“This does not mean there is a massive flow of U. funds into Canada, because the differentials are mitigated by other factors.

4. “This does not mean there is a massive flow of U.S. funds into Canada, because the differentials are mitigated by other factors. The discount on the forward Canadian dollar has kept step with the interest rate differential, and it is only on an unhedged basis that the full advantage of the differential can be gained.” The discount on the forward Canadian dollar keeping in step with the interest rate differential means that the interest rate differential

a) should produce a steady rise in the value of the Canadian dollar

b) is producing capital flows that are causing expected changes in the exchange rate

c) is a difference in real interest rates and so influences the future value of the exchange rate

d) reflects inflation differentials and so the exchange rate is expected to change by an equal amount

5. “Before the advent of modern international financial markets in the mid 1970s, domestic financial markets placed a serious constraint on the ability of governments to borrow their way to popularity or prosperity. Historically, domestic financial markets were largely closed systems where excessive borrowing by governments led quickly to …..” Complete this clipping.

a) inflation b) lower taxes c) unemployment d) higher interest rates

6. “The 4.8 percent yield on Japanese short-term securities is due to a strong yen; Australia’s 16.1 percent yield is a product of its weak dollar.” The most reasonable explanation for these numbers is that 132

a) Japan has a low inflation rate and Australia a high inflation rate

b) interest rates are not relevant here – Japan must have a balance of payments surplus and Australia a balance of payments deficit

c) the explanation should be reversed – the weak dollar is creating a high Australian interest rate and the strong yen is creating a low Japanese interest rate

d) there is a typo – the numbers should be reversed – the high interest rate is creating capital inflows making the Australian currency strong and the low interest rate is making the yen weak

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