Foreign Exchange Rates: five questions to try now
Real past-paper questions, the answer key from the mark scheme, and the explanation that goes with it. No account needed to answer them.
Question 1
In October 2015, one UK pound could be exchanged for 100 Indian rupees. By October 2016, one UK pound could be exchanged for 80 Indian rupees. What would be a short-term consequence of this change?
Answer: D.
The correct answer is D: UK manufacturers would find it easier to export to India.
Read the movement carefully. One pound bought 100 rupees in 2015 and only 80 rupees in 2016, so the pound now buys fewer rupees. The pound has depreciated against the rupee (equivalently, the rupee has appreciated against the pound).
A weaker pound makes UK goods cheaper for Indian buyers: a good priced at £100 cost an Indian customer 10,000 rupees before and only 8,000 rupees afterwards. Cheaper in rupee terms means Indian demand for UK exports rises, so UK manufacturers find exporting easier.
Why the other options are wrong:
Read the movement carefully. One pound bought 100 rupees in 2015 and only 80 rupees in 2016, so the pound now buys fewer rupees. The pound has depreciated against the rupee (equivalently, the rupee has appreciated against the pound).
A weaker pound makes UK goods cheaper for Indian buyers: a good priced at £100 cost an Indian customer 10,000 rupees before and only 8,000 rupees afterwards. Cheaper in rupee terms means Indian demand for UK exports rises, so UK manufacturers find exporting easier.
Why the other options are wrong:
- B says Indian manufacturers would earn higher profits from exports to the UK. The reverse: Indian goods now cost more in pounds, so they become less competitive in the UK market and Indian exporters lose out.
- C says inflationary pressure in the UK would reduce. A weaker pound makes imports from India dearer in sterling, which adds to UK inflation.
- A says economic growth in India would increase. India's exporters are losing competitiveness in the UK market, so if anything the effect on Indian growth is negative.
Question 2
In 2015, China was the world’s biggest importer of oil. In August 2015, China devalued its
currency.
What is likely to have happened?
Answer: D.
The correct answer is D: the price of China's imports rose and world oil prices fell as China's demand decreased.
Two steps, taken in order.
China's import prices rose. Devaluation means the yuan buys less foreign currency, so imported goods, oil above all, cost more in yuan. The world dollar price has not changed; what has changed is how many yuan are needed to buy those dollars.
World oil prices fell. China was the world's biggest oil importer, so its purchases are a large share of global demand. Facing dearer oil in yuan, Chinese buyers reduced the quantity they bought. A fall in demand of that size shifts world demand for oil left, and with supply unchanged the world price falls.
Why the other options are wrong:
Two steps, taken in order.
China's import prices rose. Devaluation means the yuan buys less foreign currency, so imported goods, oil above all, cost more in yuan. The world dollar price has not changed; what has changed is how many yuan are needed to buy those dollars.
World oil prices fell. China was the world's biggest oil importer, so its purchases are a large share of global demand. Facing dearer oil in yuan, Chinese buyers reduced the quantity they bought. A fall in demand of that size shifts world demand for oil left, and with supply unchanged the world price falls.
Why the other options are wrong:
- A has China's export prices falling, which is true of a devaluation, but then says world oil prices rose while China's demand decreased, demand falling should lower the price, so the option is internally inconsistent.
- B has China's export prices rising, which reverses the effect of a devaluation.
- C has China's import prices falling, again reversing the effect, and has Chinese demand increasing when dearer oil should reduce it.
Question 3
What is most likely to result from a reduction in the value of a country’s currency if there are no other changes in the economy?
Answer: C.
The correct answer is C: import prices will rise.
A reduction in the value of the currency is a depreciation, so each unit of domestic currency buys less foreign currency. The same foreign good therefore costs more in domestic currency, and import prices rise. This is the most certain consequence of a weaker currency, and it is why depreciation tends to be inflationary in an economy that relies on imported goods and raw materials.
Why the other options are wrong:
A reduction in the value of the currency is a depreciation, so each unit of domestic currency buys less foreign currency. The same foreign good therefore costs more in domestic currency, and import prices rise. This is the most certain consequence of a weaker currency, and it is why depreciation tends to be inflationary in an economy that relies on imported goods and raw materials.
Why the other options are wrong:
- B, export prices rising, is the wrong direction. Depreciation makes exports cheaper in foreign currency, which is what improves competitiveness.
- A, a trade in goods surplus falling, reverses the expected effect. Cheaper exports and dearer imports should improve the trade balance, so a surplus would grow rather than shrink. (In the short run the balance can worsen if demand is inelastic, the J-curve, but that is not the likeliest outcome the question is after.)
- D, the inflation rate falling, is also reversed. Dearer imported goods and raw materials feed straight into the price level, so depreciation raises inflation.
Question 4
A US car dealer agrees an import price of US$25 000 for a Japanese car at the current rate of
exchange.
The US dollar then strengthens by 10% against the Japanese yen. What will be the new import price paid for the Japanese car?
Answer: B.
The correct answer is B: US$22,500.
The car's price was agreed at $25,000 at the original exchange rate. The dollar then strengthens by 10% against the yen, meaning each dollar now buys 10% more yen. The Japanese seller wants the same amount of yen, and the dealer can now obtain that yen with 10% fewer dollars.
So the dollar cost falls by 10%: $25,000 × 0.90 = $22,500.
Why the other options are wrong:
The car's price was agreed at $25,000 at the original exchange rate. The dollar then strengthens by 10% against the yen, meaning each dollar now buys 10% more yen. The Japanese seller wants the same amount of yen, and the dealer can now obtain that yen with 10% fewer dollars.
So the dollar cost falls by 10%: $25,000 × 0.90 = $22,500.
Why the other options are wrong:
- D, $27,500, adds 10% instead of subtracting it. This is the commonest error, and it comes from assuming that a "stronger" dollar must mean paying more. A stronger currency makes imports cheaper, not dearer.
- C, $25,000, assumes the exchange rate change has no effect. But the price was fixed in yen terms, so the dollar amount must move when the rate moves.
- A, $20,000, is a 20% reduction, double the change stated.
Question 5
In 2015, China was the world’s largest exporter of manufactured goods and a major importer of oil and minerals. China devalued the yuan (renminbi) by 2%. According to economic theory, what would have been a consequence of this devaluation?
Answer: B.
The correct answer is B: China reduced its demand for oil and minerals.
Devaluing the yuan means it buys less foreign currency. Since oil and minerals are priced in world markets and paid for in foreign currency, they became more expensive in yuan terms for Chinese buyers. Facing dearer imported inputs, Chinese firms cut back on the quantity they purchased, so demand for oil and minerals fell.
Why the other options are wrong:
Devaluing the yuan means it buys less foreign currency. Since oil and minerals are priced in world markets and paid for in foreign currency, they became more expensive in yuan terms for Chinese buyers. Facing dearer imported inputs, Chinese firms cut back on the quantity they purchased, so demand for oil and minerals fell.
Why the other options are wrong:
- A says China paid less in foreign currencies for imports. The world price in dollars is unchanged by a Chinese devaluation; what changes is how many yuan are needed to buy those dollars. So China pays more in yuan, and the same in foreign currency per unit.
- C says China's exports became less competitive. Devaluation makes exports cheaper in foreign currency, so they become more competitive; that is the usual purpose of devaluing.
- D says China's trading partners improved their balance of trade with China. Their goods become dearer in yuan while Chinese goods become cheaper in their currencies, so partners export less to China and import more from it, their balance with China worsens.
What this practice covers
These questions are drawn from past Cambridge IGCSE papers and filtered to foreign exchange rates. You answer, you find out immediately whether you were right, and you get the reasoning for the correct option and for each distractor. Wrong answers go to a mistakes locker so you can come back to exactly those.
Practice is free. You need an account only so your progress and your mistakes are still there next time.
What examiners see students get wrong here
These are the errors that cost marks on foreign exchange rates, taken from our own topic notes. Read them before you practise and you will recognise the traps in the questions.
- Using devaluation for a market movement; that is depreciation.
- Getting SPICED backwards.
- Saying a depreciation is simply good, ignoring imported inflation.
- Forgetting that a depreciation raises the cost of imported raw materials for domestic firms.
- Ignoring elasticity when judging the effect on the current account.
- Confusing demand for and supply of the currency. Remember imports supply the domestic currency.
Revise it first
If any of the above is unfamiliar, work through the notes before practising: Foreign Exchange Rates revision notes.