12 ATAR ECONOMICS

ASSESSMENT 4 - TEST - EXCHANGE RATES

MARKING KEY

PART A – MULTIPLE CHOICE

1. A free floating exchange rate is advantageous because
a. It is stable for foreign investors and attracts capital inflow.
b. It is risk free for foreign investors and allows capital outflow.
c. It lessens the effectiveness of monetary policy.
d. It allows for automatic adjustments to occur to stabilise the economy.

2. If an American can purchase $11,000AUD for $8,300USD, then $1AUD must be worth
a. $0.75USD
b. $0.75AUD
c. $1.33USD
d. $1.33AUD

3. If commodity prices were to fall in 2019 then

a. Import receipts would increase.
b. The Australian Dollar is likely to appreciate.
c. Exports would become more price elastic.
d. The Australian Dollar will depreciate.

4. If the Australian economy were to grow at a faster rate than the rest of the world then
a. Capital outflow will increase and depreciate the AUD.
b. Imports will decrease due to an appreciation in the AUD.
c. Capital inflow will increase and appreciate the AUD.
d. The trade balance is likely to stay the same due to exchange rate movements.

5. The short-term effect on a floating exchange rate if the terms of trade improves is
a. An appreciation of the AUD
b. A depreciation of the AUD
c. Volatile movements in the AUD
d. No change to the AUD

6. A floating exchange rate reduces swings in the balance of payments because if the current account
deficit is rising,
a. An AUD depreciation will increase the trade balance and lower the CAD
b. An AUD appreciation will decrease the trade balance and lower the FAS
c. An AUD depreciation will decrease the trade balance and lower the CAD
d. An AUD appreciation will increase the trade balance and lower the CAD
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 PART B – DATA INTERPRETATION AND SHORT ANSWER

Question 7

Nine News | James Hall | 8 Feb 2019

The Australian dollar is on track for its worst one-day fall in nearly two years following Reserve Bank boss Philip Lowe’s

comments a rate cut was likely with growing concerns over the local economy.

The Aussie dollar fell 1.35 US cents in the 24 hours between midday yesterday and today in response to the RBA governor’s

admission the economy may be weaker than expected.

It was buying 71.03 US cents at noon and economists say it will crash well below 70 US cents if the rate is cut, with one expecting

a fall as low as 65 US cents.

The central bank on Monday kept the rate at a record low of 1.5 per cent for 30 consecutive months.

a) Using the data, explain the relationship between interest rates and the exchange rate. (3
marks)

Marks
Appropriate reference to data 1
Explanation of the relationship between interest rates and the exchange 2
rate
Answers could include:
 There is a positive relationship between interest rates and
exchange rates, as supported by the statement in the article
about the Australian Dollar,
 “It was buying 71.03 US cents at noon and economists say it
will crash well below 70 US cents if the rate is cut”
 The relationship is positive because as interest rates fall, the
return on investment is lower for foreign investors, so the level
of foreign investment in Australia will fall and therefore
foreigners will demand less Australian Dollars, causing the AUD
to depreciate.

b) Explain the recent trends in the movements of the Australian Dollar. (8 marks)

Marks
Explanation of trends in movements in the AUD over the last 10 years 1-4
Explanation of trends in movements in the AUD over the last 10 years 5-8
using supporting evidence
Answers could include:
 The Australian Dollar (AUD) was strong and appreciating in the
lead up to 2009 due to the mining boom.
 Australia’s growing economy, beneficial interest rate differential
and large amount of capital inflow from China caused a
persistent increase in demand for the Australian Dollar, causing
the AUD to appreciate to $1AUD/$0.96USD.
 The Global Financial Crisis then caused a large, albeit
temporary, depreciation in the AUD due to fears over world
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 economic wellbeing from the external shock.
 The AUD depreciated to $1AUD/$0.65USD in 2009 due to the
GFC.
 The Australian Dollar recovered after the initial GFC shock and
peaked at $1AUD/$1.10USD in 2011 before the decline of the
mining boom in 2012.
 Since 2011, the Australian Dollar has gradually depreciated due
to slowing growth in Australia and China – a major trading
partner and investor in Australian markets.
 Commodity price falls and unfavourable interest rate
differentials with the US since 2011 have caused the AUD to
depreciate.
 The Australian Dollar is worth just over $0.70USD as of
February 2019.

Question 8

a) What is $10USD worth in Australian Dollars, as at 12 February 2019? (2 marks)

Marks
Conversion of exchange rate 1
Correct calculation of exchange to AUD 1

$1AUD/$0.710467USD Converted = $1USD/$$1.407525AUD

$10USD = 10 x 1.407525 AUD

= $14.08AUD

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b) Illustrate and explain the effect on the Australian dollar and Singapore Dollar if an Australian business
was to buy a large quantity of imports from Singapore. (4 marks)

Diagram space:
Australian Dollar Singapore Dollar
Price of
Price of $1 SGD
$1 AUD Supply Supply
in AUD
in SGD Supply2

P1

$0.96 $1.04
P1
Demand2

Demand Demand

Qe Q1 Quantity Qe Q1 Quantity

Marks
Correctly drawn and labelled diagram 2
Explanation of international trade effects on AUD and SGD 2
 Importing goods from Singapore will depreciate the Australian
Dollar because the Australian purchaser will supply Australian
dollars to purchase Singapore Dollars, increasing supply and
decreasing the value of the dollar
 The Singapore Dollar will appreciate in value because there will be
increased demand for the dollar to purchase the goods.

c) Explain two possible causes and two effects of an exchange rate depreciation. (8 marks)

Marks
Outlines two causes and effects of an exchange rate depreciation 1-4
Explains two causes and effects of an exchange rate depreciation 5-8
Answers could include:

An explanation of any two of the following:

Causes
• Decreased exports
• Decreased income credits
• Decreased capital inflow
• Lower terms of trade
• Lower IR differential
• Lower relative inflation
• Worsened international competitiveness
• Increased imports
• Increased income debits
• Increased capital outflow

An explanation of any two of the following:

Effects
• Decreased prices of exports  more competitive
• Increased prices of imports  more demand for domestic goods
• Net exports will increase  decreased CAD
 • AD increases
• Inflation rises from higher import prices

d) Justify which exchange rate is a better indication of the value of the Australian Dollar, the AUD/CNY
or Australian TWI. (4 marks)

Marks
Argument – TWI is a better indication of the value of the AUD 1
Justification 3
Answers could include:
 The TWI is a better indication of the value of the Australian Dollar
than the AUD/CNY
 The TWI is a better indicator because it compares the Australian
Dollar to all of Australia’s main trading partners.
 Although China is a trading partner of Australia, the TWI weights all
major trading partners according to the percentage of Australia’s
international trade each country comprises.
 The real movements in demand and supply of the AUD will be
determined by all Australian trading partners

END OF TEST