to the left.

b. cause the RETd line to shift to the right.

c. cause the RETf line to shift to the left.

d. cause the RETf line to shift to the right.

e. cause Et to fall.
17. Long term bonds are riskier than short term bonds because they have more interest rate risk. Interest rate risk is:
a. the risk that a borrower will not make the interest payments on time.

b. the risk that the interest rate paid by the borrower will fall after the bond is sold.

c. the risk that prices and returns for holders of the bonds will vary due to changes in market interest rates.

d. the risk that most of the interest rate will consist of compensation for inflation, rather than a real return.

e. none of the above.
18. According to the theory of asset demand, asset demand increases with increases in _______, and decreases with increases in _______.
a. wealth of asset buyers and liquidity of the asset; expected return of alternative assets

b. wealth of asset buyers and expected return of alternative assets; liquidity of the asset

c. wealth of asset buyers and risk of the asset; liquidity of the asset

d. expected return of alternative assets and liquidity of the asset; risk of the asset

e. liquidity of the asset and risk of the asset; wealth of asset buyers
19. The difference between the M1 measure of the money supply and the M2 measure of the money supply is that:
a. the M2 measure of the money supply includes assets that are not liquid enough to be included in M1.

b. the M2 measure of the money supply includes fiat money, the M1 measure of the money supply counts only commodity-backed money.

c. the M2 measure of the money supply includes bank-issued money, the M1 measure of the money supply counts only government-issued money.

d. the M2 measure of the money supply includes bank deposits, the M1 measure of the money supply counts only cash.

e. none of the above.
20. Which of the following is an investment intermediary?
a. a credit union.

b. a fire and casualty insurance company.

c. a finance company.

d. a pension fund.



e. none of the above.


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