International Finance: Impact of Country Risk and Exchange Rate on Interest Rates

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What is the primary reason why lenders require a higher interest rate when lending to a country with high political or economic turmoil?

To maintain money market equilibrium.

To compensate for the risk of default on loan repayments. (correct)

To influence the country's exchange rate expectations.

To compensate for the expected currency depreciation.

In the Mundell-Fleming model, what is the effect of an increase in the risk premium θ on the IS* curve?

The IS* curve remains unchanged.

The IS* curve becomes vertical.

The IS* curve shifts to the left. (correct)

The IS* curve shifts to the right.

What is the consequence of an expected depreciation of a country's currency on the attractiveness of holding that currency?

It depends on the country's interest rate.

It remains unchanged.

It becomes more attractive.

It becomes less attractive. (correct)

In the Mundell-Fleming model, what is the consequence of an increase in the risk premium θ on the level of income Y?

Y must rise to restore money market equilibrium. (D) Signup and view all the answers

Why might the central bank try to reduce the money supply in response to an increase in country risk or expected depreciation?

To prevent a depreciation of the currency. (D) Signup and view all the answers

What is the likely consequence of a fixed exchange rate on a country's monetary policy?

Reduced uncertainty and volatility in international transactions (B) Signup and view all the answers

Which of the following countries experienced a stock market decline of around 20% during the 1997-1998 crisis?

South Korea (A) Signup and view all the answers

According to the Impossible Trinity, what is the trade-off between exchange rate management and monetary policy?

A country can have a floating exchange rate, free capital flows, and independent monetary policy (B) Signup and view all the answers

What is the likely effect of capital outflows on a country's exchange rate?

Depreciation of the exchange rate (D) Signup and view all the answers

What is the likely consequence of a currency being undervalued?

Increased competitiveness of domestic producers (D) Signup and view all the answers

In the Mundell-Fleming model, under a fixed exchange rate regime, what is the effect of monetary policy on output?

Monetary policy has no effect on output. (C) Signup and view all the answers

In a fixed exchange rate regime, what is the consequence of a trade policy restriction on imports on the exchange rate?

The exchange rate will remain unchanged. (B) Signup and view all the answers

What is the result of a fiscal expansion in a floating exchange rate regime, according to the Mundell-Fleming model?

The exchange rate increases and net exports decrease. (B) Signup and view all the answers

In the context of the Mundell-Fleming model, what is the key difference between monetary policy under fixed and floating exchange rates?

Monetary policy is effective under floating rates but not under fixed rates. (A) Signup and view all the answers

What is the effect of import restrictions on output in a fixed exchange rate regime, according to the Mundell-Fleming model?

Output increases due to the shift in demand to domestic goods. (A) Signup and view all the answers

What is the primary effect of import restrictions on the labor market?

Shift of employment from export-producing sectors to domestic industries (D) Signup and view all the answers

Under a fixed exchange rate system, what is the role of the central bank?

To shift the LM curve to maintain the preannounced exchange rate (C) Signup and view all the answers

What is the effect of a fiscal expansion on the exchange rate under a floating exchange rate system?

It increases the exchange rate (B) Signup and view all the answers

What is the primary difference between the effectiveness of fiscal policy under fixed and floating exchange rate systems?

Fiscal policy is more effective under fixed exchange rates (A) Signup and view all the answers

What is the assumption about prices in the long run under a fixed exchange rate system?

Prices are flexible (A) Signup and view all the answers